MarketView for December 9

 

 

Summary 

  

The financial markets moved sharply higher on Friday, finishing the week on positive numbers after European Union leaders agreed on a plan to toughen the region's budget rules to help restore market confidence after a two-year sovereign debt crisis. The agreement tried to address the structural problems behind the bloc's debt crisis, although there is still considerable room for additional work. Nonetheless, for the week, the Dow Jones Industrial Average chalked up a gain of 1.4 percent, the S&P was up 0.9 percent and the Nasdaq turned in a 0.8 percent gain.

 

The EU summit failed to secure changes to the EU treaty among all the member countries and investors warned the move was far from a panacea. Indications suggest the region is sliding into a recession and questions about how to bring down high sovereign debt yields are still unanswered.

 

Goldman Sachs suggested that investors short German equities through the benchmark DAX index .GDAXI in a note to clients published late on Thursday.

 

"The European summit seems focused on a set of future priorities for increased fiscal risk sharing and the outlining of some of the needed elements of a new fiscal arrangement, but looks to have little to say about alleviating proximate stresses in Greece and Italy and the European banking system more generally," Goldman wrote.

 

Still, Italian bonds reversed losses, on the precept that frequent European Central Bank forays into Italian debt markets throughout the day were positive news.

 

Apparently, some so called "fast money" was covering short positions in bonds of so-called peripheral EU countries.

 

Banks, which have been pressured by the uncertainty over Europe, rallied after the EU summit. For example, Bank of America ended the day up 2.3 percent to close at $5.72, while JPMorgan Chase closed with a 3 percent gain at $33.18.

 

In the latest sign of life within our economy, consumer sentiment rose to its highest level in six months in early December on signs of a better jobs market and an improving economy, according to a survey by Thomson Reuters/University of Michigan. 

 

Nonetheless, there was still caution in the equity markets. For evidence of that you have to look no farther than DuPont, which ended the day down 3.1 percent to close at $45.04 DuPont reduced its 2011 profit outlook, citing slower growth in some businesses.

 

Texas Instruments also cut its revenue outlook for the current quarter, warning of lower demand. The stock ended the day unchanged at $29.94.

 

Trading volume saw 6.71 billion shares change hands on the three major equity exchanges, a number that was well below the year's daily average of around 7.95 billion shares.

 

Economy Continues to Improve

 

One index of consumer sentiment rose to its highest level in six months in early December and the trade deficit narrowed in October in the latest signs that the economy's health is slowly improving. The Thomson Reuters/University of Michigan preliminary December reading on consumer confidence on Friday climbed for a fourth straight month to 67.7 from 64.1 in November.

 

Improved confidence could lead Americans to spend more readily, which would add to the recent momentum gained from strong retail sales and factory output. Also supporting growth, the narrowing in the trade deficit showed that more goods and services bought by U.S. businesses and consumers were produced within the United States.

 

U.S. economic growth appears to be accelerating, even as the global economy slows. The euro zone, for example, is widely believed to be slipping into recession as it struggles to contain a sovereign debt crisis. As a result, the Fed is expected to hold monetary policy steady at a meeting on Tuesday.

 

Meanwhile, any worsening in the euro zone crisis could easily derail our. recovery from the 2007-2009 recession.

 

Separately, the Commerce Department reported on Friday that our trade deficit narrowed in October to its lowest in 10 months. The trade gap totaled $43.5 billion, in line with a consensus estimate. With the economy having expanded at a 2.0 percent annual rate during the third quarter, and JPMorgan said the trade report meant growth during the fourth quarter could exceed its 3.0 percent forecast.

 

While the shrinking trade gap bodes well for fourth-quarter economic output, both exports and imports declined, a sign of some softening in domestic and overseas demand.

 

Britain Is Odd Man Out

 

Europe secured an historic agreement to draft a new treaty for deeper economic integration in the euro zone on Friday, but Britain, the region's third largest economy, refused to join the other 26 countries in a fiscal union and was left isolated.

 

The outcome of a two-day European Union summit left financial markets uncertain whether and when more decisive action would be taken to stem a debt crisis that began in Greece in 2009, spread to Portugal, Ireland, Italy and Spain and now threatens France and even economic powerhouse Germany.

 

A new treaty could take three months to negotiate and may require losable referendums in countries such as Ireland. While nine non-euro-zone countries said they would join the euro zone in backing it, there were quickly notes of caution from some corners, including the Czech Republic and Hungary.

