Financial Market UpdateStrategicPoint of View®
May 3, 2010
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
Data was sparse – at least until Friday, when the Q1 GDP report reflected 3.2% growth for the first three months of the year. Although slightly lower than expected, growth did not disappoint, as it was led by consumer spending (+3.6% annual rate) and business investments (+13.4% annual rate). Prices paid for domestic purchases increased by only 0.6% annually, the lowest in 50 years – signaling that interest rates may be kept low. This message was reinforced when the Federal Reserve met mid week.
S&P 500: 1186 (down 2.55% for the week and up 6.37% on the year)
Dow: 11,008 (down 1.75% for the week and up 5.56% on the year)
NASDAQ: 2461 (down 2.73% for the week and up 8.46% on the year)
10-year: 3.65% (from 3.81% last week)
Crude Oil (June): $86.15 (from $85.20 last week)
Gold (June): $1,180 (from $1,154 last week)
USD/Euro: $1.3290 (from $1.3380 last week)
THIS WEEK
Upcoming economic reports: Personal Income, Consumer Spending, ISM Non Manufacturing, Construction Spending, Motor Vehicle Sales, Factory Orders, Pending Home Sales, ADP Employment, ISM Manufacturing, Jobless Claims, Productivity, Non-farm Payrolls, Unemployment Rate. Could we have a longer list? Or a more important one? This week’s economic data could help to confirm if the recovery is sustainable.
COMMENTARY
Volatility was back with a vengeance this past week, with markets witnessing yo-yo gyrations that swung between 214 points down to 122 points up. Two stories propelled the markets – one far more important than the other.
First – the lesser story, but the one that caused the most drama on Wall Street. Goldman Sachs came under scrutiny early in the week when executives were grilled in front of a Senate subcommittee. On Friday, potential accusations against GS expanded with a criminal investigation being launched by the New York’s Attorney General’s Office. The stock was downgraded by several analysts, leading to a 9% decline on Friday. Other financial stocks swooned in sympathy, as suspicions rose that Goldman would not be the only firm to suffer closer scrutiny and increased regulatory oversight. Much of the rally of the last year has been supported by outsized gains in the financial sector. As potential limits to future profits are factored in, financials could suffer further losses, in spite of the fact that this sector is still down 51% from its October 2007 highs.
The bigger story was the European Union’s questionable financial leadership in its planned rescue of Greece from itself. Yes, agreements were reached on a $147B rescue, but that was this past Sunday not last week. Fears of a contagion have not subsided. Recall that in 2007/2008 the default of a relatively small number of subprime mortgages eventually caused the biggest global credit crisis in sixty years. (Caveat: the insolvency of any country is far different than the bankruptcy of a company. Companies fold; the demise of a country unfolds.)
The concern is that if Greece is rescued, other countries in economic difficulty will not use proper fiscal restraint to control their own balance sheets – relying on the generosity of others to bail out poor debt management. This is called a ‘moral hazard.’
To gain a bit of perspective, picture the European Union as a big family of 27 siblings (countries). Mom is the European Central Bank and step-Dad is the IMF. Son Greece goes to Mom and Dad for financial help. Mom and Dad agree to provide some loans, but say Greece’s brothers and sisters also have to throw in some money of their own. The siblings (particularly the wealthier ones as Germany and France) complain loudly. “Why should we be responsible for our brother’s spend thrift ways, especially when we know that he is unlikely to change?” They have their own issues and know that once they help out Brother Greece, they could be expected to bail out Brother Portugal and Sister Spain. After all, we are talking family here.
This past week the S&P ratings services downgraded both Portugal and Spain debt issuance while the price of credit default swaps (those same unregulated derivatives that got AIG a US bailout in 2008) for both Portugal and Spain have risen dramatically. This has resulted in major increases in the cost of sovereign debt issuance for Greece, Portugal and Spain.
Rescuing Greece will take time. And Portugal and Spain are not on the brink of default. If the resolution of this crisis is allowed to unfold naturally, markets should be able to absorb the negatives. If the markets lose their confidence in Portugal, Spain or other countries, however, they may precipitate a crisis of confidence – warranted or unwarranted. Overseas banks could suffer and the European Union could be faced with unprecedented challenges.
Meanwhile, the US still looks like a better place to invest by comparison. Stocks may not stay down for long – at least in the near term. Any potential pullback still has the appearance of a correction for overpricing as opposed to any acceptance of a stalled recovery.
What makes us better than Europe right now? We have only one government – not 27 – to contend with and our stimulus/rescue program is winding down not up. With strong earnings reports, high productivity, low inflation and a Federal Reserve that is willing to hold interest rates low for the foreseeable future, investing in the U.S. is considered to be a safer bet than other parts of the world. Keep an eye on Europe, however. Spills – as we saw in the Gulf this week – have a tendency to spread unpredictably.
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*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.
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