MarketView for January 13

 

 

Summary 

  

The major equity indexes ended the day lower on Friday, ahead of an upcoming holiday for the markets. Wall Street is closed on Monday, in honor of Martin Luther King Day. The downtrend ended a four-day winning streak and was partially the result of news reports that Standard & Poor's would downgrade credit ratings on several euro-zone countries.

 

The ratings agency was reportedly set to downgrade euro-zone countries, including France and Austria, but leave the ratings of Germany and the Netherlands unchanged. French Finance Minister Francois Baroin said the country has been notified of a one-notch cut.

 

In recent days, the S&P 500 had reached five-month highs on the back of solid U.S. economic data. The tight relationship between U.S. stocks and the euro has broken down in recent weeks, a sign investors have placed less emphasis on the euro zone's woes.

 

The Friday selloff shows Europe's debt problems can still make U.S. investors skittish. However, it is notable that the major U.S. stock indexes finished well off the day's lows.

 

Banks led the decline, as the impending downgrades and lackluster earnings from JPMorgan Chase drove those shares lower.

 

For the week, the Dow Jones Industrial Average is up 0.5 percent, while the S&P 500 chalked up a gain of 0.9 percent, and the Nasdaq posted a gain of 1.4 percent.

 

JPMorgan Chase closed down 2.5 percent at $35.92 after the bank indicated that its fourth-quarter earnings fell as the European debt crisis weighed on trading and corporate deal-making. Chief Executive Jamie Dimon expressed renewed concerns about the euro-zone debt crisis. Bank of America fell 2.7 percent to close at $6.61. Goldman Sachs was down 2.2 percent to close at $98.96.

 

Volume was light with about 6.39 billion shares changing hands on the three major equity exchanges, a number that was below a daily average of 6.68 billion shares.

 

France Loses AAA Credit Rating

 

Standard & Poor’s cut France’s sterling credit rating, cut Portugal’s credit to junk status and downgraded Italy’s debt by two steps in a wide-ranging action revision of European countries caught in the euro crisis.

 

The actions, which lowered the ratings of nine countries, were the strongest signal yet that Europe’s sovereign debt woes were far from over and would pose fresh political challenges for politicians, including President Nicolas Sarkozy of France, as they try to stabilize the problem on the Continent, now in its third year.

 

A downgrade by a single ratings agency would have an immediate, though not devastating, impact on the countries’ ability to borrow money. S.& P. warned in December that the agency was reviewing the credit ratings of 15 European Union countries because of the crisis. Germany and the Netherlands, which were on the original list, were not expected to receive a downgrade Friday, news agencies reported.

 

Finance Minister François Baroin of France confirmed the loss of France’s AAA grade to AA+, but he insisted the country was headed in the right direction and that no ratings agency would dictate the policies of France.

 

“It’s not good news,” Mr. Baroin said on France television earlier in the day, but it is “not a catastrophe.”

 

Rumors of imminent downgrades trickled out all day Friday, the end of a week in which Prime Minister Mario Monti of Italy and Mr. Sarkozy warned that the crisis could deepen if steps were not taken to stoke growth. Both delivered their messages to Chancellor Angela Merkel in her offices in Berlin, prompting the German leader to admit for the first time that the harsh program of austerity she has been pushing on the euro zone was not a cure-all for the crisis.

 

S&P issued its warning last month after all three leaders held an emergency European summit meeting aimed at establishing a consensus for better fiscal discipline in the euro monetary union.

 

However, the bid to reassure the financial markets about the European Union’s resolve quickly fizzled, as investors fretted that the years-long efforts to strengthen the foundations of the euro currency club could be overwhelmed in the meantime by a looming recession in most of Europe.

 

In addition, the new European rescue fund, the European Financial Stability Facility, which is designed to prevent the contagion from spreading to large countries like Italy and Spain, would likely see its borrowing costs rise. France is one of its major financial backers, and if the country is downgraded, that could make the fund less effective in stemming the euro crisis.

 

Greek Debt Talks Stall

 

Negotiations between Greece and private-sector creditors over a restructuring of the country’s crushing debt were suspended Friday due to a continuing disagreement over how much of a loss banks and investors should take on their holdings.

 

Charles H. Dallara of the Institute for International Finance, the bank lobby that represents private-sector bondholders, said in a statement that discussions had “not produced a constructive consolidated response by all parties, consistent with a voluntary exchange of Greek sovereign debt.”

 

While people involved in the negotiations described it as a more of a negotiating tactic than a sign that Greece was going to default, the disagreement was a reminder of how wide the gap remains between the two sides, even after months of discussions.

 

But the announcement, along with reports of possible downgrades of euro zone nations’ credit ratings and data showing that banks in the euro zone remain reluctant to lend to each other, helped to squelch the enthusiasm that remained in the market after relatively strong debt sales in Italy and Spain.

