Headlines Drive Votalitiy
July, 30 2012, 2:49 PM
Category: Weekly Market Update
Volatility was the name of the game last week as markets responded positively to better-than-expected earnings, flinched at ratings downgrades in Europe, and then rallied again on news that the EU is moving towards tighter integration. Overall, equities remained in positive territory, with the S&P; 500 gaining 1.7%, the Dow picking up 2.0%, and the Nasdaq growing 1.1%.1
Last week’s earnings results continued the trend established at the outset of the season in which nearly two-thirds of S&P; companies have beat earnings estimates, while 60% have missed revenue expectations. Despite the worst showing for corporate profits in three years, investors seem relieved that things aren’t worse. The fact that earnings are still relatively strong despite problems abroad is giving some traders confidence that equities might be a value play right now.2 While revenue misses show that the slow economy is affecting business, strong earnings may leave firms poised for growth when things turn around.
After the week’s promising start, global stocks tumbled midweek as ratings agencies continued to issue warnings and downgrades on Europe. Moody’s cut its outlook on Germany and Holland, and issued a negative warning on Luxembourg on fears that bailout commitments will negatively impact the economies of core nations.3 Egan-Jones continued the previous week’s downgrade rampage by cutting Italy’s debt rating to CCC+ from B+, officially pushing the world’s 8th largest economy into junk bond territory.4 In spite of all this, stocks managed a rally on Thursday after remarks by European Central Bank president Mario Draghi indicate that the ECB is actively pursuing closer EU fiscal integration and stands ready “to do whatever it takes to preserve the euro.”5
Despite the market’s optimism, the growing realization of the eventual cost of multiple bailouts makes the ECB’s promises ring hollow. Is the European Union really worth saving at any cost? The previously unthinkable possibility of a Greek exit is starting to be actively discussed by analysts. Just last week, in fact, the prestigious Wolfson Economics Prize6 was awarded to the research group with the best plan for a euro breakup. With Greece unwilling (or unable) to abide by its bailout terms, a Greek exit is looking more likely, and it might not be such a bad thing. Allowing Greece to exit gracefully would enable it to return to its sovereign currency, devalue its currency (to make its exports cheaper and pay back its debt more easily), and develop an austerity plan on its own, all without threatening the rest of Europe.
It appears that domestic equity markets are being affected more by headlines from abroad than the underlying strength of American companies, so we will not be surprised if we see continued volatility in the months ahead as the European situation continues to develop.