MarketView for June 13

 

Summary  

 

Stock prices meandered over the landscape on Monday, with the result that the major equity indexes were virtually unchanged although for the most part they did close out the day in positive territory. The key reason was simply fear, fear of another economic downturn despite the fact that the odds are very much against such a move.  Nonetheless, the S&P 500 index chalked up a small gain for only the second time in the past nine sessions. However, apparently share prices are still not cheap enough for bottom feeders to begin to feed in earnest.

 

Evidence of a weak global economic recovery has provided the impetus for a 6.6 percent drop in the S&P 500 from its May 2nd high. At the same time, deals in the insurance, apparel and communications technology sectors underscored the view that valuations are attractive. Allied World Assurance agreed to buy Transatlantic Holdings for $3.2 billion in stock. Transatlantic shares closed 9.5 percent higher at $48.19, while Allied closed down 4.5 percent at $55.44.

 

VF Corp, owner of the North Face clothing brand and chain, is buying Timberland, known for its hiking boots, for $2 billion to make a larger dent in the sales of outdoor gear, its biggest business. VF Corp shares rose 10 percent to close at $101.01, while Timberland closed up 44 percent at $43.20.

 

Selling pressure continued on Chinese Internet stocks, as E-Commerce China Dangdang fell 19.3 percent to $10.74, Renren lost 14.4 percent to $8 and Youku.com was down 14.5 percent to close at $26.78.

 

Volume was light with about 6.91 billion shares changing hands on the major exchanges, a number that was well below the daily average of 7.59 billion shares.

 

S&P Cuts Greece Again

 

Greece became the lowest-rated country in the world according to Standard & Poor's, which downgraded it on Monday and warned that any attempt to restructure the country's debt would be considered a default.

 

Greece now has a lower credit rating than countries such as Pakistan and Ecuador, which has been shut out of international markets since a 2009 default. The cost of insuring Greek debt is now almost twice as much as the price of insuring Pakistani bonds.

 

S&P's move was the latest blow for Greece's Socialist government, which is scrambling to push an unpopular austerity package through parliament to ensure continued funding under a year-old bailout plan.

 

Barely a year after Athens was granted a first 110-billion-euro (158-billion-dollar) aid package, the European Union, the IMF and the European Central Bank are working on a second funding deal. Some European countries such as Germany oppose giving more money to Greece without the assistance of private creditors.

 

S&P said European policymakers looked increasingly likely to impose a restructuring of Greece's debt -- either via a bond swap or by extending bond maturities -- as a means of making the private holders of Greek bonds share the burden.

 

"In our view, any such transactions would likely be on terms less favorable than the debt being refinanced, which we, in turn, would view as a de facto default according to Standard & Poor's published criteria," the agency said.

 

In such a case, S&P said, Greece's credit rating would be lowered to "selective default," or SD, while the ratings on the country's debt instruments would be cut to D. It also cut Greece's long-term sovereign credit rating to CCC, four steps away from default, from B. The short-term rating was affirmed at C and all ratings were removed from credit watch.

 

The move takes S&P's rating of Greece one notch below Moody's Caa1, while Fitch ranks Greece at B-plus. This makes Greece the lowest country in S&P's rankings. S&P said the outlook on the long-term rating remained negative, a sign that another downgrade is likely in the next 12 to 18 months. S&P said it will probably downgrade the ratings of four Greek banks as well -- National Bank of Greece, EFG Eurobank Ergasias, Alpha Bank, and Piraeus Bank, all of which are currently rated B.

 

Greece said the move by Standard & Poor's overlooked its commitment to carry on with tough fiscal efforts to repair public finances and remain a member of the 17-member euro currency club.

 

"The decision also overlooks the government's moves to avoid any problems relating to Greece's contractual obligations, as well as the will of all Greeks to plan our future inside the euro zone," the Finance Ministry said in a statement.

 

Several international banks have come out publicly in favor of rolling over their holdings of Greek debt, including France's Credit Agricole, which owns Greek bank Emporiki.

 

The banks' participation would be part of a second bailout for Greece worth around 120 billion euros aimed at giving Athens more time to tackle its 340-billion-euro debt load, under the assumption that it will not be able to borrow on international markets this year or next. Concerns that a second rescue may trigger a credit event drove the cost of insuring Greek government debt against default to a record high of 1,600 basis points on Monday.

