Mounting fears over the potential impact here from economic weakness in Europe and China came to a head on Tuesday when the United States finally exposed a chink in its armor in the form of a weaker-than-anticipated retail sales figure for the month of December.
Although plummeting oil prices were expected to have a negative impact on the number, even with oil removed from the calculation it still amounted to a decrease of 0.3% versus the consensus estimate of an increase of 0.5% (the raw number, including oil, was a decline of 0.9%).
Compounding the decline in U.S retail sales was the near-simultaneous release of a report from the World Bank that lowered its estimate for global growth from 3.4% to 3.0%. This downward adjustment is mostly due to slower growth in China and a near standstill in the European economy.
The financial market's response was swift and severe; the stock market tanked, and commodity prices plunged. In short, so-called "risk assets" have quickly fallen out of favor while cash and government bonds seem to be the only asset classes immune from the threat of deflation (provided they are held in a currency that does not become devalued in the process).
Apparently one day of economic havoc was either too much or not enough for one participant depending on how you look at it. On Thursday the Swiss National Bank removed the cap on its national currency so that it was free to float in value against the Euro.
The immediate fallout from this action was felt by currency traders and hedge funds with short positions in the Swiss franc. However, an indirect consequence was a shift in relative values between the Swiss Franc and the U.S. Dollar, so anyone with a net short position in that pairing also lost money.
Of greater concern is continuing economic weakness in Europe, which will require intervention from the European Central Bank to reverse the tide of interest rates that recently teetered into negative territory. The International Monetary Fund confirmed what many wondered on Thursday when its Managing Director, Christine LaGarde, openly speculated that lower oil prices and the relative strength of the U.S. economy might not be enough to prevent the global economy from getting sucked into a deflationary spiral.
At this point it is apparent that the fight for global economic supremacy has turned into a one-horse race, with the United States being the only developed nation to appear immune from the malaise slowly enveloping the remainder of the "Group of 7" (Canada, France, Germany, Italy, Japan and the U.K.).
The U.S. needs its trading partners to remain healthy in order to avoid getting dragged into the quicksand with them, so expect to see an unprecedented level of cooperation among the G7 finance ministers. The economic battleground is shifting from interest rates to currency values, which is why the Swiss National Bank decided to bail out on the Euro now.
The concern is no longer how soon the Fed may begin to raise interest rates, or by how much, but rather how does the U.S. continue to grow GDP while allowing the dollar to weaken against the euro while the G7 economies are so weak? The logical answer is that it cannot, which explains the negative volatility in the market this week.
I learned a long time ago not to bet against the Fed, and I'm inclined to extrapolate that faith across the entire G7. Some of the countries that will end up on the short end of the stick, such as the oil-dependent economies of Russia, Venezuela and Nigeria, have already been identified. I don't know who all the others will be, but I'm confident the U.S. (and Canada) will not be among them.
As an investor, it is critical to recognize that the Q.E.-fueled growth in stock prices of the past three years is over. Just as the global economy is quickly evolving into the haves and have-nots, so too is the U.S. stock market evolving into a two-tiered market that rewards one company at the expense of another.
If you don't have a system for figuring out who those winners and losers are going to be, then you need to get one. I'd also recommend using stop-loss orders to protect your gains in the event of a major stock market correction. The world is not coming to an end, but it is about to get a bit messier for a while.
This article originally appeared in the Mind Over Markets column. Never miss an issue. Sign up to receive Mind Over Markets by email.
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