March 16, 2011

Following Tuesday’s volatile swings, U.S. stocks will likely respond today in a more measured and deliberate fashion to the situation in Japan. Despite today’s soft U.S. Housing Starts numbers, I am looking for a more stable trading session today.  

While the fate of the nuclear reactors still remains uncertain, it is becoming increasingly clear that the severe human tragedy in Japan is unlikely to have material negative impact on the U.S. economic recovery. In fact, barring a nuclear meltdown — which remains a material unknowable risk factor at this stage — the Japanese earthquake/Tsunami will be no more than a minor hiccup for the global economic recovery. 

We have to keep the entire macro-economic backdrop in mind when looking at the behavior of stocks since around mid-February. Don’t lose sight of the fact that the stock market had become jittery ahead of the Japan story on account of developments in the Middle East. Runaway oil prices, which prior to Japan had been moving well north of $100 a barrel, were feared to put a serious dent in the U.S. recovery. 

The stock market had enjoyed an impressive run of around 25% from around September last year to the middle of last month. This bull run reflected the realization that the U.S. economy had resumed a sustainable growth trajectory, which was confirmed by all sorts of economic reports. Even the long laggard labor market appeared to be on a turnaround, though the trend needs to be confirmed over the coming months to form part of the consensus view.

This has been the economic backdrop when first the turmoil in the Middle East and then disaster in Japan took center stage. Of these two, oil is a more potent threat, which has been blunted somewhat by the Japanese disaster. But oil’s drop is most likely temporary, as the situation in the Middle East remains very unstable. 

On the whole, though, the U.S. recovery is stable enough to withstand $100 oil. But the continuing volatility in this key commodity will provide the stock market with an unsettling backdrop. 

Sheraz Mian
Director of Research
 
Zacks Investment Research