MarketView for May 23

Summary  

The major equity indexes closed at their lowest levels in a month on Monday in a sign of increasing doubt that equity markets can weather recent weakness in global manufacturing and demand. Companies within the industrial, energy and technology sectors, sectors that are closely related to growth, were among the day's worst performers. Poor manufacturing figures from Germany and China were a surprise, which in turn led investors to start to take some money off the table. A good example of a company whose share price was hurt is Caterpillar, its shares ended the day down 2.3 percent to close at $101.89.

The drama surrounding the euro zone's debt crisis added to the day’s anxiety. Negative ratings actions on Greece and Italy and regional election results in Spain raised concerns about the deepening of the euro zone's debt problems. The logic is that voter rebellions against austerity plans could put some government debt at risk of default. That in turn added momentum to the recent trend of selling commodities, the euro, and stocks in tandem. The euro hit a two-month low against the U.S. currency.

In a sign of technical weakness, the S&P 500 closed below its 50-day moving average for the first time since April 19. It is also at its lowest level since that day. The stronger dollar hurt commodity prices and stocks in the energy and basic materials sectors. Large exporters, which have benefited from a weaker dollar, were also hit hard. A good example is Coca-Cola whose shares ended the day down 1.2 percent to close at $67.49, and equipment manufacturer Joy Global whose shares closed down 3.1 percent at $87.54.

Gasoline futures are down roughly 15 percent so far this month. On Monday, July crude oil futures lost 2.4 percent to settle at $97.70 a barrel.

About 6.44 billion shares changed hands on the major exchanges, far below last year's estimated daily average of 8.47 billion and under the 7.63 billion traded daily on average so far this year.

More Trouble on the European Front

Financial markets piled pressure on heavily indebted euro zone countries the result of increased concerns over the rising investment risks in Spain and Greece as the ratings agencies stoked new concerns over Italy and Belgium. Italy, which has the euro zone's biggest debt pile in absolute terms, was hit by credit ratings agency Standard & Poor's decision on Saturday to cut its outlook to "negative" from "stable".

In an explanatory statement, S&P said it did not expect Rome to seek financial help from the EU or IMF due to the "absence of significant imbalances". The sheer size of its public debt effectively made it too big to bail out.

Government sources said Rome would bring forward to next month planned decrees to slice 35 to 40 billion euros ($50-$56 billion) off the budget deficit in 2013 and 2014, in an effort to reassure markets.

Fitch Ratings warned it may downgrade Belgium's AA+ credit rating if the caretaker government misses its deficit targets due to a lack of political consensus on a balanced budget. The country has not had a proper government since a general election last June but is enjoying an economic boom.

A weekend rout of Spain's ruling Socialists in regional and municipal elections raised fears of clashes over deficit curbs between central and local government as Madrid fights to avoid following Greece, Ireland and Portugal into a bailout.

The premiums charged by investors to hold Italian and Spanish 10-year bonds rather than safe-haven German bunds rose to their highest levels since January, at 186 and 261 basis points respectively, before easing slightly.

The euro briefly fell below a key support level at $1.40, hitting a two-month low against the dollar. Similar concerns hit stocks, with the Milan exchange falling 3.3 percent. The shared European currency has lost as much as 6.5 percent against the dollar over three weeks, mainly through debt worries and despite a favorable interest rate differential.

The Greek government launched a long-stalled privatization program and announced other deficit reduction measures in a drive to win disbursement of a crucial 12 billion euro EU/IMF aid tranche next month and cut its budget gap to 7.5 percent of gross domestic product this year. It said it will sell its full stake in OTE telecoms immediately and in Hellenic Postbank and the two main ports of Piraeus and Thessaloniki by the end of this year, that in turn could raise as much as 5.5 billion euros.

Earlier in the day, stratospheric Greek debt yields rose still further, with 10-year bonds yielding more than 17 percent as investors worried about continued talk of "voluntary" debt re-profiling. The Greek yields do not reflect Athens' real borrowing costs because the country is surviving on IMF/EU loans and trading in Greek bonds is thin, but they are a barometer of market anxiety about some form of restructuring.

Visiting inspectors from the European Commission, the European Central Bank and the International Monetary Fund are withholding judgment on Greece's compliance with its rescue program until they see progress on spending cuts, revenue increases and privatizations. Among planned new belt-tightening measures were deeper cuts in public sector wages, more consumer tax increases and even the taboo issue of dismissing full-time civil servants. However, any attempt to modify debt maturities could trigger default insurance payouts and downgrades by ratings agencies would be likely to face legal challenge.

Austerity measures imposed under the IMF/EU bailouts or to avert a bailout are taking a high political toll on governments across Europe. Spain's ruling Socialists suffered their worst election result since the restoration of democracy in 1978, slumping to 27 percent of the vote, 10 percentage points behind the conservative opposition Popular Party.

Italy's center-right government lost ground in local elections last week, and a weekend opinion poll in Greece showed that for the first time since Socialist Prime Minister George Papandreou took office in 2009, the center-right opposition New Democracy party has drawn level with the ruling Socialist party.

The unpopularity of rescuing euro zone debtors was reflected in another disastrous regional poll result for German Chancellor Angela Merkel's center-right coalition on Sunday. Her Christian Democrats slumped to just 20 percent in Bremen, Germany's smallest federal state, while the liberal Free Democrats, junior partners in government, scored just 2.6 percent and lost their seats in the local assembly.