What Is the Cause of the Market’s Volatility?

Ashley Page, Senior Vice President/ Wealth Consultant09/12/11: In the markets, as in life, there are no guarantees but everyone is entitled to their opinion. Here’s my opinion on the financial markets today.

Escalating fears about the euro-zone’s debt crisis are driving a global sell-off in risk assets today.  Overall, this is a continuation of Friday’s session in which the lack of political unity in Europe has raised doubts about policymakers’ ability to tackle the crisis.  Risk of French bank downgrades are adding to the gloom, reflected in a U.S. 10-year Treasury yield near 1.9% and a weakening euro.  Not even gold is providing a safe haven as investors apparently prefer cash and Treasuries in the event that the European situation gets worse.

Looking back at Friday, heightened fears of an imminent Greek default following the resignation of a German ECB official drove a global sell-off Friday, turning a positive holiday-shortened week into a roughly 2% decline.  The S&P 500, which has fallen six out of seven weeks, is now down 7% on the year and again nearing bear market territory.  Obama’s call for targeted tax cuts and job-oriented stimulus Thursday night did little to help sentiment, continuing the unfortunate trend of the market protesting policy action (or inaction).  Financials and resources led the slide, as all 10 S&P sectors fell.  Defensive sectors generally fared better, though even the best performing sector, Telecom, fell 1.2%.  A weakening demand outlook and firm dollar weighed on commodities, which fell nearly 2% as a group, though gold managed to hold steady around $1860.

Around our financial planning services firm this morning, we were discussing four items that we thought would be of particular interest to our readers this week:

Individuals are selling stocks at a near-record pace. The near-term uncertainty over the outcome of the European debt problem, and the fragile state of the U.S. economy, has kept individual investors scared and prompted them to sell their holdings of stocks at the fastest pace since the peak of the financial crisis in 2008.  We can see this in the monthly money outflows from U.S. stock mutual funds totaling $35 billion in August, close to the record set in October of 2008.  This outflow comes on the heels of massive selling in July and June.  In total, the selling over the past three months matches the selling that took place around the financial crisis in 2008, totaling over $80 billion.

Magnifying glass on EuropeThe main issue keeping markets in the volatile ranges is Europe. The debt problems in the eurozone require policy actions to get peripheral countries on the right fiscal path and ensure their funding until the European banks are sufficiently insulated and a partial default for Greece can take place.  The overall question of whether Greece’s default can be orderly is complex.  German bank exposure to Greek debt is about 1.2% of consolidated cross-border debt holdings and for France it is 1.8%.  The fear among some market participants is that the default or restructuring of Greece’s debt will trigger a series of financial institution defaults and a financial crisis throughout Europe and beyond.  Deposit insurance is done country-by-country in Europe.  In short, foreign subsidiaries are covered by the country they are in; foreign branches are covered by their home country.

And speaking of Greece, the country has passed more austerity plans. Greece’s economic shortfall led to worse revenue collection than projected.  Greece passed more tax hikes and spending cuts today to meet the plan and get the next tranche of the bailout money.  Germany’s comments on Friday that it is formulating a contingency plan if Greece defaults were intended to generate this outcome.  Germany will vote on September 29th on a second Greek package and revamped rescue fund originally passed in 2010.

After a relatively quiet week for data last week, the economic calendar is “chock full” of reports this week. On the data front, all of the following come out: (1) retail sales, (2) industrial production, (3) consumer prices and producer prices for August, (4) Empire State manufacturing index for September, (5) jobless claims and (6) mortgage applications.  On the policy front, Federal Reserve officials are largely ignoring the traditional “quiet period” ahead of the September 20-21 FOMC meeting, as several Fed officials, including Fed Chairman Bernanke, are scheduled to deliver speeches this week.

If you have any questions or comments, please feel free to email me.

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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