Equity Market to Continue its Path of Correction?

The equity market took the news of the negative U.S. credit outlook rather hard yesterday. Even before that news, a lot of stocks, especially those commodities related stocks (except for precious metals) had corrected quite significantly.

I've been saying for the last three years that this economic crisis is quite different from the previous ones that we've experienced such as the burst of the dot com bubble. The logic is simple: it was the governments around the world that always came to the rescue whenever recessions hit the economies. However, due to deteriorating fiscal situations of those sovereign states (especially many European states and the U.S), governments will be forced to cut back their spending on social safety nets and various types of government programs in an effort to trim down their debt loads (part of which they incurred to save failing financial institutions few years ago).

To add insult to the injury, the two biggest economies (the U.S. and the European Union) are in trouble. In previous economic crises, it was the U.S. and the EU nations that were able to buy goods produced from the rest of the world (including the countries going through economic crises), thereby helping these nations to get out of the economic crises. 

Possible layoffs of government employees and reduced government spending around the world will put deflationary pressures on the economy. As a result, coupled with the already well known European debt crisis, we could see another run for the safety, and the US dollar, bullion and Treasuries can appreciate, while commodities will be hammered. 

Central banks around the world will continue to face a difficult dilemma. Their liquidity injections to curve the economic recession are now slowly coming back in a form of inflationary pressure. However, it will be a lot tougher to react as increased interest rates will put a lot higher pressures on debtor nations and households in financing the debts. 

The news on a possible Greek debt restructuring had the yield react very severely. Any debt restructuring or default by any one of the troubled European nations will directly hit the banking system as a lot of creditors are European banks and other European sovereign states that also owe money to other parties. In other words, the tightly connected and interdependent financial systems around the world will be affected. 

Stay tuned because this time is really different in my opinion. 

p.s. in the long run, however, central banks around the world will try to monetize their debts and unfunded liabilities (especially in the US) that investors will be worse off owning cash and government bonds in the long run in my opinion.