I thought this summary from Robert DiClemente at Citigroup was a very good description of where we stand now at the end of a tough week in the stock market (I have added the highlights):
- Renewed risk aversion and eroding liquidity in money and capital markets stemming from events in Europe pose new threats to financial stability necessary for continued U.S. economic recovery.
- Heading into this storm, financial conditions were vastly improved, including signs of a further thawing in tight bank credit.
- Solid private sector payroll gains in recent months reveal a key element of self-sustaining recovery and represent an important milestone for Fed policymakers. A traditional sequence of rising productivity, profits and job growth is poised to bolster overall income gains.
- Plummeting Treasury bond yields suggest that one possible channel of contagion from sovereign debt woes is not operative in the U.S. case and in fact may help buffer some of the drag from a rising dollar.
- Nonetheless, the deterioration in financial markets, if not arrested, would signal a return to subpar growth that could shelve indefinitely further unwinding of extraordinary monetary policy accommodation.
First, the economy is continuing to show signs of economic recovery. Today's jobs report of 290,000 new jobs is another data point confirming this trend.
Second, there is no doubt that the credit markets are spooked by what is going on in the euro block. I don't know what the solution is, but I suspect the end game will probably involve at least Greece dropping out of the euro block.
Finally, I think all of this is very deflationary. I think we will begin to see "beggar thy neighbor" policies adopted by governments desperate for job growth and tax revenue. The dollar will likely strengthen in this scenario, and could actually help our capital markets.
High quality stocks and bonds should continue to be favored.
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