Dollars and Sense: Europe starts quantitative easing, fears of a correction loom

Another volatile week. The markets were volatile again last week. After a five-year rally without a serious correction, sometimes news the markets think could throw a wet blanket on the fire causes a big drop. Then, the fire burns through the blanket anyway and the markets rise again. That cycle causes big drops and then—usually within a day or two—big gains again take us back to where we started.

Good news is bad news—again. This cycle began a week ago Friday, with a strong jobs report. The unemployment rate fell to 5.5 percent, and the number of new jobs significantly beat expectations. But the markets fell significantly because traders now think the Federal Reserve is going to raise interest rates, which could hurt the stock market. The rally we’ve been in since 2008 has been driven mostly by extremely low interest rates and an ever increasing money supply generated by the federal reserve’s quantitative easing program. Extremely low interest rates mean you can’t really make money by just putting your money in the bank. So, more of that money flowed into the stock market, searching for a rate of return. More money chasing shares drove prices up. That’s why a lot of conservative economists, in particular, would laugh when someone said inflation was near zero. Consumer price rises may have been near zero, but some economists say assets have been inflating for years.

Europe redux. The situation in Europe is adding fuel to the fire. Last week, the European Central Bank began its own quantitative easing program. A lot of analysts are expecting the same thing to happen in Europe as happened in the United States: Share prices will go up. So we now have a situation in which lots of people think U.S. shares are over-valued, interest rates are about to start rising, and European share prices are on their way up. While all of this may be true, not of it is certainly true. Europe may not respond to quantitative easing in the same way the U.S. markets did because the situation there is somewhat different. Case in point: The value of the euro, which just hit a 12-year low against the dollar, dipping to 1.08 euros per dollar.

Is a correction coming? Almost everyone agrees the U.S. markets will have at least a 10 percent correction at some point. And with the Dow near 18,000, a 10 percent correction is going to look pretty dramatic. But no one can say precisely when that will happen, another reason the markets are startling at their own shadows. Still, U.S. corporate earnings were strong last quarter, and they’ve been strong for three or four quarters in a row. So maybe U.S. stocks are not overvalued. Take retailers that reported last week: Foot Locker beat both earnings and revenue expectations. Staples reported earnings that topped estimates, though revenue missed forecasts, in part because a strong U.S. dollar took a toll on sales. Discount retailer Big Lots also beat earnings and came in line with revenue projections.

The week ahead. It’s going to be a slow week for government reports. Housing starts and industrial output reports come out this week. They’re not known for moving the markets that much. I would continue to keep an eye on Europe. But if it weren’t for all the volatility of the past few weeks, I would be inclined to say we’re in something of a quiet period. We’re still a few weeks away from getting first quarter earnings reports. Of course, I could have said the same thing about last week!

Listen to "Dollars and Sense" on The World and Everything in It.