MarketView for November 9

 

 

 

Summary

 

The major equity indexes lost about 3 percent of their value on Wednesday in the market's worst day since mid-August. A sharp rise in Italian bond yields signaled the European debt crisis had worsened. The S&P 500 saw its worst daily percentage drop since August 18.

 

All 10 S&P sectors were down, but S&P financials were the hardest hit on worries about European exposure, dropping 5.4 percent. U.S. stock markets have grown more chaotic in response to rising volatility in European debt markets, and investors have trouble keeping up with a steady stream of headlines and pricing in how the crisis might play out. 

 

The spread of the crisis to Italy has lifted it to a new level. European Union sources said German and French officials were discussing drastic plans, including an overhaul that would possibly create a smaller euro zone.

 

Italy's bond yields shot up to 7.502 percent, a new high since the euro was introduced in 1999. Investors were forced to sell Italian bonds after a European clearing house increased the collateral needed to borrow against that debt. The 7 percent level was the point where European nations, including Ireland and Portugal, had to seek bailouts as their financing costs ballooned.

 

General Motors fell 10.9 percent to $22.31 after the automaker said it would not break even for the year in Europe, as it had forecast, due to deteriorating conditions in the region. 

 

Prime Minister Silvio Berlusconi's insistence on elections instead of an interim government raised concerns of prolonged instability and delays to economic reform.

Italy has replaced Greece at the center of the euro zone debt crisis and is seen teetering on the cusp of requiring a bailout. A deal on forming a Greek national unity government collapsed while economic turmoil continued.

 

Reflecting growing market anxiety, the CBOE Volatility Index VIX jumped 31.6 percent, its biggest daily percentage gain since mid-August. The index usually moves inversely to the S&P 500 as traders use it as a hedge against falling stocks. Among bank stocks, Morgan Stanley fell 9 percent to $15.76. Goldman Sachs closed down 8.2 percent to $99.67. Bank of America lost 5.7 percent to $6.16.

 

After the closing bell, shares of Cisco Systems rose 2.2 percent to $18 after it reported earnings that beat expectations.

 

During the session, approximately 8.65 billion shares changed hands on the three major equity exchanges, just above last year's daily average of 8.47 billion.

 

Italy Facing Disaster

 

Italian borrowing costs reached the breaking point on Wednesday after Prime Minister Silvio Berlusconi's insistence on elections, instead of an interim government, threatened prolonged instability and kindled fears of a split in the euro zone.

 

European Commission President Jose Manuel Barroso issued a stern warning of the dangers of splitting the zone, rocked by an escalating debt crisis. Rumor has it that French and German officials have held discussions on just such a move.

 

"There cannot be peace and prosperity in the North or in the West of Europe, if there is no peace and prosperity in the South or in the East," Barroso said.

 

Italian 10-year bond yields moved above the 7 percent level, the point at which it is widely that such a yield is both unsustainable and reflects the rapid disintegration of investor confidence.

 

German Chancellor Angela Merkel said Europe's plight was now so "unpleasant" that deep structural reforms were needed quickly; warning the rest of the world would not wait. "That will mean more Europe, not less Europe," she told a conference in Berlin.

 

She called for changes in EU treaties after French President Nicolas Sarkozy advocated a two-speed Europe in which euro zone countries accelerate and deepen integration while an expanding group outside the currency bloc stays more loosely connected -- a signal that some members may have to quit the euro.

 

"It is time for a breakthrough to a new Europe," Merkel said. "A community that says, regardless of what happens in the rest of the world, that it can never again change its ground rules, that community simply can't survive."

 

The European Central Bank, the only effective bulwark against market attacks, intervened to buy Italian bonds in large amounts but remained reluctant to go further. Italy has replaced Greece at the center of the crisis and is on the cusp of needing a bailout that Europe cannot afford.

 

Having lost his majority in a parliamentary vote, Berlusconi confirmed he would resign after implementing economic reforms demanded by the European Union, and said Italy must then hold an election in which he would not stand.

 

He opposed any form of transitional or unity government -- which the opposition and many in the markets favor -- and said polls were not likely until February, leaving a three-month policy vacuum, during which havoc could ensue.

 

Italian President Giorgio Napolitano said there was no doubt about the resignation of Berlusconi, once economic reforms were implemented by parliament within days. "Therefore, within a short time either a new government will be formed...or parliament will be dissolved to immediately begin an electoral campaign," Napolitano said.

 

Even with the exit of a man who came to symbolize scandal and empty promises, it will not be easy for Italy to convince markets it can cut its huge debt, liberalize the labor market, attack tax evasion and boost productivity.