 

On Friday, the Italian Treasury sold a total of about €4.8 billion, or $6.1 billion, of debt, including €3 billion of three-year bonds priced to yield 4.83 percent, down sharply from the 5.62 percent it paid at the last auction of such securities in late December. But the bid-to-cover ratio for the three-year bonds, a measure of demand, was lukewarm at 1.2 times — below the 1.36 times at the last sale.

 

A day earlier, Spain sold €10 billion of bonds, twice the targeted amount, with yields falling about a full percentage point from previous auctions.

 

The European Central Bank began a new funding program last month to backstop banks, helping to restore a semblance of stability to the euro zone financial system and to hold down the rates governments must pay to sell debt.

 

Another confidence gauge — the gap, or spread, between Italian and German 10-year bonds — barely budged. Rome’s long-term borrowing costs are still more than three times higher than Berlin’s.

 

E.C.B. data released Friday indicated that banks had deposited a record €489.9 billion overnight, almost the same amount lent under the three-year program. The figure has been elevated since the loans were made.

 

The I.I.F.’s statement on the negotiations in Athens came at the conclusion of talks between Mr. Dallara and the Greek finance minister, Evangelos Venizelos, on Friday.

 

At issue, bankers and government officials say, is less the actual 50 percent write-down, or haircut, that investors would absorb with their new bonds than the coupon, or interest, these new instruments would carry.  Investors are pushing for a higher interest payout to mitigate both their loss and the fact that their exposure to Greece will be lengthened considerably with the new bonds.

 

The International Monetary Fund and Germany, both of which have become increasingly worried about Greece’s ability to service its debts as its economy continues to plummet, are pushing for a lower rate that would ease Greece’s debt payments and require investors to take a bigger loss on their holdings.

 

An I.M.F. spokeswoman said Friday that it was important that any private-sector agreement, “together with the efforts of the official sector, ensures debt sustainability.”

 

As foreseen, the deal is expected to bring Greece’s debt down from about 150 percent of gross domestic product, which it is now, to 120 percent of G.D.P. by 2020. But the I.M.F. in particular has become very pessimistic about Greece’s ability to recover economically and believes its debt burden must decrease at a faster rate.

 

Within the fund as well as in Europe, the view is that the private sector needs to pay a larger share. Europe’s banks counter that they are in no position to take on more losses.

 

In its statement, the I.I.F. said that “discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach.”

 

The not-so-subtle message is that if Europe pushes too hard on this point, then the creditors can no longer accept the agreement as a voluntary one. This is important, because an involuntary restructuring would be seen by creditors as a default and trigger credit default swaps — something Europe and Greece are trying very hard to avoid.

 

The negotiations have been complicated by the increased influence of a bloc of investors, largely hedge funds, who have bought billions of euros of discounted Greek debt and have said they will not participate in a restructuring. They are betting that Europe will blink, give Greece its money and because the deal would be voluntary, these holdouts would get their payday.

 

With the breakup of the talks and the increased threat of a default, these investors may well choose to participate in the deal — in the hopes of getting something as opposed to the very little they would get if Greece went bankrupt.

 

A Rise in Consumer Sentiment

 

According to a report released on Friday, the Thomson Reuters/University of Michigan preliminary January reading on consumer sentiment hit an eight-month high in early January as Americans grew more optimistic about job prospects. The preliminary January reading on its overall index of consumer sentiment rose to 74.0 from 69.9 in December for the fifth month of gains and the highest level since May 2011.

 

Thirty-four percent of consumers polled in the confidence survey said they had heard of recent job gains, a record high in the survey's history and well above December's 21 percent.

While the gain brought the index close to 2011's high point, it is still well off the strength seen before the financial crisis. However, consumers still lacked confidence in government economic policies with the majority rating them unfavorably for the sixth month in a row.

 

Americans also remained dour on their personal finances with just 24 percent expecting their finances to improve in January, slightly below 25 percent last month. The survey's barometer of current economic conditions rose to the highest since February at 82.6 from 79.6 while its gauge of consumer expectations gained to 68.4 from 63.6.

 

Separate data released by the Commerce Department indicated that the U.S. trade deficit widened in November to its largest in five months. According to the Department, the data indicated a trade gap of $47.8 billion in November.

 

The wider deficit is a confirmation that more goods and services were produced outside the country, subtracting from gross domestic product. Separately, a dip in import prices showed inflation pressures were still muted, giving the Federal Reserve wiggle room as it holds U.S. benchmark interest rates at ultra-low levels. Import prices were down 0.1 percent in December after a 0.8 percent gain in November as oil prices fell, in line with economists' expectations.