 

Nonetheless, the debt markets remained cautious with interbank lending rates easing, while at the same time, Italian 10-year bond yields rose to around 6.5 percent.

 

Under the new treaty plan, the leaders agreed to pursue a tougher budget discipline regime with automatic sanctions for deficit sinners in the single currency area, but Britain said it could not accept the proposed treaty amendments after failing to secure concessions for itself on financial regulation.

 

"This is a breakthrough to a union of stability," German Chancellor Angela Merkel said. "We will use the crisis as a chance for a new beginning."

 

After 10 hours of talks that ran into the early hours of Friday, Britain found itself without any allies around the table, diplomats said. All the other nine non-euro states said they wanted to take part in the fiscal union process, subject to parliamentary approval.

 

The rift, which could widen into a permanent divide between London and the continental mainland, occurred 20 years to the day after European leaders agreed at the Maastricht summit to create the single currency, with Britain opting to stay out. Prime Minister David Cameron insisted at a news conference that it remained in Britain's interest to stay in the EU and take advantage of its single market.

 

One senior EU diplomat called Cameron's negotiating tactics "clumsy." Among other things, he had sought a veto on a proposed financial transaction tax, which may now be voted through by a majority over the objections of London's financial center.

 

ECB President Mario Draghi called the EU's decision a step forward for the stricter budget rules he has said are necessary for the euro zone to emerge stronger from the turmoil.

 

"It's going to be the basis for a good fiscal compact and more discipline in economic policy in the euro area members," Draghi said. "We came to conclusions that will have to be fleshed out more in the coming days."

 

French President Nicolas Sarkozy told reporters the ECB's move to provide unlimited three-year funds to cash-starved European banks would be more effective, by enabling them to continue buying government bonds. "This means that each state can turn to its banks, which will have liquidity at their disposal," he said.

 

Merkel said the world would see that Europe had learned from its mistakes and avoided "lousy compromise." Sarkozy sounded elated at having united a big group around the euro zone as the EU's core, long a French objective, and many diplomats perceived France as being the big winner.

 

"This is a summit that will go down in history," he said. "We would have preferred a reform of the treaties among 27. That wasn't possible given the position of our British friends. And so it will be through an intergovernmental treaty of 17, but open to others."

 

One EU diplomat summed up the outcome as: "Britain seethes, Germany sulks, and France gloats."

 

Active ECB support will be vital in the coming days with markets doubting the strength of Europe's financial firewalls to protect vulnerable economies such as Italy and Spain, which have to roll over hundreds of billions of euros in debt next year.

 

Britain refused to allow its partners to amend the EU treaty, demanding guarantees in a protocol protecting its financial services industry, roughly one-tenth of the country's economy. Sarkozy described Cameron's demand as unacceptable.

 

Cameron hinted London may now try to prevent the others from using the executive European Commission and the European Court of Justice, saying: "Clearly the institutions of the European Union belong to the European Union, they belong to the 27."

 

But European Council President Herman Van Rompuy, who chaired the summit, said the EU institutions would be fully involved in the new treaty, which would be signed in early March at the latest. The euro zone plus nine may hold a summit without Britain as early as January, diplomats said.

 

Britain conducts more than half of its trade within the EU and could suffer on a broad range of financial regulation issues if the other countries decided to move forward as 26.

 

However, a new treaty will take weeks of wrangling as countries like Finland and Slovakia oppose a Franco-German drive to take decisions on future bailouts by an 85 percent supermajority to avoid being taken hostage by a single small country.

 

In a meeting billed by some as a last chance to save the euro, the leaders also took several decisions on the permanent bailout fund, the European Stability Mechanism, which will come into force a year early in July 2012.

 

The ESM's capacity will be capped at 500 billion euros ($666 billion), less than had been suggested was possible before the summit, and the facility will not get a banking license, as Van Rompuy originally had proposed, due to German opposition.

 

It also was agreed that EU countries would provide up to 200 billion euros in bilateral loans to the International Monetary Fund (IMF) to help it tackle the crisis, with 150 billion euros of the total coming from the euro zone countries.

 

Cameron's decision to stay out of the treaty-change camp could spell problems for Britain. Deeper integration on the continent could involve changes to the single market and financial regulation, both of which could have a profound impact on the British economy.