The “butterfly effect” isn’t difficult to understand. The phenomenon states that a change of circumstances in one region can disproportionately create a much greater change in another. Illustrating its proof through deriving academic formulas is possible but unnecessary. One need not look any further than the European debt crisis and its effect on domestic stock prices.
The correlation has never been more intense than it is today. Stock prices have moved in tandem with the headlines out of Europe. It isn’t always this way and it won’t continue forever. But right now, it is. While the mess in Europe will accompany a likely recession and the potential need to print money to cap bond yields, change the EU Treaty, or eventually break apart the union, there are signs that the US economy is decoupling from the region.
Last week, the number of people who filed for unemployment insurance in the US dropped to 366,000, the lowest level since May 2008 when the unemployment rate was 5.4% (8.6% today). This marks the tenth drop in the past 12 weeks. Continuation of this strong labour demand will surely fuel economic growth. Furthermore, surveys out of New York and Philadelphia both demonstrate that manufacturing activity expanded in December. This shouldn’t be entirely surprising. After all, despite Europe comprising a quarter of US exports, it accounts for only 1.97% of Gross Domestic Product.
The problems facing Europe today were confronted by the US in 2008-9. Banks recapitalized, the Federal Reserve turned on its printing press to keep interest rates low, and fiscal policy was expanded while the consumer caught its breath. Though US policymakers were firmly committed to act as needed, Europeans seem unwilling to do so today. Nevertheless, the volatility in North American stock prices represents a buying opportunity for rational investors who inform themselves through facts and numbers rather than daily movements in the stock market. As Benjamin Graham eloquently stated, the market will “serve you” a price but not “instruct you” whether that price is a good or bad one.
