Like shell-shocked war veterans who instinctively duck when a car tire pops, investors show understandable signs of post-traumatic stress disorder after what the past few years have wrought. And that jitteriness was on full display last week as the markets lurched violently in reaction to major developments across the globe.But despite investors' paranoia, a closer look at events unfolding in key economies like that of the U.S., China and Europe suggests that -- after years of sudden and unusual measures to put out the flames brought on by the credit crisis -- something approaching "normal" is, in fact, setting in.
The Gears Are Starting to Move Again
A surprise move by the U.S. Federal Reserve to raise its discount rate (the interest rate the Fed charges to banks for emergency, short-term loans) to 0.75% from 0.5% was the latest event to send investors -- especially in Asia and Europe -- initially scrambling for cover. Since higher interest rates generally pose a headwind to stocks, and undue Fed tightening before a real recovery has set in is especially dangerous, it's easy to understand the fear traders harbored.
Yet the U.S. market swung around once it was more fully digested that the Fed had made clear it has no plans to slam the breaks on its ultra-accommodative monetary policy. Indeed, the Fed's nudge to push banks to tap their usual source of funding rather than using the Fed's emergency lending measures is a further indication that many parts of the capital markets that had seized up after the collapse of Lehman Brothers are now functioning again.
With businesses less reliant on leverage then before, "the market may be able to digest this first 'shot across the bow' very well for now after paying a short 'homage to rising rates,'" Ticonderoga Securities analyst John Stoltzfus wrote about the discount rate hike in a note to clients. "The normalization is on."
Nightmare, or Mere Bookkeeping?
A further illustration of investor anxiety surfaced when a Treasury Department report showed that Chinese holdings of U.S. Treasurys fell by a record amount in December. While the report was greeted with suspicions of a nightmare scenario unfolding -- many speculated that China, a key source for U.S. government financing, was at long last losing its appetite for U.S. debt -- it may have been nothing more than China doing some routine bookkeeping instead.
Rather than dumping Treasury, purchases by the Chinese may have shifted to custodians in London and Hong Kong, for example, which makes it harder to track data about who's holding what. Moreover, Chinese authorities seem to have simply let some of the country's short-term Treasury holdings expire, and they recycled the funds into longer-dated coupon debt, where Chinese holdings increased by $4.6 billion.
Combine that move with last week's announcement that sovereign wealth fund China Investment Corp was going to buy a $1.5 billion stake in U.S. private equity funds through transactions in the secondary market – where private equity investors can offload their existing positions -- and it's clear that China is signaling a longer-term orientation toward U.S. assets. In fact, these moves are a vote of confidence in the U.S. economy.
Even Europe Isn't All Bad News
Indeed, China scrambled for safety and piled into short-term U.S. Treasurys in the wake of Lehman Brothers just as many other investors did. Now, a rebalancing of its portfolio is a step toward normalization. Chinese holdings of short-dated Treasurys surged from $14 billion prior to Lehman's collapse to $210 billion by May of 2009 and are now back to about $70 billion.
At the same time, fears about Greece and other sovereign debtors in the Eurozone as the euro slides have hogged the spotlight and masked signs of progress in Europe. Benchmark indexes in the U.K., Germany and France all gained more than 4% last week, and first-quarter earnings by Western European companies have beat analysts' estimates by a sharp 15% so far, according to data compiled by Bloomberg.
The gains come amid surprising manufacturing strength. A purchasing managers' index report last week breezed by expectations to show that manufacturing activity picked up further steam from January, and the new-order index clocked in at a three-year high of 56.5, doubling from 28.2 a year ago.
Of course, major challenges remain for the global economy -- one of the biggest threats being a double-dip recession in Europe. And unemployment in the U.S. stubbornly hangs in at sky-high levels. But investors who look more closely beyond the skittish markets are likely to find a global economy that's creeping back toward normal again.
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