MarketView for October 10

 

 

Summary  

 

The major equity indexes were up 3 percent on Monday, extending gains into a second week as a pledge by German and French leaders boosted hopes that the euro-zone debt crisis may be resolved. The gains lifted the S&P 500 above its 50-day moving average for the first time since late July, a bullish technical signal. The S&P 500 is now up about 11 percent since its low on Tuesday, when it briefly fell into bear-market territory.

 

Financials, the most beaten-down stocks during the recent slide, led the rally with JPMorgan Chase up 5.2 percent at $32.30 and Bank of America up 6.4 percent at $6.28. The gains, however, came on the second-lightest day of trading since July and may not be indicative of a long-term trend. The advance has been driven by short-covering and managers buying stocks as they try to catch up to the sharp rally built on headlines out of Europe.

 

German Chancellor Angela Merkel and French President Nicolas Sarkozy promised on Sunday to unveil a comprehensive new package to ease the euro zone's debt crisis.

 

Earnings season is set to begin with Alcoa's report tomorrow after the closing bell and will likely become a driver for stocks in coming weeks.

 

Adding to optimism that there may be a resolution of the euro zone's problems, a move to nationalize Franco-Belgian bank Dexia was seen as an indication that governments would step in and keep large lenders from failing.

 

The energy and materials sectors also ranked among the day's strongest-performing sectors, while the Dow Jones Transportation Average gained 3.9 percent. Tech provided another source of strength, with the Philadelphia semiconductor index up 2.8 percent.

 

The materials and energy sectors are forecast to have had the highest earnings growth rates for the third quarter, Shares of aluminum company Alcoa, which is one of the 30 Dow industrials, jumped 3.9 percent to $10.09.

 

Volume was lighter than average, possibly affected by the Columbus Day holiday. Government offices and the Treasury bond market were closed for the holiday. About 6.82 billion shares were traded on the major equity exchanges, well below the year's daily average so far of 8.03 billion shares.

 

Will the Markets Continue Their Upward Trend?

 

The stock market is riding a wave of renewed optimism and the question is whether or not the upcoming earnings season will enable us to rally through the remaining quarter. I would have to vote yes. The European debt crisis and worries over our economic growth have placed considerable pressure on the markets. Since hitting 13-month lows last week, though, stocks have rallied sharply, putting the bulls back in the driver's seat as shorts scramble to cover their bets.

 

The market's lousy psychology for most of the past two months -- built on expectations for poor economic growth and a worsening euro-zone crisis -- could mean investors are still expecting disappointments. Such cautious expectations might end up helping stocks if results are not dismal.

 

The earnings period is due to kick off on Tuesday, when Alcoa reports after the market's close. Google and JPMorgan Chase are expected to report on Thursday.

 

Analysts' forecasts for S&P 500 companies' profits have come down slightly in recent weeks. They expect a rise in profits of 12.6 percent compared with the third quarter a year ago. On July 1 their forecast was for 17 percent growth, Thomson Reuters data showed.

 

Investors have worried that the European debt and U.S. growth problems, as well as possibly less-robust expansion in China, hurt third-quarter results. With recent economic data coming in better than expected, it has given investors hope that company results will be strong enough to bolster stock prices.

 

Unlike the euro-zone crisis, a vast problem that causes investors to respond mostly at an emotional level, earnings reports allow for direct comparisons to current market valuations. And by many measures, stocks are relatively cheap. The price-to-earnings ratio of the S&P is low by historical standards. The S&P 500's forward P/E of 10.8 is at its lowest in roughly 10 years.

 

Sectors expected to see the greatest growth are energy and materials. To that, I would add technology and consumer staples.

 

Progress at Athens

 

The European Union postponed a crucial summit to allow time for a broader solution to Greece's debt crisis on Monday after Athens said it had concluded talks with international lenders on an aid payment it needs to hold off default.

 

Chancellor Angela Merkel and President Nicolas Sarkozy gave no details of their proposals but said they would also cover closer euro zone integration and steps to tackle Greece's debt mountain and prevent financial market contagion.

 

"The German and French governments are convinced this will be a contribution to the euro zone winning back confidence and its capacity to act -- and I do mean a contribution, not the 'miracle cure' everyone keeps asking for," German government spokesman Steffen Seibert said.

 

The next regular summit of EU leaders was postponed by six days to October 23 to allow time "to finalize our comprehensive strategy on the euro area sovereign debt crisis," European Council President Herman Van Rompuy announced.

 

"Further elements are needed to address the situation in Greece, the bank recapitalization and the enhanced efficiency of stabilization tools (EFSF)," he said in a statement.

 

The German candidate for the European Central Bank's executive board said on Monday that all systemically important banks in the 27-nation EU should be made to raise fresh capital simultaneously to avoid singling out individual lenders.

