MarketView for December 17

 

 

Summary

 

The S&P 500 index hit another two-year high watermark on Friday as we progress towards the end of the year and what is usually a considerable drop off in trading activity during the last week prior to Christmas, and then during week prior to the New Year holiday. Meanwhile, the S&P has already chalked up a 5 percent gain so this month.

 

At the same time, some indicators seem to imply a degree of complacency. The CBOE Volatility index .VIX, a measure of expected volatility on Wall Street, fell to its lowest level since April, falling 7.4 percent to 16.11. At the same time, there is some evidence that the markets are in an overbought situation, specifically, a high call to put ratio, which points to a lack of interest in hedging portfolios. In other words, investors appear to be confident that the major indexes still have energy left in them.

 

Nonetheless, some of the stocks that have seen the greatest gains during the year are now facing some profit-taking. For example, Apple closed down 0.2 percent at $320.61, while Salesforce ended the day down 0.7 percent to close at $136.50.

 

This was offset on the Nasdaq by gains in both Oracle and Research in Motion a day after they posted strong quarterly results. Oracle gained 3.9 percent to close at $31.46, while RIM added 1.6 percent to close at $60.20.

 

Meanwhile, concerns over European debt also resurfaced, with Moody's downgrade of Ireland's ratings hitting European bank shares. Banco Santander fell 2 percent to $10.52 while Royal Bank of Scotland was down 5.5 percent, closing at $11.90. However, the impact on companies whose share prices are not directly linked to the Irish situation was limited.

 

Regional banks traded higher after Canada's Bank of Montreal agreed to acquire Marshall & Ilsley for $4.1 billion, sending the shares up 18 percent to close at $6.85, while Regions Financial gained 1.8 percent to close at $6.24.

 

About 8.9 billion shares were traded on the New York Stock Exchange, the American Stock Exchange and the Nasdaq, over the year's daily average of 8.5 billion. However, volume was increased as a result of traders adjusting or exercising derivative positions on four different types of expiring equity futures and options contracts during what is known as a "quadruple witching" day.

 

Moody’s Downgrades Ireland’s Debt

 

Moody's expressed its displeasure on Friday with regard to Europe's attempt to resolve a spreading EU debt crisis by reducing Ireland's credit rating as EU leaders remain stoic in the face of the ensuing market turmoil over the EU’s deteriorating debt situation.

 

Moody's cut Ireland's rating by a stunning five notches during a European Union summit meant to restore confidence in the euro zone by creating a permanent financial safety net from 2013 and vowing to do whatever it takes to protect the euro.

 

Moody's cut Ireland's rating to Baa1, three notches above junk, with a negative outlook from Aa2 and warned further downgrades could follow if Dublin was unable to stabilize its debt situation, caused by a banking crash after a decade-long property bubble burst.

 

The EU problem was aggravated when the 27 leaders failed to agree any specific measure to stop contagion spreading from Greece and Ireland, which have received EU/IMF bailouts, to other high-deficit countries such as Portugal and Spain.

 

"The recent events have demonstrated that financial distress in one member state can rapidly threaten macro financial stability of the EU as a whole through various contagion channels," a final summit statement said.

 

The leaders ignored calls for immediate practical steps such as increasing the size of a temporary bailout fund or allowing it to be used more flexibly to buy bonds or open credit lines before troubled countries are shut out of the credit markets.

 

German Chancellor Angela Merkel, who led opposition to those options, sought to reassure citizens and markets, declaring: "We are doing everything to make the euro secure." Merkel said the existing EU rescue fund was sufficient, and she was impressed by reforms announced by Spain and Portugal.

 

On the sidelines of the summit, non-euro member Britain won support from France, Germany and other countries for a drive to freeze the common EU budget in real terms over the next decade to take account of national spending cuts.

 

Prime Minister David Cameron said the EU's big three would issue a joint letter on Saturday calling for a lean budget in the seven-year spending plan after 2013, rising only in line with inflation "to stop this budget getting out of control."

 

"It is unacceptable to spend more and more and more through the EU budget," he said, playing to Euro skeptics in his Conservative Party who have been disappointed that he has not done more to confront Brussels.

 

Poland, set to become the biggest beneficiary of the 126.5 billion euro annual budget, voiced anger at the move.

 

The European Central Bank took action to bolster its firepower to fight the debt crisis by announcing on Thursday it would almost double its subscribed capital. However, the feeling on Wall Street is that this was chiefly to cover the risk of write downs on the 72 billion euros ($95.83 billion) in euro zone sovereign bonds it has bought so far, not to step up such purchases to support governments in trouble.

 

At Germany's insistence, the 27 leaders said the long-term crisis-resolution mechanism, to be added to the EU's governing treaty, would only be activated "if indispensable to safeguard the stability of the euro as a whole," making it a last resort.

 

The premium investors charge to hold Greek, Irish, Portuguese or Spanish bonds rather than benchmark 10-year German Bunds crept up in thin pre-Christmas trading, and the cost of insuring their debt against default also rose.

 

The record seventh summit this year approved a two-sentence amendment to the EU treaty at Germany's behest to permit the creation of a European Stability Mechanism to handle financial crises from June 2013.

 

The ESM, to replace the temporary fund created in May, will be empowered to grant loans on strict conditions to member states in distress, with private sector bondholders sharing the cost of any write downs after 2013 on a case-by-case basis.

 

The aim is for all 27 member states to ratify the change by end 2012. European Council President Herman Van Rompuy, chairing the summit, said no country would need to put it to a referendum, removing one potential risk. Decisions will be taken by unanimity, ensuring that EU paymaster Germany retains a veto.

 

It is distinctly possible that Greece and Ireland will default before then, but ECB executive board member Lorenzo Bini Smaghi dismissed such talk in a Financial Times article, stating that the cure could do more harm than the disease.

 

The Outlook for the New Year Continues to Look Promising

 

The economy is gathering steam as the year draws to a close, adding to the rising optimism about prospects for 2011, according to measures published by two separate economic research firms on Friday.

 

The Conference Board's measure of leading economic indicators rose 1.1 percent in November, the largest increase since March and the fifth straight monthly gain. Separately, the Economic Cycle Research Institute said its gauge of future growth rose to its highest level since May.

 

It was the latest evidence of steady improvement in the economy's prospects after a summer lull. Retail sales in particular have been surprisingly strong, raising hopes for consumer spending.

 

"The U.S. economy is showing some sparks of life in late 2010," said Ken Goldstein, an economist at The Conference Board. "The indicators point to a mild pickup after a slow winter. Looking further out, possible clouds on the medium term horizon include weakness in housing and employment."

 

Passage by the Congress of the Bush-era tax cut extension also added the ebullient attitude, despite the fact that passage also means an ever rising budget deficit and national debt.

 

Gross domestic product grew at a 2.5 percent annual rate in the third quarter, but that was not enough to bring down the jobless rate, which rose to 9.8 percent in November. Nonetheless, the economic outlook for the New Year looks almost good enough to start making a dent in the number of unemployed.