Will Overseas Volatility Hit U.S. Shores?

By: Clif Droke, Gold Strategies Review / GoldSeek.com

While the U.S. indices have been mostly upbeat, most of the action has been in Europe. 

Stocks across several European exchanges were hard hit last week as investors overseas panicked over a slate of negative news – the same news, ironically, that investors in the U.S. blithely ignored.  Adding to the dramatic reversal in sentiment, the European Commission reported on Friday an unexpected drop in household and business economic confidence.  Economists are also concerned about the threat of deflation since the euro zone inflation rate remains stubbornly below 1%.

To give you an idea of the damage suffered across European bourses in the last few days, France’s CAC40 stock index declined nearly 5% below its 6-month high from early June.  The following chart of the iShares MSCI France ETF (EWQ), a proxy for the France stock market, shows the extent of the damage.  Banks on the continent were also under pressure as they face the prospect of additional capital-raising stock sales, according to Michael Santoli of the Daily Ticker.

Britain’s FTSE stock market index was particularly hard hit by selling pressure recently.  The iShares MSCI United Kingdom ETF (EWU), a proxy for Britain, was some 6% below its year-to-date high from just two weeks ago.  The stock markets of Germany and Italy were also lower in trading last week.

In London, the Bank of England (BoE) recently identified rising house prices as a major threat to financial stability, imposing new “loan to value” limits on mortgage lenders.  This is part of an ongoing concern as two chief U.K. financial-policy makers warned earlier this month of a U.K. housing bubble.  BoE Governor Mark Carney called real estate “the greatest risk to the domestic economy.” 

Commenting on this, the Wall Street Journal wrote: “Britain’s concerns highlight a central challenge to policy makers in the era of low interest rates: how to prick bubbles early without sapping a tremulous recovery.”  The preemptive strategy for preventing the sort of real estate crash the U.S. suffered a few years ago isn’t without peril, however.  Putting the brakes on lending and trying to deflate bubbles can often backfire and create panic in the investment markets, thereby creating a self-fulfilling prophecy of deflation.  Such a scenario, if it unfolds, could easily put pressure on U.S. equities as investors temporarily exit risk assets and move into safe havens like gold and Treasuries.  It’s important to remember that increased volatility at home sometimes begins with market turbulence abroad.

This brings us back to the short-term technical considerations for the U.S. stock market.  As we look under the hood we find that most short-term technical indicators remain positive and are confirming the immediate-term uptrend.  The single most important factor of the market’s immediate-term (1-3 week) health is the fact that the SPX remains above its 15-day and 30-day moving averages on a closing basis.  Another important confirming indicator is the NYSE Advance-Decline (A-D) line, which as of this writing has closed at another new high.

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