 

Five-year credit default swaps (CDS) on Greek government debt rose 58 bps on the day to 1,600 bps, according to data monitor Markit, meaning it cost 1.6 million euros to protect 10 million euros of exposure to Greek bonds. By comparison, Pakistan's five-year CDS were trading around 880 bps.

 

The euro pared gains against the dollar and the U.S. stock market briefly turned negative after the downgrade. Brent crude oil also fell after the move increased investors' nervousness over the economy and oil demand.

 

There are differences between the leaders of European Union states and the ECB, which remains opposed to private sector involvement in any Greek debt restructuring, saying it may set off a chain reaction in financial markets that would undermine the credit-worthiness of other stressed euro zone sovereigns. EU leaders will discuss a new deal at a June 23-24 summit.

 

After failing to meet fiscal targets under the first bailout deal the government, which is trailing the conservative opposition in opinion polls, has decided to raise taxes and slash spending more than planned this year to avoid default. The prospect of more austerity and rising unemployment has fueled 20 days of protests in central Athens with a big general strike planned for Wednesday, challenging the government as its new package is headed for parliament for a vote.

 

Summers Calls for Additional Stimulus

 

Former White House aide Larry Summers on Sunday urged expanded tax cuts on wages, warning that America's economy was at risk of years of Japan-style stagnation without such a move. In an opinion piece, Summers -- a Harvard professor and former Treasury secretary under President Bill Clinton -- argued that it would be "premature" to withdraw fiscal support for the economy at the end of 2011.

 

Summers' comments come as Republican and Democratic lawmakers debate ways to reduce the deficit and as his former colleagues in President Barack Obama's administration mull a temporary cut in payroll taxes for employers.

 

Summers said the United States might have faced a double-dip recession if Obama had not agreed to a deal last year with congressional Republicans to extend unemployment insurance benefits and payroll tax cuts for workers. The deal was part of a wider package that included an extension of Bush-era tax cuts for the wealthiest Americans.

 

"Fiscal support should be continued and indeed expanded by providing the payroll tax cut to employers as well as employees," Summers wrote. "Raising the share of the payroll tax cut from 2 percent to 3 percent would be desirable as well." He said the cost would be a little over $200 billion.

 

"These measures offer the prospect of significant improvement in economic performance over the next few years translating into significant increases in the tax base and reductions in necessary government outlays," he said.

 

Summers said the $200 billion would cover both the expansion of the tax-cut and its extension through 2012. He also said the economy would benefit from an extra $100 billion in infrastructure spending over the next several years and recommended additional aid to states and cities.

 

Summers, who headed the National Economic Council for the first two years of the Obama administration, said that the "greatest threat" to U.S. creditworthiness was a sustained period of slow growth.

 

"This means that essential discussions about medium-term measures to restrain spending and raise revenues need to be coupled with a focus on near-term growth," Summers wrote. "Substantial withdrawal of fiscal support for demand at the end of 2011 would be premature."

 

During much of 2010, Obama's economic advisers wrestled with a debate over whether to shift toward deficit reduction or pursue further fiscal stimulus.

 

Summers and former White House economist Christina Romer were in the camp arguing that the recession that followed the financial markets meltdown of 2008-2009 was a unique event that required aggressive stimulus to avoid a long period of stagnation similar to Japan's "lost decade" of the 1990s.

 

Former White House budget director Peter Orszag was among those who cautioned against a further big stimulus that was not coupled with deficit reduction in later years, as he warned of the danger of ballooning debt and deficits.

 

The payroll-tax cut was enacted late last year just before Summers returned to his teaching job at Harvard University. He left the administration hopeful that the package would be enough to restore the economy to vigor. Solid payroll growth in the first few months of the year offered reasons for optimism.

 

Summers listed several factors that contributed to the slowdown: the fallout on the global economy from Japan's earthquake, concerns in European debt markets, high oil prices and a deceleration in China's rate of growth.

 

But he also said the U.S. economy is in a "cycle that has some of the characteristics of what happened in Japan" following the bursting of its asset bubble and that's why it has struggled to regain its stride.

 

"The economy isn't as strong as I expected last winter," Summers. He said that in post-bubble recessions, such as Japan's in the 1990s and the Great Depression of the 1930s, there is a tendency to assume any pickup in growth means a return to normal growth but recoveries in those cases take much longer.