Investors Are Scared, With Good Reason

Not looking up yet.

It's always been easier to justify what the market did today than to predict what it will do tomorrow. So after the Standard & Poor's 500 Index saw its steepest intraday fall since 2011, there were explanations aplenty: Everything from Germany's fear of inflation to anxiety over Ebola was invoked.

The truth is simpler and more mundane: Investors are easily spooked at the moment, with good reason.

The global economic expansion ought to be gathering momentum. The U.S. has led the way back with a recovery that's been slow and halting -- but a recovery nonetheless. One would expect growing confidence in the U.S. to fuel demand at home and, by drawing in imports, help Europe and other regions get their own economies up to speed.

This virtuous circle isn't yet working. Crucially, the once-indomitable U.S. consumer still isn't celebrating. A surprising drop in U.S. retail sales in September (new iPhones notwithstanding) was the immediate trigger for alarm. Disappointing new figures for U.S. manufacturing output and producer prices underlined the point.

These measures are volatile by nature and in other circumstances might have been dismissed. And if investors had been in a better mood, the recent fall in the price of oil, cited this week as further cause for concern, might have been greeted as good news -- which it is, actually. Cheap energy raises real incomes and gives consumers more purchasing power. Other things being equal, it also lowers inflation, which gives central banks scope to extend their unorthodox efforts to support demand.

Sadly, context is everything. With quantitative easing in the U.S. drawing to a close, investors are nervous about the timing of the Federal Reserve's next move on interest rates. That puts the deflationary influence of oil prices in a more threatening light.

QuickTake The Fed's Taper

Worse, as the U.S. economy takes one step forward, the euro area is taking two strides back. In August, Germany's industrial output saw its biggest drop in five years. The euro zone is flirting with outright deflation -- and, at this inopportune moment, European Central Bank President Mario Draghi has lost his knack for reassuring investors with words as opposed to deeds. Even now, the ECB has no plan to start Fed-style QE.

It needs to get such a plan, and fast. Even without that, in the U.S. and in the global economy, there's no great risk of recession -- but the expansion could and should be stronger. The Fed can help by emphasizing that monetary policy will be tightened only when inflation is rising above its target rate, and not before. Where feasible, governments can spend more, too. Meanwhile, until this long-delayed recovery finds its feet, investors can expect more sleepless nights.

--Editors: Clive Crook, Michael Newman.

To contact the editor on this story:
David Shipley at davidshipley@bloomberg.net