MarketView for November 17

 

 

Summary

 

Scared by the S&P index's decline below a key technical level, brought on in part by ongoing concerns over the debt troubles facing Europe, investors and traders alike decided that it was time to sell. The end result was another substantial decline in all the major equity indexes. The S&P 500 fell steadily throughout the morning trading hours until it broke through 1,225, when selling picked up in both the futures and cash markets.

 

The fall around midday was swift and volume picked up once the 1,225 level was breached. About 2.83 million S&P E-Mini futures contracts traded on Thursday, with nearly 250,000 changing hands in an unusually busy 15-minute period when the market fell more than 1 percent.

 

The S&P struggled to break above 1,225 in August and September before piercing it on the way to a two-month high in late October. Computer-generated trading usually uses previous clusters of buying and selling as triggers.

 

There is no question that Wall Street has been obsessed over the European debt issues along with the political turmoil being faced by a number of EU countries.  This predilection for Europe’s economic data has the Street focused on Europe in general and bond yields in Spain and Italy in particular. Now there is no argument that the yields both Italy and Spain are currently being forced to pay are viewed as unsustainable and therefore merit attention. However not to the complete disregard for domestic data that is better than we have seen in some time.

 

Specifically the unemployment data (see below). New U.S. claims for jobless benefits hit a seven-month low last week and permits for future home construction rebounded strongly in October, the latest data to suggest the economy was gaining traction.

 

During the day in Europe, Spanish bond yields hit their highest level since 1997 at a 10-year auction, while a French bond auction also drew high yields. About 8.6 billion shares changed hands on the three major equity exchanges, a number that was above the current daily volume average of just above 8 billion shares.

 

Tech shares dragged the market lower, with the S&P technology down 2.2 percent. The 10 major S&P 500 sectors closed in the red for the day.

 

The broad sell-off repeated the pattern seen lately in which stocks are treated as an asset class, with little differentiation between winners and losers.

 

The 7 percent mark for bond yields that both Italian and Spanish benchmarks are close to is viewed as a line in the sand. Both Greece and Portugal were forced to seek bailouts after yields hit similar levels.

 

Good New on Unemployment

 

New U.S. claims for jobless benefits hit a seven-month low last week and permits for future home construction rebounded strongly in October, the latest data to suggest the economy was gaining traction.

 

The improving economic picture was spoiled somewhat by another report on Thursday showing factory activity in the Mid-Atlantic region slowed this month on weak orders. However, employers hired more workers and increased working hours.

 

Initial claims for state unemployment benefits fell 5,000 to 388,000, the Labor Department said, pushing a four-week average below the 400,000 mark for the first time since April. The report covered the survey period for the government's employment count for November and offered hope that hiring accelerated this month after payrolls rose 80,000 in October. First-time claims dropped 16,000 between the October and November survey weeks. The government will release its job count on December 2.

 

The weak labor market, marked by a 9 percent unemployment rate, has been one of the hurdles to stronger economic growth. Outside the jobs market, there were signs of stability in housing, with permits for home building soaring 10.9 percent to a seasonally adjusted annual rate of 653,000 last month.

 

While new construction fell 0.3 percent to annual rate of 628,000 units, economists believe residential building will soon contribute to growth as demand for rentals boosts the construction of apartment buildings. Last month, permits for buildings with five units or more rose to their highest level in three years.

 

The fairly upbeat data had little impact on Wall Street, where Europe's debt problems continued to dominate sentiment. Recent data, such as retail sales and industrial production, point to firming growth and is further proof of a continuing reduction in the risk of a new recession. In that vein, economists believe fourth-quarter growth could top an annual pace of 3 percent, stepping up from 2.5 percent in the July-September period.

 

However, the crisis in Europe, which has caused bond market turmoil across the region, could derail the recovery. St. Louis Federal Reserve Bank President James Bullard said Europe certainly posed a risk, but that he didn't believe it would hit the U.S. economy hard.

 

"If it blows up in a big disorderly way, which is what everyone is worried about, then that could come back to haunt the U.S.," he told CNBC. "If it just tumbles along for a long period of time, which is the most likely outcome, then I'm not sure that you get much feedback to the U.S."

