I think Krugman has it just right in a short piece today on the Dow and Treasuries markets:
Once again: S&P declared that US debt is no longer a safe investment; yet investors are piling into US debt, not out of it, driving the 10-year interest rate below 2.4%. This amounts to a massive market rejection of S&P’s concerns.Again, if S&P were right, the Dow and Treasuries would move down in sync. In fact, they're moving opposite to each other. In other words, U.S. Treasuries are still the world's safe haven. And the Dow is having a Wile E. Coyote moment ("Tree? What tree? I'm just sawing this branch—oops!)
The “signature” of debt concerns should be stock and bond prices both falling; what we actually see is those prices moving in opposite directions. And that’s normally the signature of concerns about a weak economy and deflation risk (see Japan, decline of).
What triggered economy fears? To some extent I think this is a Wile E. Coyote moment, with investors suddenly noticing just how weak the fundamentals are. Also, the mess in Europe.
I'll add two points: (1) Krugman is right also that this market drop allows the S&P to bully the government into killing even more of the safety net.
(2) Just me now: Watch the magic Dow @ 10,000 point. Stock won't really be in trouble (i.e., out of control—and I do mean "control") until that line is approached and breached. That's the scare point for us "small people" where we do the next round of real belt-tightening.
If you want to know why I'm optimistic about the stock market longer term, read this.
GP
