A false dawn for stocks

After dipping in June, equity markets bounced strongly in July. The S&P 500 index gained 7%, the best monthly return in a year. The FTSE 100 is more than 10% up on its late June level, while pan-European indices have hit three-month highs. Solid bank earnings buoyed most markets early this week.

It seems investors are determined to look on the bright side and have been brushing off negative data. They took a relaxed view of Europe's bank stress tests, while the slowdown in China is already being treated as evidence that the authorities have managed to engineer a soft landing, says David Rosenberg of Gluskin Sheff. But the "divergence between Wall Street and Main Street" has been most striking when it comes to the American backdrop.

Last week's second-quarter GDP data were "frightening", says Rosenberg. Annualised growth of just 2.4% is measly. The average at this stage of a recovery in the post-war period is 6%. It's especially poor given that the stimulus this time round has been "unprecedented" and is now set to be removed. The outlook for consumption, which comprises 70% of GDP and fell back in the second quarter, is poor. Consumer confidence is below the level seen in typical post-war recessions and there is vast slack in the labour market.

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The grim state of the housing market also bodes ill for consumption. America's still highly indebted consumers are "not likely to relinquish their newfound frugality" any time soon, says Alan Abelson in Barron's. That's bad news for earnings and stocks. Even without a double-dip, a growth slowdown and a "persistently sub-par recovery", as Martin Hutchinson puts it on Breakingviews, are on the cards. A slowdown in America will temper the export boom in Germany, which is leading the eurozone recovery, says FAZ.net. Meanwhile, China's growth is slowing and "Europe isn't exactly booming".

With no sign yet of a consumer revival in Germany, there seems scant hope that German growth can offset weakness elsewhere in the eurozone, says Capital Economics, especially given its forthcoming fiscal squeeze. And credit conditions for businesses were tightened again in the second quarter. So expect eurozone growth to ease to 0.5% next year from 1% in 2010. Equity investors have been "asleep at the wheel", as Albert Edwards of Societe Generale puts it although the market jitters mid-week suggested they may now be waking up.