One Of These Stock Markets Is Doing Its Own Thing

by: Eric Parnell, CFA

"One of these things is not like the others

One of these things just doesn't belong"

--Sesame Street

Can you tell me which thing is not like the others by the time I finish this article?

The U.S. stock market remains remarkably resilient in the face of extreme stress. This includes domestic economic data that deteriorates by the day, an international growth outlook that is even worse and a crisis threat in Europe that continues to build. Thursday was just another trading day filled with more evidence of weakness on all of the above fronts, yet U.S. stocks as measured by the S&P 500 (SPY) managed to rise for the fourth session out of the last five. And from a broader perspective, U.S. stocks continue to hover at levels not far below their post crisis highs.

The primary driver of sustained stock market rallies since the stock market bottom several years ago has been monetary stimulus. When the U.S. Federal Reserve (the Fed) or the European Central Bank (ECB) has been engaged in balance sheet expanding monetary stimulus (QE in the U.S., LTRO in Europe), the stock market has risen almost without interruption. But as soon as the money printing machines are turned off, the U.S. stock market has faltered.

This phenomenon helps explain why U.S. stocks are hanging in there despite the widespread downside risks, as investors continue to hope that the next round of QE from the Fed is coming right around the corner. But what happens if the Fed does not deliver QE3? Worse yet, what if the Fed delivers QE3 and the market doesn't respond this time around?

To help answer this question, it is worthwhile to examine how the rest of the world's stock markets are holding up. A quick tour of the world reveals that U.S. stocks are clearly doing their own thing. And this is not good for the U.S. stock market outlook.

We begin with a collective look at developed non-U.S. stocks as measured by the MSCI EAFE Index (EFA). While U.S. stocks managed to set new post crisis highs in 2012 and are still battling to break out above 2011 peaks, developed non-U.S. stocks remain locked in a sharp downtrend at levels that are well below 2011 peaks.

One could reasonably counter, however, that this weakness could be attributable to the ongoing crisis in Europe. And certainly markets in the Euro Zone (EZU) have struggled. But they are not alone.

A similarly weakening story is unfolding in developed Asia. Japanese stocks (EWJ) are well below their early 2011 highs, and other developed markets throughout the Pacific region (EPP) including Australia (EWA), Hong Kong (EWH) and Singapore (EWS) all remain off the mark.

But what about Emerging Markets. After all, the developing world is likely to be a primary driver of growth in the coming century. Unfortunately, the story here is just as bad if not worse.

Emerging Market stocks as measured by the MSCI Emerging Market Index (EEM) are off sharply from year ago levels and remains locked below a variety of technical resistance thresholds.

And the pain is broadly distributed when examining emerging markets at an individual country level. China (FXI) is reflecting the growth slowdown that has been underway for some time and South Korea (EWY) is showing the weakness that exists across the region. And the markets in Brazil (EWZ) have unraveled to the point that they are fighting to stay above levels last seen in mid 2009 not long after the crisis bottom.

So what does all of this worldwide stock weakness imply for the U.S. stock market in the months ahead?

First, this is not a case of the U.S. stock market being right and the rest of the world being wrong. To the contrary, the U.S. stock market looks wildly out of place given the difficult economic outlook.

Second, the U.S. economy is not decoupled from the rest of the world. Given the global integration that exists today, we're all in this together. So if the rest of the world is slowing, the impact will be felt profoundly in the U.S.

Lastly and perhaps most importantly, if investor hope is riding exclusively on another round of QE from the Fed, such a thesis is fraught with great risk. For what the rest of the world's stock markets are signaling is that if we do not see QE3 from the Fed in the near future, the U.S. stock market may soon be in for a very nasty slide lower as it finally faces up to the economic reality that the rest of the world is already recognizing. Time will tell.

One of these markets is doing its own thing. It is the U.S. stock market. But in this game, markets around the world will eventually fall in line together. And in this regard, the U.S. stock market looks rather uncomfortable in standing out all alone.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.