Is The Fear Of An Economic Meltdown Necessary?

Includes: CAT
by: Wall Street Wisdom

A steep fall in commodity prices led the stock market to its worst day this year on Monday, as worries about the global economy resurfaced.

After setting a string of record highs in recent days, the Dow fell 265.86, or 1.8 percent, to close at 14,599.20. The broader S&P 500 index fell 36.49 points, or 2.3 percent, to 1,552.36. Exchanges across Europe all posted losses as well. Caterpillar (NYSE:CAT), a maker of heavy equipment used by miners, led the index lower, falling 3 percent to $82.27.

It was the biggest drop for the stock market since Nov. 7 - Election Day - last year.

"A spring swoon for the stock market isn't surprising given the strong run we've been enjoying," said Jerry Webman, chief economist at Oppenheimer Funds, but he believes markets will recover when investors see that the economic weakness is only temporary. "Market fundamentals and the economy appear to be in generally better shape now than they were last year at this time," when the economy took a major nose dive, he said.

The trigger for the sell-off came from China, where the world's second-largest economy expanded 7.7 percent in the first three months of the year, well below forecasts of 8 percent or better. That news bashed copper, oil and other commodities. Shares of oil and mining companies fared the worst because China is a huge importer of their products.

The decline came after a pile of negative economic reports. In addition to the concerns about China, a separate report showed weak manufacturing in the Northeast, and a home builders' survey indicated housing activity isn't going to be strong, either, said Steven Ricchiuto, chief economist for Mizuho Securities.

"People are realizing that the global economy isn't as strong as they expected it to be," he said.

The pullback disrupted, at least for the moment, the phenomenal rally that has sent the Dow Jones industrial average (DJIA) up 13 percent and the Standard & Poor's 500 (INX) index up 11 percent in 2013. But the market's exceptional performance has fueled widespread speculation about an inevitable retreat.

Concerns that Cyprus and other troubled European countries may sell gold to raise cash have also weighed on prices for precious metals, said Dan Greenhaus, chief global strategist at the brokerage BTIG.

Frank Fantozzi, CEO of Planned Financial Services, a wealth management firm, says people had bought gold since the financial crisis on the belief that it was a safe place to keep money. But now that the metal has slid 20 percent this year, they're jumping out.

Cetin Ciner, a finance professor and expert in precious metal markets at the University of North Carolina, Wilmington, said gold had also offered a protection against rampant inflation when the economy recovered. That helped push gold prices as high at $1,900 in 2011, but the high inflation they worried about still hasn't hit.

Gold "was bound to collapse at some stage," Ciner said. "People were waiting and waiting for higher inflation, and they finally realized it's not happening."

In the market for U.S. government bonds, which traders often buy when they're concerned about the economy, the yield on the 10-year Treasury note retreated to 1.69 percent, its lowest level of the year. That's down from 1.72 percent late Friday.

What Does It All Mean?

Although there is certainly some alarm among investors, experts doubt that the drop in stock prices is a harbinger of another global recession. Deep government budget cuts have slowed the U.S. economy and kept Europe in recession. And China's economy is cooling. But economists still expect the U.S. economy - the world's biggest - to gain strength during the second half of the year.

Nearly four years after the Great Recession ended, the American economy has a stronger foundation. Rising home prices and near-record stock prices make consumers feel wealthier and more willing to spend. And although China's growth was below expectations, it was still a pace that would be considered strong anywhere else.

The broader outlook for stocks is not likely to be tremendously affected by the Monday's sell-off. In March, Ben Bernanke and the Federal Reserve announced to continue QE3 - the promulgated program that buys $85 billion worth of monthly bond purchases. With how much money is being pumped into the system, it has to go somewhere. Since 2008, the Federal Reserve has bought for than $2 Trillion in bonds.

Personally, I do not believe investors should fear in the slightest an economic meltdown in the near future. Ultimately, the sell-off in commodities appears to be an overreaction to recent events, and investors should not be worried of a global meltdown anytime soon. It is important to keep an eye on the events in China in subsequent months, but I would not be surprised if we see the various Indexes back to pre-Monday levels within a few days.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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