The Stock Market in May -- Worst Since 1940

The stock market had its worst May performance this year since 1940: Most of the indexes were down 8%. What's puzzling is why the root causes of the drop weren't offset by an improving economy and the expectation by most economists that gross domestic product -- GDP -- and joblessness will improve in the U.S. between now and the end of the year.

Investors Panicked

Greece and economic trouble in the Eurozone panicked may investors. Greece was bailed out by a nearly $1 trillion round of funding raised from governments in the region and the International Monetary Fund. Many analyst believe that a restructuring of Greek debt, which could involve a de facto default, is still two or three years away. In other words, it's no threat to the European economy for now.

But there was other trouble among Eurozone nations. Spain and Portugal announced that they would implement austerity budgets to decrease their deficits and improve their prospects of funding national debt. Fitch downgraded Spain's debt from AAA to AA+ on May 28th. This roiled the U.S. markets on the last trading day of the month, dropping markets another 1%. All of these pieces of news raised the possibility that a drop in GDP for the EU region would hurt U.S. exports. Shares of companies with sales in Europe were hit particularly hard.

Bank stocks were hurt for two reasons. The first is that Congress may pass a financial reform bill that will limit trading practices that are highly lucrative. The other is that American banks hold an unknown but probably large position in the sovereign debt of some Eurozone countries and of banks in those nations.

Fairly Good Economic News

But, the net data about the U.S. economy was fairly good. There were some modest improvement in housing, which may be hurt in future months because government tax credits for home buying lapsed in April. Unemployment showed some signs of improvement, though weekly jobless claims didn't improve as much as expected. Most measures of purchasing and manufacturing ticked up.

Trouble in Europe did cause money to flow into U.S. Treasury bonds as "safe haven" investments. That brought down U.S. borrowing costs just as the government is furiously raising money in the global capital markets to fund the U.S. deficit. The Fed has also pledged to keep rates low. The net effects of these actions is that mortgage rates are at the lowest levels in decades.

The stock market is supposed to be a predictor of the economy and business prospects six months into the future. Whatever the reasons for May's trouble, it doesn't bode well for the fourth quarter -- if the market is indeed right.