Markets Brace for Fresh Bout of Turmoil

By MARK GONGLOFF

Markets are bracing for another rocky week as finance ministers around the world ready new defenses to keep the sovereign-debt crisis from spreading.

On Monday, European finance ministers expect to sign off on a €440 billion ($527 billion) loan package to act as protection against the debt crisis that began in Greece earlier this year and now imperils other countries. Separately, top finance officials from the Group of 20 major industrial and developing economies are nearing agreement on new rules to make sure that major banks keep enough money in reserve to insulate them against future crises.
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The precarious state of the world economy was underscored by a sudden crisis in Hungary, after politicians there said the country might be forced to default on its debt. Hungarian officials spent the weekend devising a fiscal plan after the country saw runs on both its currency and its debt Friday. Officials have backtracked on the default threats and pledged the country would cut spending instead.

Though most American investors still doubt the U.S. economy will sink into a double-dip recession, they increasingly fear that growth could slow without continued government support.

"We've been wondering how the European situation will affect us," says Guy LeBas, chief fixed-income strategist at Janney Capital Markets. "Now, in addition to that, we're wondering how the organic U.S. recovery is faring."

The Dow Jones Industrial Average slid 3.2% Friday to its lowest level since early February. Investors were jolted by a disappointing employment report in the U.S. and by the Hungary news, which weakened the euro to below $1.20 for the first time in more than four years.

Rattled investors dialed back exposure to stocks, corporate bonds, commodities and currencies such as the euro in favor of relatively safe Treasury bonds and the dollar. Treasury yields, which drop when investors gobble up U.S. debt, are nearly back to their lowest levels of the year.

"We probably will see a volatile week" this week, said Nick Kalivas, vice president of financial research at MF Global, with the market's attention focused not only on Hungary but also a slew of Chinese economic data. China is a particular area of concern for the market, with worries about a slowdown there helping drive global commodity prices lower in recent weeks.

Friday's U.S. employment report was a reminder of what Europe and the U.S. have in common: the powerful influence of governments on economic growth lately. The effects of U.S. fiscal stimulus will fade later this year, and with the U.S. debt surging, further measures to jump-start the economy likely face stiff opposition.

Though the economy continues to benefit from low interest rates, the Federal Reserve can't cut rates much further because they're already near zero. The economy will eventually have to generate its own momentum, and investors are questioning its ability to do that.

"A key question is how much of this growth we have seen is due to government stimulus?" says Jason Brady, portfolio manager at Thornburg Investment Management in Santa Fe, N.M. "This jobs number is a bit of a microcosm of that."

Still, one month doesn't make a trend. Many economists expect the labor market to keep recovering, however hesitantly, the rest of the year. Most still doubt there is much of a chance of a double-dip recession later this year. And the employment report didn't change the minds of some stalwart market optimists.

Economists at Barclays Capital doubled down Friday on their long-held bullish outlook for the economy. They raised their forecast for U.S. gross-domestic-product growth in four of the next five quarters, citing unexpected strength in construction of commercial real estate. At the same time, they also pushed back the expected date of a Federal Reserve rate increase because of the turmoil in markets.

J.P. Morgan Chase U.S. equity strategist Thomas Lee reiterated his call that the Standard & Poor's 500-stock index will reach 1300 by the end of the year, a 22% gain from Friday's close of 1064.88. "This is probably going to prove to be a very good entry point" for stock buyers, he said in a conference call.

After a decline of nearly 13% in the S&P from its April high, stocks are cheap, says Mr. Lee, trading at about 13 times estimated earnings for 2010. That suggests the downside for stocks could be limited, assuming analysts are right about their earnings estimates. Similarly, high-yield corporate bonds have tumbled from their April highs.

Still, it is difficult at the moment to see what would inspire much of a lasting rally in junk bonds, stocks or other risky assets any time soon. For one thing, Europe's problems are likely to provide a continuing stream of bad news.

Even before Friday's jobs number, other recent U.S. economic data had been downbeat. In one key sign that the recovery is stagnating, a leading economic index compiled by the Economic Cycle Research Institute, which includes jobless claims and market indicators, fell last week to its lowest annualized growth rate since last June, about the time the recession is thought to have ended.