Financial Market Update

StrategicPoint of View®: July 25th, 2011

Welcome to the StrategicPoint of View® -- a market and economic overview of what occurred last week, what's up for this week, and our commentary on the economy and current market activity in general for "Making Money" listeners.

LAST WEEK 

Take some positive signs on the debt issues in Europe, add in some encouraging news (at the time) on our own debt ceiling and top it off with positive earnings news from several market leaders and you get a recipe for a strong rally in the markets.

News of the $157 billion plan to bail out Greece was well received, but perhaps more important in the deal was the increased ability of the EFSF (European Financial Stability Facility), allowing it to lend directly to governments. This increased capacity will now allow the states to recapitalize financial institutions. The hopes are that this will ultimately be the solution to the issues arising in Spain and Italy. Without this measure, to calm investors in Spain and Italy, the plan probably would not have been as well received as it was.

Here in the US, by mid-week, rumors were flying that President Obama and Republican House Speaker John Boehner had reached a deal to resolve the debt ceiling expiration. The feeling at the time was that the two men were closing in on a package, calling for $3 Trillion in savings from spending cuts and increased revenue, as a result of tax code changes. However, by Friday morning the rumors appeared to be misleading, as Boehner walked away from the talks, and without any resolution. At the time, markets hoped that the weekend would allow further progress to be made.

S&P 500: 1,345 (up 2.19% for the week and up 6.95% on the year)
NASDAQ: 2,858 (up 2.47% for the week and up 7.76% on the year)
Dow: 12,681 (up 1.61% for the week and up 9.53% on the year)
US Treasury 10 yr: 2.96% (from 2.91% last week)
Crude Oil (Sept): $99.87 (from $97.38 last week)
Gold (August): $1,601 (from $1,594 last  week)
USD/Euro: $1.4356 (from $1.4158 last week)

THIS WEEK

The economic calendar this week is chock full of important releases. Tuesday sees the release of the Consumer Confidence report, which has slid the last two months, albeit just slightly. Wednesday the markets will get to see the latest Durable Goods report. Expectations are wide for this report, but it is an important indicator for both capital spending outlooks and industrial production. Finally, after the pending home sales figures on Thursday, the market will get a chance to digest the initial 2nd quarter GDP numbers. Estimates are for continued sluggish growth in the 1.5% to 2% range.

The reality is even with all these economic releases, and the continuation of the earnings season, the markets will continue to react more so to every headline issued from Washington DC. Expectations originally had been that a deal would not be struck until the final hour. The markets, it appears, were fooled last week into believing that our elected officials would realize the enormity of the issue and come to some compromise prior to the August 2nd deadline. The rally in equities was largely predicated on the belief that a deal was imminent. We even had hoped that by the time you would be reading this, that at least the framework of a deal would be agreed upon. We now know this will not be the case.

COMMENTARY
74

According to the non-partisan Congressional Research Service (CRS), the creation of the debt ceiling was to give “Treasury a greater ability to respond to changing conditions and more flexibility in financial management”. So while seventy-four was certainly not the temperature around most of this area over the weekend it is the total number of times that the debt ceiling has been raised since 1962. Ten of those times, have been since 2001 alone. Not once was the political grandstanding as high as it is today. Time after the time the vote came and went, without much of a mainstream discussion other then perhaps cursory coverage. One could argue that perhaps if there was more serious discussion and analysis placed on those previous votes, that the US would not be in such a quandary as it finds itself today. Alas, here we were over the weekend patiently awaiting the newest press release on some sort of agreement.

Markets and investors alike were sucked in this past week, to the thought that perhaps our elected officials had finally come to some sort of agreement on the debt ceiling for the 75th time. The theory at the time was that both sides realized the enormity of the current situation, and that the potential fallout from a failure to raise the ceiling was far too great a price to pay. Economists and politicians have struggled to explain with certainty what might the outcome be of a failure to raise the ceiling, but they both do agree that the expectations are quite dour.

The base case since this debt ceiling crisis began has always been that there would be a midnight hour resolution. Like a child, procrastinating on his or her homework, Congress and the President would wait until the very last possible second to finally sit down and really come to some sort of resolution. Sure, like any parent, investors can hope that just this one time they would not wait until the very last moment to compromise and come to some sort of resolution. Yet here we sit with less then eight days till August 2nd, and they appear to be no closer today then they were two or three weeks ago.

So is it time to change that base case scenario to something much more troubling? For many, including us, the best indicator to watch is Treasury yields. If the market begins to question the ability of a corporation to pay back their creditors, bond prices generally drop as investors demand higher returns for the perceived increase in risk. It’s why junk bonds pay so much more than Treasuries; there is a risk that you may not get your principal back. So far, Treasuries prices have yet to react to the constant conflict in reports on a compromise. Even the constant coverage by the mainstream media on the potential downgrade of US Treasuries has yet to move prices. No one can say for certain what will come of the last minute discussions, even though many will try. For many, the reality is that until they see higher Treasury yields, the original thought that a deal won’t be struck until the midnight hour remains in full effect. In the meantime we’ll continue to watch the headlines and hope that a resolution comes in soon. 

 *Past performance is not indicative of future results. Indices are unmanaged and you cannot directly invest in them. The Nasdaq Composite Index measures all NASDAQ U.S. and non-U.S. based common stocks listed on the Nasdaq Stock Market. The S&P 500 index is based on the average performance of 500 industrial stocks monitored by Standard and Poor’s. The data referred to above was taken from sources believed to be reliable. StrategicPoint Investment Advisors has not verified such data and no representation or warranty, expressed or implied, is made by StrategicPoint Investment Advisors.