MarketView for December 1

 

 

Summary 

 

The major equity indexes were essentially on idle on Thursday after the Labor Department posted what was pretty much a lackluster reading on new unemployment claims. The Labor Department reported that the number of individuals who filed for unemployment insurance for the first time increased by 6,000 claims to a total of 402,000 claims for the week ended Nov. 26. That number was up from a revised 396,000 claims in the previous week.

 

The Institute for Supply Management's manufacturing index increased to 52.7 in November, the highest level registered since June. This was better than the Street had been expecting and was above the 50.8 figure registered in October. A level above 50 indicates expansion of activity within the manufacturing sector.

 

Meanwhile, construction spending increased 0.8 percent to an annual rate of $798.5 billion in October, according to the Census Bureau. Spending was expected to have increased 0.3 percent in October, compared with 0.2 percent in September.

 

Sentiment was also being weighed down by a weak reading on Chinese manufacturing activity. China's purchasing managers’ index contracted for the first time since February 2009, falling to a worse-than-expected reading of 49 in November from 50.4 in October. The data was released just a day after China's central bank said it would cut the reserve requirement ratio for lenders by 50 basis points starting Dec. 5.

 

Despite the action of central banks on Wednesday to increase liquidity in the euro zone, the issue of outstanding debt owed by a variety of countries continues to present sever challenges to the region.

 

European Central Bank President Mario Draghi called Thursday for a "new fiscal compact" that would "enshrine the essence of fiscal rules and the government commitments taken so far, and ensure that the latter become fully credible, individually and collectively," suggesting that the bank is willing to expand its role in solving the European debt crisis on the condition that euro zone nations begin working together more closely on budget policies.

 

Benchmark Italian bond yields fell below the 7 percent crisis level Thursday following well-received Spanish and French bond sales, indicating that the coordinated liquidity action by global central banks was already having a positive impact on funding for the region.

 

Major financial stocks were facing significant pressure after Massachusetts Attorney General Martha Coakley's office announced it is filing a lawsuit against five banks including Bank of America and JPMorgan Chase, alleging unlawful and deceptive practices in the foreclosure process.

 

The lawsuit also names Citigroup, Wells Fargo and Ally Financial as well as Mortgage Electronic Registration System and its parent MERSCORP as defendants, according to a Coakley statement. The AG's lawsuit accuses the banks of unlawful foreclosures, false documentation, robo-signing, and deceptive practices related to loan modifications.

 

In other corporate news, Yahoo is reportedly entertaining more offers for the company. Alibaba, Softbank, Blackstone Group and Bain Capital are reportedly in advanced talks to make a bid for all of Yahoo, according to a report from Bloomberg. That news followed a report earlier Wednesday that Silver Lake and a consortium of investors are bidding for a minority stake Yahoo! that would value shares at $16.60 each. Bloomberg also reported that private-equity firm TPG Capital may have submitted a higher bid for Yahoo! than Silver Lake.

 

Aeropostale, the casual apparel retailer, posted a disappointing forecast for its fiscal fourth quarter. The retailers said it expects to earn 35 cents to 38 cents a share in the three months ending in January.

 

The Machinists union and Boeing said jointly that they have tentatively agreed to a landmark deal that extends their contract, locates construction of the new 737 MAX in Renton, Wash., and ends a bitter dispute over whether Boeing can build 787s in South Carolina. The deal appears to reverse what had been a combative relationship and provide a global solution to a series of contentious issues that have troubled both parties.

 

Finisar, the optical networking equipment maker, posted mixed fiscal second-quarter earnings and gave a below-consensus outlook. Finisar reported a non-GAAP profit of $21.6 million, or 23 cents a share, for the quarter ended Oct. 30 with revenue totaling $241.5 million, a sequential increase of 5.8%. For its fiscal third quarter, Finisar forecast revenue and earnings below analysts' expectations.

 

About 6.86 billion shares changed hands on the major equity exchanges, a number that was well below the current daily average of 7.96 billion shares traded per day.

 

Money May Not Be Enough for The EU

 

As European Union leaders prepare for yet another crisis summit meeting next week to discuss fundamental changes in economic governing, there are growing concerns that the latest potential approach — a more aggressive intervention by the European Central Bank — will not be enough to stabilize the markets and preserve the euro.

