MarketView for December 12

 

 

Summary 

  

It was another one of those days as all three major equity indexes slid downward from the opening bell. While some of the losses were reduced  towards the end of the trading day, it was nonetheless a day of across-the-board red ink. If you are looking for an exact reason, consider that the three major credit rating agencies who warned the world that European leaders had not done enough to tackle the region's debt crisis, meaning that the measures agreed to were insufficient to quell the euro zone debt crisis

 

The decline was broad. All ten of the S&P industry groups ended in negative territory, and most dropped more than 1 percent. The banking sector was hit the hardest, while technology shares also fell after Intel, a part of the Dow Jones Industrial Index, lowered its quarterly revenue expectations due to parts supply problems. Intel ended the day down 4 percent to $24.00 after cutting its fourth-quarter revenue forecast due to supply shortages of hard disk drives. Intel follows similar moves by DuPont and Texas Instruments, both of which cut their outlooks last week.

 

After initial elation on Friday over an agreement reached at an EU summit to enforce tighter budget control over the euro zone, the mood turned sour on Monday as more doubts arose over whether the measures would be sufficient. Fitch Ratings indicated on Monday that a failure by European Union leaders to come up with a "comprehensive" solution to the region's debt crisis has increased short-term pressure on debt ratings of all euro zone countries. Investors in Europe in turn gave their verdict by spurning Spanish and Italian debt, causing borrowing costs to rise. The yield on Italy's benchmark 10-year note again came within range of 7 percent, the level considered a danger zone, but recovered to close at 6.60 percent.

 

Banks were among the worst performers on renewed concern that problems in Europe's financial system could spill over to U.S. institutions. As a result, Bank of America slumped 4.7 percent to $5.45 and JPMorgan Chase closed down 3.4 percent at $32.04. Italian one-year borrowing costs stayed close to a record high at an auction. Yields on 10-year Italian bonds briefly threatened the 7 percent level, which is considerable a danger zone. An index of European equities .FTEU3 closed down about 1.9 percent.

 

Moody's and Fitch reminded the markets on Monday that the deal on Europe reached last week was not enough to diminish the chance of sovereign ratings downgrades in the euro zone in the near- to mid-term. Last week, S&P put 15 euro zone countries on a watch for potential credit rating downgrades.

 

Resource-related stocks also fell on Monday as crude oil futures fell 1.3 percent and copper prices dropped 2.6 percent to a near two-week low on deepening concern over Europe. Alcoa was off 3 percent to $9.35, and Freeport McMoRan Copper & Gold fell 3 percent to $38.54. Exxon Mobil slid 1.6 percent.

 

Volume was light, with about 6.28 billion shares changing hands on the three major equity exchanges, a number that was below last year's daily average of 8.47 billion shares.

 

Europe Has More Work to Do

 

A European summit deal to strengthen budget discipline in the euro zone failed to restore financial market confidence on Monday, forcing the European Central Bank to once again take action. The ECB purchased short-term Italian debt after yields on Italian and Spanish debt spiked.

 

The central bank revealed on Monday it had slashed bond purchases in the week before the EU summit as it raised pressure on the bloc's leaders to act. It bought just 635 million euros in bonds in the week to December 9 compared to 3.66 billion the previous week.

 

As a result, the euro fell and borrowing costs for Italy and Spain rose as investors world wide weighed the outcome of last week's summit that split the European Union, with Britain blocking treaty change and forcing euro zone countries to negotiate a fiscal accord outside the Union.

 

French President Nicolas Sarkozy said the legal basis of a new accord to enforce debt and deficit rules in the 17-nation euro area with quasi-automatic sanctions and intrusive powers to reject national budgets would be worked out before Christmas.

 

"In the next fortnight, we will put together the legal content of our agreement. The aim is to have a treaty by March," Sarkozy told newspaper Le Monde in an interview.

 

Italian 5-year bond yields shot up above 7 percent, widely seen as a danger level while 10-year yields spiked above 6.8 percent and Spanish 10-year yields topped 6 percent. Investors' appetite for short-term paper drove Italian one-year borrowing costs down just below 6 percent at an auction but yields remain uncomfortably high.

 

Meanwhile, the major ratings agencies could make matters worse as Sarkozy prepared French voters for a possible downgrade of the country's AAA credit rating but insisted he could cut the deficit without cutting salaries and pensions.

