Market Analysis

Ceilings and Seesaws

Even if Congress passes a debt ceiling extension, don’t expect markets to sound the “all clear.”

The US debt ceiling stalemate thawed somewhat Sunday, as President Obama and congressional leaders reached a preliminary agreement to raise it. As of this writing the extension isn’t yet a done deal, as it needs to pass through Congress, but as we’ve written, economic and fiscal disaster seems unlikely to strike whether or not a deal is inked by midnight August 2nd.

Given how volatile markets were as the standoff escalated, it’s easy to assume a deal would clear the way for stocks to rise from here. But it’s not so simple in practice—no single factor ever dictates market movement, though near term it can contribute to volatility. Though the debt ceiling debate may be foremost in US headlines, it’s not all stocks are contending with. They’re also fighting sentiment headwinds on factors like the PIIGS, slowing growth fears and a few municipal bankruptcies.

But are these enough to materially drag down stocks in 2011? Q2’s 1.3% US GDP growth isn’t fast, albeit a reacceleration from Q1’s revised 0.4%—not a continued slowdown. Not the fastest two quarters together, but not an automatic sign of continued slowness—economies frequently slow only to speed up again. Still, Monday’s ISM manufacturing report prompted renewed jitters over retrenchment, as the unexpected slowdown in manufacturing growth seemed to point to slowing demand. But monthly data fluctuations—good or bad—aren’t terribly meaningful. Here’s a more powerful takeaway: July was the 24thstraight month of US manufacturing growth and the reading was still expansionary. In our view, some slowness—whether in GDP or manufacturing or other metrics—is normal growth rate volatility.

As for PIIGS, it’s no secret Europe continues to face ongoing fiscal uncertainty. But Monday’s news—higher Spanish and Italian yields, reports that Italy is the world’s leading credit default swap target and the possibility of Cyprus tapping the EFSF—doesn’t change the fact officials seem bound and determined to sort things out. While the endgame isn’t clear today, there’s enough of a backstop for the most troubled nations through 2013.

And regarding those muni bankruptcies, though developments in Rhode Island and Alabama are attention-grabbing, the level we’re seeing overall isn’t unusual—and defaults are down from last year while muni prices are overall up. We’ll likely see more muni defaults this year, but nothing approaching the very dire predictions commonly heard as 2010 closed.

Though poor sentiment tied to these issues can hang on stocks in the nearer term, remember: Nothing occurs in a vacuum, and today’s negatives must be weighed against extant positives. Like corporate earnings, which showed continued strength in Q2. Of the 327 companies reporting through July 30, 73% beat expectations and by a healthy margin, with earnings growing broadly across most sectors. Even Financials would be showing growth had not one major US bank taken a one-time, non-recurring charge. On top of this, global economic growth continues and is widely expected to remain strong—consensus European growth expectations have inched up this year—and global trade is robust.

In our view, today’s positives outweigh the negatives, though ongoing sour sentiment wouldn’t surprise us one whit. Moreover, a market-wide “all clear” sigh of relief when this debt deal is done is unlikely. More probable is continued back and forth, seesawing volatility for the balance of the year. Stocks can still be positive on that, but our expectation remains that healthy resumption of the bull market probably won’t kick into gear till 2012.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.