 

Recapitalization "should be done in an EU27 context in a way to avoid stigma effects," Joerg Asmussen told the European parliament. "The best is not to do this institution by institution, but to do this for all systemically important banks in the EU 27 at the same time.

 

In Athens, Finance Minister Evangelos Venizelos said Greece had concluded talks with European Union and International Monetary Fund officials and expected private bondholders to make a bigger contribution than originally envisaged in a second bailout deal agreed in July.

 

Greece says it needs an 8 billion euro aid installment in November to avoid running out of money to pay salaries and pensions. Its next bond redemption is due in December.

 

Venizelos said Athens expected improvements in the 109 billion euro rescue package agreed by euro zone leaders and hinted that banks will take heavier losses, calling it "PSI Plus." PSI stands for private sector involvement.

 

"We expect an overall package better than the one initially drafted, because we have to take into consideration the new parameters," he said, alluding to a deeper than expected recession that has derailed Greece's budget deficits.

 

The EU, IMF and ECB mission chiefs, known as the troika, are likely to conclude their visit with a joint statement by Tuesday. They will then prepare reports for euro zone finance ministers and the IMF board to decide on the aid tranche.

 

A German newspaper said Merkel had concluded Greece was insolvent and was pushing for a mandatory debt restructuring.

 

Business daily FT Deutschland, citing unnamed government officials, said Germany was trying to persuade EU partners to accept the inevitable, but faced opposition from the European Commission, the European Central Bank, and several member states, including France.

 

German Finance Minister Wolfgang Schaeuble has said private bondholders may have to contribute more than the 21 percent write down agreed in July. Government spokesman Seibert declined to go further, saying Berlin was awaiting the troika's report.

 

The fragility of Europe's banks was highlighted early on Monday when the board of Franco-Belgian municipal lender Dexia approved a break-up plan under which the French and Belgian governments will guarantee 90 billion euros in toxic assets, including euro zone sovereign bonds.

 

Austria's Erste Group Bank, the second biggest lender in emerging Europe, said it would lose up to 800 million euros this year and not pay a dividend after taking hits on foreign currency loans in Hungary and euro zone sovereign debt.

 

Other European banks expect to be ordered to raise more capital under the Franco-German effort to draw a line under the debt crisis.

 

"We expect the EU to come up with a minimum core tier I (capital) level under certain stress scenarios and a higher one without any stress. Then banks will be asked to reach this level in a short period of time," said a senior German banker.

 

Banks were not involved in talks yet with governments on likely capital needs, several bankers said, although options were being considered in case they need to act quickly.

 

From outside the euro area, British Prime Minister David Cameron urged euro zone leaders to take a "big bazooka" approach to the crisis, telling the Financial Times they need to break a cycle of doing "a bit too little, a bit too late." He pressed them to increase the firepower of the 440 billion euro European Financial Stability Facility and remove all uncertainty about Greece's economic future to prevent economic disaster.

 

Nobel Prize in Economics Awarded

 

Americans Thomas Sargent and Christopher Sims shared the Nobel Prize in economics on Monday for work that governments use to gauge the effect of policy, but they had no easy answers to a global crisis one called simply "this mess."

 

Central to research the two conducted separately in the 1970s were efforts to model and quantify cause and effect in economies, including the complex interplay of state and central bank policy with the expectations of people and businesses.

 

"Panics and crises, ... what's going on in Europe now with the euro, that's all about expectations about what other people are going to do," Sargent said in an interview aired on the Nobel Prize organization's website.

 

For example, government spending to bounce an economy out of slump may have its impact limited by people seeing the limits to state finances and expecting the stimulus to run out. But, while his research had "tightened" ideas about how expectations influenced policies and their impact, Sargent cautioned that he and Sims, long colleagues at the University of Minnesota, had no easy answers to today's crisis.

 

"We're just bookish types that look at numbers and try to figure out what's going on," Sargent said. "We try to experiment in our models before we wreck the world."

 

Sims said of the world's present financial troubles: "If I had a simple answer to that I would have been spreading it around the world ... It requires a lot of slow work looking at data, unfortunately."

 

But he said: "The methods that I have used and that Tom has developed are essential to finding our way out of this mess."

 

The Royal Swedish Academy of Sciences said it made the 10 million crown ($1.5 million) award in honor of "empirical research on cause and effect in the macro economy" and said their work laid the foundation for modern macroeconomic analysis.

 

"One of the main tasks of macroeconomic research is to comprehend how both shocks and systematic policy shifts affect macroeconomic variables in the short and long run," the Academy said in a statement. "Sargent's and Sims's awarded research contributions have been indispensable to this work."

 

Sargent developed a mathematical model in his work and described it in a series of articles in the 1970s. Sims wrote an article in 1980 which introduced a new way of analyzing data using a model called vector-auto regression.