 

Moody's Investors Service said it intends to review the ratings of all 27 members of the European Union in the first quarter of 2012 after EU leaders offered "few new measures" to resolve the crisis at their summit on Friday.

 

Fitch Ratings said the summit failed to provide a "comprehensive" solution to the crisis, thus increasing short-term pressure on euro zone sovereign ratings.

 

Standard & Poor's, which warned last week of a possible downgrade of 15 euro zone countries shortly after the summit, still has to announce its decision.

 

If some of the euro zone's AAA-rated members are downgraded, it would call into question the solidity of the euro zone's rescue fund, which would likely suffer a similar fate. Its permanent successor will not come on stream until mid-2012 at the earliest.

 

The euro area faces the next potential crunch point in mid-January when Italy, which has a debt mountain of 1.9 billion euros or 120 percent of its annual output, has to start issuing tens of billions of euros in bonds towards a 2012 total of 340 billion euros needed to roll over maturing debt.

 

Political aftershocks from Friday's historic rift between Britain and the rest of the 27-nation bloc continued to shake Europe, with Prime Minister David Cameron facing tension in his coalition and doubts in the business community. Cameron was given a hero's welcome by Eurosceptics in his Conservative party but faced a backlash from his Liberal Democrat coalition allies after he wielded a veto that has cast Britain adrift from its continental partners.

 

"Britain remains a full member of the EU and the events of the last week do nothing to change that," Cameron told parliament. In a defiant statement, he told lawmakers he made no apology for having demanded safeguards for the City of London financial center in any new EU treaty.

 

In Brussels, officials were groping for a strong legal basis for the planned fiscal compact, with Britain arguing that the euro zone cannot use the EU treaty institutions - the European Commission and the European Court of Justice.

 

The crucible of the crisis, Greece, could yet cause havoc if negotiations over a second bailout fall apart, leading to a rapid default. Greek Finance Minister Evangelos Venizelos said he wanted to move fast in talks with the EU, IMF and bankers, reaffirming the aim of clinching a voluntary debt restructuring deal by end-January before the country heads to elections.

 

"We will proceed smoothly and with the maximum possible speed," Venizelos said after separate meetings with the head of bank lobby IIF and with EU, IMF and ECB inspectors, on key aspects of a 130 billion euro bailout plan.

 

EU leaders have now said banks may not take a hit in any future sovereign rescues after they were roped into the Greek bailout, a move which proved a final straw for many investors.

 

Part Shortages Hurt Intel

 

Intel warned on Monday that hard-disk drive supply shortages would hurt its current-quarter revenue, due to the effects of flooding that has crippled factories in Thailand. The warning sent shares of the world's top chipmaker down 4.8 percent and weighed on Wall Street.

 

PC makers have been scrambling to buy increasingly scarce hard drives after the flooding shut down factories in the country, which is the world's second largest exporter of the components.

 

"In the last two weeks, as the supply became more apparent, we saw a substantial change in our order rate. Most of our customers are concerned the shortage will continue -- especially through the early part of the first quarter," Intel Senior Vice President Tom Kilroy told analysts on a conference call.

 

Major PC makers including Hewlett Packard, Dell, Lenovo and Acer have warned to varying degrees that they may build fewer PCs as they use up the current stock of hard drives and struggle to replace them.

 

Intel said its customers are reducing their stock of chips in anticipation of the hard drive shortage continuing early next year, although it said it still expects sales of PCs to be up in the fourth quarter.

 

Damage caused by the floods is expected to shrink global hard drive output by about a third in the current quarter. Western Digital, the hard drive manufacturer hit hardest by the floods, this month resumed production and warned of tight global supplies into next year. Western Digital expects a world shortage of 60 million hard drives in the December quarter.

 

Seagate's Thai plants have been largely unaffected by the catastrophe, but production has been curtailed due to tight component supplies as factories of some key suppliers were flooded.

 

Intel Chief Financial Officer told investors on the call that he expects the shortage to accelerate the adoption of solid-state drives as the main storage devices in PCs. Made with NAND semiconductors, solid-state drives are much faster than hard drives but are also a lot more expensive and are currently used only in high-end PCs like Apple's MacBook Air.

 

Intel said quarterly revenue is now seen at $13.7 billion, plus or minus $300 million, below a previous forecast of $14.7 billion. Intel said non-GAAP gross margin is expected to be around 65.5 percent versus previous expectations of 66 percent.