Monday, May 10, 2010

All eyes on EU's actions to stem debt contagion

Analysts are split over whether a strong response will halt slide for long

ON Wall Street, the adage goes that on trading days where Thursday is bad and Friday is bad, Monday is rarely good. After two positively terrible days to end last week, investors have had the weekend to worry about how much more they could lose and will be coming to work today primed to sell.

'That will likely be the case unless we get some strong statements from the ECB over the weekend clarifying how they're going to handle this crisis,' said Max Bublitz, chief market strategist at SCM Advisors.

On Saturday, French President Nicolas Sarkozy and his German counterpart, Chancellor Angela Merkel, jointly promised that the European Union would have a 'financial defence plan' in place by the time financial markets open Monday to protect the euro, support the EU's most troubled economies, and reassure investors frazzled by a tumultuous week that featured a harrowing plunge of nearly 1,000 points in the Dow Jones Industrials.

Investors will surely be holding them to that promise this week, with the stock market equivalent of all hell breaking out if the EU fails to convince the financial markets it is taking sufficient steps to backstop its beleaguered economies and keep the sovereign debt crisis causing such turmoil in Europe from sweeping through the globe, a la 1997's Asian contagion, which started with a run on the Thai baht and ultimately threatened economies worldwide.

The rise of a new global credit crisis over the last week has all but guaranteed a strong response from the European Union, but the question is whether the measures being voted on by the finance ministers of all 27 of the European Union member countries in Brussels will be sufficient to convince the stock and bond markets that it is doing enough to get out in front of an economic crisis that has swelled far beyond Europe's borders.

'The thing that really touched off this whole thing for me, and most professional investors I think, was the Trichet press conference, when he didn't even discuss quantitative easing,' said Nick Colas, chief market strategist at ConvergEx, referring to European Central Bank president Jean-Claude Trichet's refusal last Thursday to consider quantitative easing, or new liquidity measures to calm investor fears over the sovereign debt crisis.

'It was just like when the House wouldn't pass Tarp the first time through Congress,' said Mr Colas.

Assuming the EU and its central bank do enact emergency measures to combat the crisis, Wall Street traders said it must be on the same level of response that the US government and Federal Reserve took back in October, 2008. 'Otherwise, the dominos will keep on falling,' said Joe Saluzzi, co-manager of trading at Themis Trading, LLC.

Even with a strong move from the eurozone's finance ministers and central bankers, Wall Street market pros are split over whether it will staunch the bleeding in the stock markets for long.

'If the ECB does the 'right thing', we're oversold in US equities and the euro, and there are buying opportunities,' said Mr Colas, a view echoed by Mr Bublitz.

'The crisis in Europe automatically adds another three months' worth of the Fed keeping interest rates at zero per cent, which has been the basis of the 14-month rally,' he said.

Mr Saluzzi disagrees. 'Even with a strong response, we've got plenty of room to go down further. The market has already baked in all the good news on the economy's recovery and corporate earnings, and now it wants more before you see momentum go back with the bulls.'

Indeed, investors should remember that US stock indices faced their worst losses on a percentage basis weeks after the US government's emergency bailout was passed by Congress in response to Lehman's collapse and the sub-prime mortgage crisis. For veteran trader James Awad, its all about clarity.

'Regardless of the steps the ECB takes, markets are now profoundly shaken and worried about public sector debt and its effect on the private sector. Will these worries overwhelm the positive cyclical economic uptick here? That's the question, because if not, the cyclical upswing has further to go, and that's bullish for stocks,' said Mr Awad, the managing director at Zephyr Asset Management.

'I think it's too early to say. I certainly won't be laying any big bets over the next few weeks without a lot more clarification on the extent of the risks, and the EU's capacity to mitigate those risks,' he added.

On Friday, US stocks slid further into negative territory after Thursday's collapse. The Dow Jones Industrials sank for the fourth straight day, this time by 140 points, or 1.3 per cent to finish a tumultuous week at 10,380.43. The S&P 500 retreated 17.3 points, or 1.53 per cent, to 1,110.88, while the Nasdaq was the day's biggest loser, with a 54-point, 2.3 per cent decline to 2,265.64.

For the week, the Dow lost 4.7 per cent and the S&P 500 fell 6.4 per cent while the Nasdaq dropped almost 8 per cent.

The dollar gained nearly 5 per cent in the past week against the euro in a flight to safety, which also boosted gold prices, which rose to new 2010 highs on a 1.3 per cent surge on Friday.

If the way investors disregarded last Friday's big, estimate-beating April employment number of 290,000 new jobs is any indication, the number of key economic reports and earnings releases due out this week may matter very little compared to the moves by the European Central Bank and EU finance ministers to address the sovereign debt crisis.

Source: Business Times, 10 May 2010

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