Politics and China Trump the Economy
But next week's GDP could provide a psychological lift.
While this week's data were mixed, I remain bullish on the recovery. I believe it is more important to focus on big-picture, long-term trends and be a bit cautious in interpreting some of the short-term data. I (along with the rest of the economist community) think that next week's GDP report will show a fourth-quarter growth rate of over 5% compared to 2.2% in the third quarter and a decline of 0.7% in the second quarter. Remember that real GDP is the broadest measure of economic activity. Although a large improvement is widely anticipated, I believe a headline number that big (along with the inevitable commentary, "Best growth rate since 2003!") splashed on the front of every newspaper across the country could provide a psychological lift.
China Tightens Again
Although this week's economic data weren't the best, I don't think that was why equity markets had such a bad week. The Dow was down 3.7% following a fractional decline last week. More important was news out of China that pointed to continued tightening as the government tries to get its arms around some pretty aggressive lending policies. This in turn could lead to slower growth in China, which has been a key engine in the worldwide economic recovery. As a big user of many commodities, slowing growth in China could lead to lower commodity prices as well. While the market was getting jittery, Dan Su, our analyst covering Chinese data, believes that it was a positive sign that China was trying to put the stopper back in the bottle before the expansion and inflation level in China got out of control.
Financial Reform Resurfaces as an Issue
On top of the China news, Thursday the Obama administration proposed limits on both the size and trading activities of banks. Besides affecting bank stocks directly (financials are still an important part of the general market indexes), there was also fear that the regulations might make it tougher to trade financial instruments and raise the cost of capital. Higher costs of capital weigh directly on the valuation of securities.