 

Worries that the debt crisis could be infiltrating the core of the euro zone were reflected in the spread of 10-year French government bonds over their German equivalent blowing out to a euro era high around 140 basis points.

 

Christine Lagarde, head of the International Monetary Fund, told a financial forum in Beijing that Europe's debt crisis risked plunging the global economy into a Japan-style "lost decade." "If we do not act boldly and if we do not act together, the economy around the world runs the risk of downward spiral of uncertainty, financial instability and potential collapse of global demand."

 

Berlusconi has reluctantly conceded that the IMF can oversee Italian reform efforts.

 

Euro zone finance ministers agreed on Monday on a road map for leveraging the 17-nation currency bloc's 440-billion-euro ($600 billion) rescue fund to shield larger economies like Italy and Spain from a possible Greek default.

 

However, there are doubts about the efficacy of those complex plans, and with Italy's debt totaling around 1.9 trillion euros even a larger bailout fund could struggle to cope.

 

Many outside Europe are calling on the ECB to take a more active role as other major central banks do in acting as lender of last resort. German opposition to that remains implacable, seeing it as a threat to the central bank's independence.

 

The discussions among policymakers in Paris, Berlin and Brussels raise the possibility of one or more countries leaving the zone, while the core pushes to deeper economic integration.

 

Possible Downsize of the EU

 

German and French officials have discussed plans for a radical overhaul of the European Union that would involve establishing a more integrated and potentially smaller euro zone, EU sources say.

 

French President Nicolas Sarkozy gave some flavor of his thinking during an address to students in the eastern French city of Strasbourg on Tuesday, when he said a two-speed Europe -- the euro zone moving ahead more rapidly than all 27 countries in the EU -- was the only model for the future.

 

The discussions among senior policymakers in Paris, Berlin and Brussels go further, raising the possibility of one or more countries leaving the euro zone, while the remaining core pushes on toward deeper economic integration, including on tax and fiscal policy.

 

Such steps are also opposed by many EU countries, whose backing would be needed for any adjustments to the bloc's treaties, making them anything but a done deal. To an extent the taboo on a country leaving the 17-member currency bloc was already broken at the G20 summit in Cannes last week, when German Chancellor Angela Merkel and Sarkozy both effectively said that Greece might have to drop out if the euro zone's long-term stability was to be maintained.

 

However, the latest discussions among European officials point to a more fundamental re-evaluation of the 12-year-old currency project -- including which countries and what policies are needed to keep it strong and stable for the next decade and beyond -- before Europe's debt crisis manages to break it apart.

 

In large part the aim is to reshape the currency bloc along the lines it was originally intended; strong, economically integrated countries sharing a currency, before nations such as Greece managed to get in.

 

Speaking in Berlin on Wednesday, Merkel reiterated a call for changes to be made to the EU treaty -- the laws which govern the European Union -- saying the situation was now so unpleasant that a rapid "breakthrough" was needed.

 

"The world is not waiting for Europe," she said in comments that focused on treaty change but hinted at more fundamental shifts. "Because the world is changing so greatly, we have to make a mental decision to find an answer to the challenges."

 

From Germany's point of view, altering the EU treaty would be an opportunity to reinforce euro zone integration and could potentially open a window to make the mooted changes to its make-up. Therefore, a treaty change will be formally discussed at a summit in Brussels on December 9, with an 'intergovernmental conference', the process required to make alterations, potentially being convened in the new year, although multiple obstacles remain before such a step is taken.

 

While the two-speed Europe referred to by Sarkozy is already reality in many respects In Sarkozy's vision, the euro zone would rapidly deepen its integration, including in sensitive areas such as corporate and personal taxation, while the remainder of the EU would be left as a "confederation," possibly expanding from 27 to 35 in the coming decade, with enlargement to the Balkans and beyond.

 

Within the euro zone, the critical need would be for core countries to coordinate their economic policies quickly so that defenses could be erected against the sovereign debt crisis. France and Germany see themselves as the backbone of the euro zone and frequently promote initiatives that other euro zone countries reject. The idea of a core, pared-down euro zone is likely to be strongly opposed by the Netherlands and possibly Austria, although both would be potential members.

 

New Prime Minister for Greece Non-existent

 

A deal on forming a Greek national unity government collapsed on Wednesday as the country headed toward an economic abyss, hours after outgoing Prime Minister George Papandreou said he was handing over to a coalition that does not exist.

 

In a day that was bizarre and chaotic even by Greek political standards, Papandreou wished his successor well and headed off to meet the president -- only for it to emerge that there was no successor due to feuding in the political parties.

