One of the consensus talking points among optimists recently has been that the ugliness in the U.S. stock market does not jibe with the outlook for the overall economy, which may not be beautiful but is also not so hideous that you should be afraid to take it home to meet mom.
But what if the chickens and eggs are all mixed up here? In other words, what if instead of an ugly economy sinking the stock market, the stock market turns so ugly that it sinks the economy? It's a possibility that is being considered by the likes of JPMorgan Chase's Dubravko Lakos-Bujas, who on Tuesday became the most bearish strategist on Wall Street and (probably) made many nostalgic for his perennial optimist predecessor Tom Lee.
The problem relates to psychology, an area that may be an even trickier than quantitative finance. According to Lakos-Bujas:
There is increasing risk that elevated volatility starts incurring enough technical damage to market psychology and spills over, negatively impacting investor, consumer and business sentiment, resulting in a lack of risk taking, and eventually creating a negative feedback loop into the real economy.
That feedback loop is already squealing loudly on Wall Street, where everyone dresses too well to be considered part of the "real economy" but where the headlines describing the negative effects of financial-market volatility have been piling up. Initial public offerings have ground to a halt. Corporate debt issuance is off to the slowest January. As a result of these and a hodge-podge of other reasons, bank stocks are in a bear market.
It doesn't appear to have reached Main Street yet. Richard Fairbank, chief executive officer of Capital One Financial Corp., told analysts that most indicators of the "quote, unquote, real economy" in the U.S. continue to look pretty strong. "Obviously, the economy is something of a wild card, and if the turmoil we're seeing in financial markets spills over into the real economy, we would expect that to show up in our credit metrics eventually," he said. "But we are not seeing any indications of that now."
Sorting out the effects is easier for some companies than others. At State Street, management estimates that a 10 percent decline in global equity markets reduces revenue by about 2 percent. At Apple, financial-market volatility contributed to Tim Cook making a wider-than-normal revenue forecast for the current quarter, when sales are forecast to drop for the first time since 2003.
The so-called wealth effect of trillions of dollars of vaporized equity market value doesn't seem to have economists too worried just yet, judging by a round-up of opinions from Bloomberg's Simon Kennedy. Among the reasons: the strength in the jobs and housing markets are enough to compensate for lost wealth in the stock market.
Somewhere stuck in the middle of the feedback loop is the Federal Reserve, which on Tuesday disappointed equity investors by not acknowledging the risks more strongly: "The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook" is all policy makers said.
The problem may be, as Marketfield Asset Management CEO Michael Shaoul put it: "The lag between financial market weakness and economic damage can be considerable."
In other words, Wall Street may feel as if it's a long way from Main Street, but the two could intersect eventually.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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