When the U.S. market sneezes, the saying goes, the rest of the world catches a cold. But the relationship can work the other way, too. These days, many investors look abroad for signals about how the U.S. stock market will perform.
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Is it any wonder? Foreign market moves and news from Europe, China and other key economies - whether good or bad - can quickly spill over to Wall Street. Consider, for instance, the effect the Greek crisis had on the U.S. market in 2011. Standard & Poor's 500-stock index tumbled 18.6% during that year's market correction - largely over concerns about a Greek default. And these jitters about the slowdown in China's once-torrid economic growth can send the U.S. stock market tumbling. "The international market matters very much to the U.S. [now], more than ever. The capital market has been globally linked, and the U.S. can't move forward alone," says Jim Russell, a stock-market strategist with U.S. Bank.
That's why many forecasters and investors go beyond checking domestic company earnings or U.S. job reports. To get a good read on the U.S. market, they also observe the economic conditions of foreign countries, the strength of the euro against the dollar, and the health of China's manufacturing industry, among other things. Read on for more details on foreign indicators and what they mean for the U.S. market.
General economic indicators
Mark Luschini, a strategist at Janney Montgomery Scott, a brokerage firm based in Philadelphia, says he watches the same key economic and business measures for Germany, France, Spain and China as he does for the U.S. They include gross domestic product and the purchasing managers index (a measure of the health of the manufacturing and services industry). Over the past half year, Russell says, Europe has been stabilizing, which has been good news for U.S. companies, especially multinational firms that export their goods to the region. Luschini says he also keeps an eye on investor sentiment overseas - such as the German ZEW Indicator of Economic Sentiment, as it is officially known - and consumer confidence. Finally, major market indexes, such as China's Shanghai Composite and Japan's Nikkei, are important benchmarks, too. Strong overnight gains in Asia can boost investor confidence when the U.S. market opens a few hours later.
Dirk Hofschire, a senior vice-president of Fidelity's investment-management arm, says he likes to focus on indicators such as employment and housing, in addition to GDP, to get a comprehensive picture of the soundness of a foreign nation's economy. "If other countries are doing well, it's good news for U.S. companies," Hofschire says.
If the euro strengthens against the dollar, it means that European customers get a break when they buy stuff made in the U.S. That's a plus for U.S. companies that export to Europe. "The first thing I do when I get up in the morning," Russell says, "is to check out how the euro is trading."
European government debt yields
Russell checks yields on ten-year German, Spanish, Greek and Italian government bonds. If their bond yields are rising too much or are way higher than U.S. yields, it means the market is losing confidence in a country's ability to pay down its debts and investors are pulling their capital away.
If the yield on a ten-year government bond surpasses 6%, Luschini says, that is a warning. Seeking to restore stability in the debt markets and boost investor confidence, the European Central Bank stepped in to buy Spanish and Italian debts in August 2011 just after yields on their ten-year bonds breached the 6% level.
Today's yields indicate that the European economy is in better shape. That's a good sign for the U.S. market, too. As of August 20, ten-year Spanish and Italian government bonds yielded 4.47% and 4.31%, respectively (compared with more than 6% for Spain and more than 5% for Italy a year ago). The ten-year German government bond now yields 1.84%.
Yields on shorter-term government bonds - say, those maturing in two years - are also important indicators, Luschini says. If yields on short-term paper are spiking, it indicates that the issuing government may have trouble finding buyers when the bonds mature and it needs to sell new debt.
If you're looking overseas to get a read on the U.S. market, it's hard to ignore China. China is the world's second-largest economy and, until recently, the world's growth engine. Russell turns to China's purchasing managers index because he says it is crucial in gauging the health of the manufacturing and services industry.
However, Luschini says there is a potential problem if investors look only at the official data. "China's statistics are less transparent," Luschini says, so you have to compare the government data with that of other sources. In July, the official manufacturing PMI climbed to 50.3, but the HSBC/Markit PMI was 47.7. (A number higher than 50 indicates an economy is expanding; a number under 50 indicates it is contracting.) The official PMI focuses more on big corporations, while the HSBC PMI surveys more small and midsize businesses. "You just have to reconcile or believe one of them and see which one is a better indication," says Luschini. Another worthwhile indicator of economic activity in China is electricity consumption. When power consumption (a figure issued by the country's National Energy Administration) is on the rise, it's a sign that businesses are humming along.
Government and central bank policies
Foreign countries' policies can be an important information source. Russell suggests paying attention to the trade and monetary policies of foreign nations, especially those of China and Japan, both of which have fairly new leaders. Also, European Central Bank decisions can be important indicators of whether economic growth in that region is accelerating or slowing down. "You need to get as much exposure and information as you can about all these geographies," Russell says.