 

Earlier, party sources said senior members of the socialist and conservative camps had settled on the speaker of parliament, veteran socialist Filippos Petsalnikos, barring last-minute snags.

 

Snags did indeed emerge, with large sections of Papandreou's PASOK party and the conservative New Democracy refusing to back Petsalnikos after a three-day hunt for someone to lead the coalition until early elections in February.

 

Greeks and the nation's international lenders have watched in growing horror for three days as party leaders feuded over a shrinking list of credible candidates to lead the national unity coalition after Papandreou's government imploded.

 

Greece will run out of money next month unless the new government comes agrees emergency funding with the European Union and International Monetary Fund, Greece's last remaining lenders, including a 130 billion euro bailout.

 

Some lawmakers said the parties would have to return to an earlier plan -- apparently stalled -- of recruiting Lucas Papademos, a former vice-president of the European Central Bank, to head the new government as a technocrat and give it the credibility that politicians lost long ago.

 

According to socialist lawmaker Spyros Vougias, "The only solution is Papademos. If he accepts by tomorrow morning we will be able to form a strong government that will pull the country out of the crisis,"

 

Papandreou and New Democracy leader Antonis Samaras began talks with President Karolos Papoulias on a new coalition to save Greece from bankruptcy. But before leaders of smaller parties could join them to seal the coalition, the talks were abruptly halted.

 

The president's office said a meeting of party leaders would be held at 0800 GMT on Thursday, although in the current chaotic atmosphere political talks are often delayed or fail to happen at all.

 

Party sources said some lawmakers saw Petsalnikos as a pawn of Papandreou, and attacked him for supporting the prime minister's failed plan to call a referendum on the bailout, which brought his socialist government to its knees.

 

Adobe Surrenders

 

Adobe Systems is halting development of its Flash Player for mobile browsers, surrendering to Apple in a war over Web standards, while signaling a strategic about-face that left Wall Street nervous about future growth.

 

Adobe's concession to Apple and its late founder Steve Jobs, who famously derided Flash as an inefficient power-hog, comes as the design software specialist warned that revenue growth will slow next year when it shifts toward leasing its software on a subscription basis instead of selling licenses up front.

 

The news, detailed Wednesday at the company's annual analyst day, caught investors by surprise and sent shares in the company tumbling about 7 percent in afternoon trading.

 

Adobe announced a restructuring plan on Tuesday that involves eliminating 7 percent of its workforce. Adobe said revenue growth is expected to slow to 4 to 6 percent in fiscal 2012 -- below the roughly 9 percent Wall Street was projecting, on average.

 

Adobe is waving the white flag on Flash more than a year after Jobs, who died in October after a years-long struggle with cancer, wrote his nearly 1,700-word Flash "manifesto," calling it unreliable and ill-suited for mobile devices. Adobe retaliated by taking out newspaper ads saying Jobs was just plain wrong.

 

The decision by the software maker means that Web developers will probably stop using its Flash tools to produce video, websites and applications for delivery over mobile browsers.

 

That would be a relief for tens of millions of iPhones and iPad users, whose browsers are not capable of viewing content built in Flash.

 

While the difference between Flash and HTML5 might seem like inside baseball for the average person, it is of keen interest to developers and device makers from Motorola Mobility Holdings Inc to Samsung Electronics Co Ltd.

 

Analysts say the cessation on Flash development might be a setback for some of the major manufacturers that had partly relied on their ability to support the standard as one reason for choosing them over Apple's gadgets.

 

"It certainly changes the position a little bit for those who said that iOS products such as iPhone and iPad were disadvantaged for not supporting flash. Clearly that's not the case anymore," said Michael Gartenberg, an analyst with Gartner. However, "Flash is definitely not going away. It's still going to be an integral part of the Web experience, particularly on the desktop (where) some of these technologies will continue.

 

Jobs refused to build Flash technology into his company's mobile browsers, insisting they offered an inferior browsing experience. Adobe refuted those claims and sought to pressure Apple to incorporate Flash into iPhones and iPads.

 

Meanwhile, HTML5 has taken off since Apple refused to adopt Flash because developers who used Adobe's proprietary technology did not want to miss out on getting their content viewed by iPhone and iPad users. The newer technology also uses open standards, which means a single company like Adobe does not have control over the technology.

 

Adobe conceded that HTML5 has become the preferred standard for creating mobile browser content. Indeed, in the past year, the company had begun diverting resources to supporting the standard. The company said it plans to infuse HTML5 technology across its entire product line over the coming years, offering increasingly sophisticated tools and services to design professionals, publishers, retailers and other businesses.