Tuesday, May 25, 2010

Has the Recent Sharp Decline in Value in U.S. Financial Markets Indicated the Economy is in the Downside of a Double-dip Recovery?

Financial Times: The Double-Dip Threat
Financial Times: S&P Falls Most Since April 2009
Wall St. J.: Data Points: U.S. Markets
Yahoo Finance: U.S. Stocks Drop in First Correction of Bull Run
Bloomberg: Good Orders, Home Sales Probably Climbed: U.S. Economy Preview
Bloomberg: Fed's Dudley Sees Start of 'Significant' Growth in Employment

Currently, there are competing economic activities that point in opposite directions with respect to whether the U.S. economy is recovering. In the past four weeks, the U.S. financial markets have declined significantly. The Dow Industrials, Nasdaq Composite, and S&P 500 were down 4.02%, 5.02%, and 4.23% this past week, respectively. Moreover, over the past four weeks, they were down 9.02%, 11.90%, and 10.65%, respectively. Does this necessarily indicate that the U.S. economy is in a “double-dip” recovery (a double-dip recovery is one where there is a brief intermittent economic recovery and then a quick fall back into recession)? Not necessarily.

Observers have articulated a number of rational theories as to the causes of this decline. Some contend that investors’ risk appetites have decreased because of the events taking place around the world, such as the financial crisis in the Eurozone, the uncertain effect on markets of U.S. financial reform, worries of a slowdown in China, the German short-selling ban, and the geopolitical tensions from Thailand to the Korean Peninsula. Others note that there has been a 14-month stock market rally which, combined with this uncertainty, may have induced investors to sell stock and realize their profits. Still other observers believe that a 10% market correction is typical after a prolonged rally. Therefore, the sharp decline in the markets does not necessarily indicate a double-dip recovery.

U.S. economic data also indicates the U.S. economy is not declining—in fact, it is strengthening. Last week, although the new weekly jobless claims surprisingly increased by 25,000, there was a decrease in the number of the long-term unemployed by 40,000. Additionally, there was an increase in bookings for durable goods, sales of new and existing homes, and construction starts. This indicates consumers are spending more, which tends to indicate a strengthening economy. Further, U.S. exports have been rising.

Thus, even though there has been a significant decline in the financial markets over the past weeks, there are perfectly rational reasons for this decline rather than a declining economy. Indeed, economic data tends to point to an economic recovery.

1) Have the worldwide events, coupled with the 14 month stock market rally, affected your decision to sell your stocks and realize profits?
2) Regardless of the economic data, do you believe that the sharp decline in the financial markets indicates another recession or is this just a market correction?
3) What is the more significant news–the decrease in long-term unemployment or the increase in the weekly jobless claims?