MarketView for November 18

Summary

We may be coming up on the Thanksgiving week holiday but there sure was not much in the way of a holiday mood on Wall Street as the Street ended its worst week in almost two months. The primary reason was Europe and essentially the Street decided to wait it out as a host of politicians in both the United States and Europe wrestle with a seemingly never ending host of problems.

The result was that Friday's directionless market showed more exhaustion than relief with whatever support there was coming after Italian and Spanish bond yields fell, primarily because of buying by the European Central Bank. In the United States, doubts grew whether a bipartisan committee could come up with budget cuts and tax increases that Congress can agree on next week.

Financial shares, which have been among the most sensitive to euro zone financial strains, rose on Friday. The S&P financial index was up 0.5 percent. Morgan Stanley edged up 0.6 percent to close at $14.21 but was down more than 13 percent on the week.

A major question has been whether the European Central Bank will find a way to act as a lender of last resort in the manner of the U.S. Federal Reserve. Speculation has grown the ECB could lend money to the International Monetary Fund to bail out some euro zone members.

For the week, the Dow fell 2.9 percent, the S&P was down 3.8 percent and the Nasdaq chalked up a 4 percent loss. At the same time, the S&P failed to rise above 1,225 after a drop below it on Thursday triggered massive selling, and it is now strengthening as technical resistance.

Spain's likely new leader, center-rightist Mariano Rajoy, pleaded with financial markets for breathing room to start tackling the country's economic crisis if he wins power in a parliamentary election this weekend.

While investors try to come to grips with how much of an impact the European crisis may have on the U.S. economy, data for the United States showed continued improvement. A gauge of future economic activity rose more than expected in October, according to the Conference Board.

About 6.7 billion shares changed hands on the three major equity exchanges, a number that was well below the current daily average of 8 billion shares.

The Economy Is Gathering Steam

The economy is gaining steam as factories increase auto production and slowing inflation increases spending power, putting the country on stronger footing to resist the economic storm gathering strength over Europe.

Recent readings of our economic pulse have steadily topped analysts' expectations. Many now think the fourth quarter will prove stronger than the third, when the economy expanded at a 2.5 percent annual rate. Forecasting firm Macroeconomic Advisers, for example, sees a growth rate of 3.2 percent over the final three months of the year.

While a widely expected European recession will likely drag on the economy next year, the United States will be able to lean into that headwind more than was possible just a few months ago. U.S. industrial output rose last month by the most since July, helped by higher production of motor vehicles and parts.

A slowdown in inflation has also helped households regain a little spending power, with weekly earnings rising in September and October when accounting for price changes. That has helped retail sales.

New car sales, for example, rose 7 percent last month to their highest level since February. Sales will likely rise another 8 percent in November, according to a forecast by J.D. Power and Associates and LMC Automotive.

Researchers at the San Francisco Federal Reserve Bank recently said Europe's travails make a U.S. recession likely by mid-2012, although most Wall Street economists are more optimistic and see odds closer to one-in-three.

In the latest hopeful sign the United States may be able to hold recession at bay, companies have cut back on layoffs substantially. New claims for unemployment benefits fell last week to their lowest level since April. That could indicate that employers are finally poised to ramp up hiring, which has been the missing piece in the country's sluggish recovery from the 2007-2009 recession. Still, it does seem that we just cannot catch a break.

Growth was picking up this time last year and many analysts thought the economy was turning a corner. Then a wave of civil unrest rippled through the Arab world, pushing oil and gasoline prices sharply higher and stinging American consumers.

Now, Europe's debt crisis looms and could become graver yet if a euro zone nation defaults on its debt or if one of the region's stronger economies has trouble finding financing. The United States could also shoot itself in the foot if lawmakers tasked with hashing out an austerity plan by next week disappoint financial markets.

Congress could also undercut the economy by allowing a payroll tax cut and extended unemployment benefits to expire, just one of the issues under debate by a special deficit-cutting panel.

Moreover, some of the recent strength in consumer spending has come from households cutting back on saving, which may not be sustainable.

Leading Economic Indicators Rise

Friday's report by the Conference Board indicated that its index of leading economic indicators rose a sharp 0.9 percent last month. It was the index's best showing since February. And it was far faster than the increases of 0.1 percent September and 0.3 percent in August. The index is designed to predict economic activity. The October figure marked the sixth straight increase.

The increase reflects gains in nine of the index's 10 components. Leading the way was a substantial increase in permits for home construction; a narrower gap between short- and long-term interest rates that suggested less concern about inflation; a recovery in stock prices; and growth in the money supply. A longer average workweek and fewer applications for unemployment benefits also contributed to the rise in the index.

All told, the components of the index signaled that the economy is steadily, if still slowly, strengthening.

Many economists said the October gain in the leading indicators offered further assurance that the economy is in no imminent danger of slipping back into a recession, so long as Europe doesn't fall into a severe downturn.

"This was a very positive reading for the leading indicators," said Mark Zandi, chief economist at Moody's Analytics. "The economy seems to be holding its own."