Is the Eurozone Moving Towards A Rescue Deal?

Ashley Page, Senior Vice President, Wealth Consultant

10/24/11: In the markets, as in life, there are no guarantees but everyone is entitled to their opinion. Here’s my opinion on the general financial situation followed by four items impacting markets this coming week:

U.S. stocks ended the past week with a strong rally, though the gains for the five-day span were limited for the most part to the large caps.  The Dow Jones Industrials rose 1.4% over the week, the S&P 500 rose 1.1%, the Nasdaq fell 1.1% and the Russell 2000 dropped 0.01%.  Despite the fact that we are heavier into earnings season in the United States and that would normally be the major market focus, investors are really “dialed in” to the situation in Europe. The European meetings over the weekend had a generally positive tone with the main issue being how much the banks will incur in loan losses driven by peripheral Europe (Greece primarily).  Previously, the amount had been 21% of credit extended, where now it appears that it will be in the 50% to 60% range.

In addition to the “all-important” upcoming European meeting this Wednesday, we have several data points concerning the U.S. economy that will be released.  On Tuesday, the S&P/Case-Shiller home price index for August will come out along with the Conference Board’s consumer confidence numbers for October.  On Wednesday, data on durable-goods orders for September are due along with a report on sales of new homes in September.  Thursday reports will provide us the Commerce Department’s initial estimate of third-quarter gross domestic product and Friday will bring the publication of The University of Michigan’s final reading of consumer sentiment for October.

Here are the four main focus points for the week that we are tracking at our financial planning services firm:

  1. The Eurozone is moving towards a rescue deal. EU leaders said they made progress over the weekend towards a comprehensive plan to solve the debt crisis, although no final decisions will be made until Wednesday.  The leaders agreed on a framework for a bank recapitalization of up to $153 billion and on how to leverage up the eurozone’s EFSF rescue fund to prevent contagion, although the differences remain over the size of losses for the banks on problem debt.  In short, the banks have agreed to a 40% “voluntary” writedown, but the governments involved are wanting levels in the 60% range.
  2. Even if we get the Eurozone debt plan in place, is Europe headed for a recession anyway? Preliminary PMI (Purchasing Managers Index) data for October certainly seems to point in that direction.  The reading dropped to 47.2 from 49.1 in September, a level consistent with a 1% overall GDP contraction.  German manufacturing fell for the first time in two years, while the services sector in France is also down.  What is most significant to us is that with the credit write-downs that the European banks will probably be taking, those institutions would be less inclined to extend business credit, thereby accelerating an already downward trend.  Simply put, a more recessionary Europe does not buy as many U.S. products and our companies here that supply them could be negatively impacted
  3. On the other side of the world, the Chinese and Japanese economies are “hanging tough.” China’s manufacturing sector returned to expansion in October and is displaying a five-month high PMI (Purchasing Managers Index) level, lowering the risk that their economy will suffer a “hard landing.”  Japan posted a $3.9 billion trade surplus in September as exports rose 2.4% year-on-year, with both indicators topping forecasts and recovering all of their losses since the March earthquake.  Exports in Japan grew despite the significant “headwinds” of a strong yen, the European debt crisis and slowing global growth.
  4. Despite another quarter of solid U.S. corporate profits, companies are still “setting aside” the cash to fund programs aimed at cutting costs and streamlining operations. Unfortunately, these moves could include job cuts and factory closings as businesses seem to believe that 2012 revenue growth will be anemic, and they want to be well positioned for it.  Our worry is that this will take some of the “steam” out of the growth that the U.S. economy is beginning to see as of late.  This move to set aside more restructuring funds comes during an earnings season that appears to be going well.  Among the 135 companies that have reported third-quarter earnings, 69% have exceeded expectations.  Profits have been up 14.7% from a year earlier, while revenue is up 9.8%, led by the strong gains of energy and materials companies.  The good news is that other than in the financial sector, there appear to be no “mass layoffs” on the horizon.  The bad news is that there will not be any major hirings above current staffing levels, either.

As always, email me here with your questions or comments.

Ashley Page
Senior Vice President
Wealth Consultant

Note: The opinions voiced in this material are for general information and are not intended to be specific advice. Any indices such as the S & P 500 can’t be invested into directly. Past performance is no assurance of a future result.

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