 

The assumption has been that if political leaders can convince voters in their countries that they are capable of enforcing greater discipline and centralized intervention in national budgets, as Germany demands, then the European Central Bank will have the political breathing space to move more aggressively to support the bond sales of Spain and especially Italy. The thought is that the bank can flood the market, driving down interest rates to tolerable levels, buying time for Europe to fix its debt problems and overhaul laggard economies.

 

However, with Europe moving towards a full-blown recession and with increased skepticism that discipline will solve the deep structural imbalances in the euro zone, the markets’ concerns have passed from doubts about the solvency of individual countries to fears for the euro zone as a whole. Those doubts now include Germany, which cannot single handily guarantee the credibility of Italian and Spanish debt, which totals more than $3.3 trillion.

 

For Kenneth S. Rogoff, an economics professor at Harvard, the biggest problem for the euro is not money as much as structure, or the lack of it. “This is a deep constitutional and institutional problem in Europe,” Mr. Rogoff said. “It’s not a funding problem.”

 

Yet, with even German interest rates rising, the markets are now worried about the sustainability of the euro zone as a whole, said Simon Johnson, a former chief economist for the International Monetary Fund and a professor at the M.I.T. Sloan School of Management.

 

“The market has signaled that the risk is relative currency risk, not sovereign risk,” Mr. Johnson said.

 

The last plan that was supposed to stop the rot, agreed upon last July but not put fully into place until mid-October, was the European Financial Stability Facility, with a lending capacity of 440 billion euros, or about $587 billion. While large enough to cover, as intended, a second Greek bailout, Ireland and Portugal, it is far too small for Italy and Spain, which are now in play.

 

And efforts to “leverage” the fund upward are falling considerably short of the $1.35 trillion target, European officials acknowledged Wednesday. That failure is in large part because even the AAA-rated euro zone countries are going up, leaving less leeway for leveraging.

 

Mr. Johnson is a euro hawk, predicting a breakup of the euro zone. Others say Europe has more time, especially if the European Central Bank can intervene to support Italy more forcefully, which by its charter it is not supposed to do, at least not directly.

 

If so, Mr. Rogoff said, “the Europeans can stretch it out a long time, they have the money.” Nevertheless, he said, they “need to take a big step toward economic and political union, whoever wants to be a part of it.” Germany “is right to hold out for systemic changes,” he said. “The Europeans hoped to have 30 to 40 years to integrate more fully. Right now they don’t have 30 to 40 weeks.”

 

France and Germany are concentrating their efforts on a fundamental shift in powers among the 17 European Union states that use the euro, seeking to amend the bloc’s treaties to allow more centralized oversight of national fiscal and budget policies, and more centralized interference in them, too. Penalties would be assessed on those countries that violate the rules of economic discipline, which will be tightened and clarified.

 

Those proposals, if accepted in principle at the summit meeting on Dec. 8 and 9, will bring about a major restructuring of the European Union and the institutionalization of a two-speed Europe, French officials said, with more economic and governmental integration among euro zone countries.

 

President Nicolas Sarkozy of France intends to speak to his country on Thursday to explain the ideas for a treaty change, and Chancellor Angela Merkel is expected to do the same in Germany on Friday.

 

Such changes, because they involve some further ceding of national sovereignty and powers, will require ratification by the nations involved, and very possibly by all 27 members of the European Union, which would mean referendums in a few countries. So France in particular is willing to move to a treaty just of the euro zone itself.

 

While treaty change can be a lengthy process, the hope is that the effort will create enough momentum for economic convergence and discipline that will provide the political cover for Germany’s leaders to allow the European Central Bank to step in much more forcibly to defend Italy and Spain and try to stabilize the market. However, it may already be too late for that plan to work.

 

New rules for discipline may help prevent future maladies, but they are a distant cure for the current disease. New disciplinary rules do little to address the structural flaws in the euro zone, where countries of very different economic levels, models and export potentials share the same currency, creating persistent trade and credit imbalances. Structural reforms inside countries, no matter how valuable in the long run, take a long time to work. And austerity alone cannot produce economic growth, which is the main cure for too much debt.