 

While the Philadelphia Federal Reserve Bank's business activity index fell to 3.6 this month from 8.7 in October, an employment sub-index rose to a six-month high and the average workweek index more than tripled.

 

A reading above zero indicates factory activity is expanding in the region, which covers eastern Pennsylvania, southern New Jersey and Delaware. But the survey is not always a good barometer of national manufacturing.

 

The claims report showed the number of people receiving benefits under regular state programs after an initial week of aid in the week ended November 5 fell to a three-year low, further underscoring the improved labor market tone.

 

Greek Unrest

 

Greek police clashed with anti-austerity protesters and Italy announced sweeping reforms in response to a European debt crisis that on Thursday pushed borrowing costs for France and Spain sharply higher. More than 30,000 Greeks took to the streets of Athens in a protest rally that marked the first public test for a new national unity government that must impose painful spending cuts and tax rises if the country is to escape bankruptcy. Greek police fired tear gas against black-clad youths as protest marchers beat drums, waved red flags and shouted: "EU, IMF out!"

 

Italy's new Prime Minister Mario Monti unveiled sweeping reforms to dig the country out of crisis and said Italians were confronting a "serious emergency."  "Only if we can avoid being seen as the weak link of Europe can we contribute to European reforms," said Monti, who was sworn in on Wednesday as head of a technocrat government after a rushed transition from discredited ex-premier Silvio Berlusconi.

 

The Spanish government was forced to pay the highest borrowing costs since 1997 at a sale of 10-year bonds, with yields a steep 1.5 points above the average paid at similar tenders this year, drawing descriptions from the market ranging from "pretty awful" to "dreadful."

 

The euro fell in response. France fared a little better, but again had to pay markedly more to shift nearly 7 billion euros of government paper. Fears that the euro zone's second largest economy is getting sucked into the debt maelstrom have taken the two-year crisis to a new level this week.

 

In Rome, Monti outlined a broad raft of policies including pension and labor market reform, a crackdown on tax evasion and changes to the tax system in his maiden speech to parliament ahead a confidence vote to confirm backing for his technocrat government. With Italy's borrowing costs now at untenable levels, Monti will have to work fast to calm financial markets given Italy needs to refinance some 200 billion euros ($273 billion) of bonds by the end of April.

 

Ireland, which has been bailed out and gained plaudits for its austerity drive, will also be forced to do more. Dublin will increase its top rate of sales tax by two percent in next month's budget, documents obtained by Reuters showed.

 

But no amount of austerity in Greece, Italy, Spain, Ireland and France is likely to convince the markets without some dramatic action in the shorter term, probably involving the European Central Bank. Most likely the only way to stem the contagion for now is for the ECB to buy up large quantities of bonds, effectively the sort of 'quantitative easing' undertaken by the U.S. and British central banks.

 

France and Germany have stepped up their war of words over whether the ECB should intervene more forcefully to halt the euro zone's debt crisis after modest bond purchases have failed to calm markets.

 

Facing rising borrowing costs as its 'AAA' credit rating comes under threat, France has urged stronger ECB action but Berlin continues to resist, saying European Union rules prohibit such action.

 

"If politicians think the ECB can solve the euro crisis, then they are mistaken," German Chancellor Angela Merkel said. Even if the ECB assumes a role as lender of last resort, it would not solve the crisis, she said.

 

Investors and euro zone officials hope that if Merkel and others find themselves staring into the abyss, the unthinkable will rapidly become thinkable. With turmoil reaching a crescendo, euro zone banks are finding it harder to obtain funding. While the stresses are not yet at the levels during the 2008 financial crisis, they have continued to mount despite ECB moves to provide unlimited liquidity to banks.

 

Fitch Ratings warned it might lower its "stable" rating outlook for U.S. banks because of contagion from problems in troubled European markets. Fellow ratings agency Moody's cut ratings of 12 German public-sector banks, believing they are likely to receive less federal government support if needed.

 

German Finance Minister Wolfgang Schaeuble said on Thursday that the euro zone's debt crisis was beginning to hit the real economy and urged vigilance to prevent contagion from infecting banks and insurance firms.