Index Daily Change
S&P/TSX composite index 1.09% Drop
Dow Jones industrial average 1.90% Drop
Standard & Poor’s 500 Index 2.34% Drop
Nasdaq Composite Index 2.04% Drop
Europe’s worsening debt crisis is intensifying pressure on policy makers (governments) to widen a bailout package beyond Greece after a cut in the nation’s debt rating to junk drove up borrowing costs from Italy to Portugal and Ireland. As German Chancellor Angela Merkel delays approval of a 45 billion-euro ($59 billion) Greek rescue, the crisis is spreading. Portugal’s benchmark stock index yesterday fell the most since the aftermath of Lehman Brothers collapse, while the extra yield that investors demand to hold Italian and Irish debt over German bunds rose to a 10-month high.
The danger for European officials is that the fiscal turmoil which started 6 months ago with a “fudged” Greek budget data will spin out of their control. As Greece waits for its Euro-region partners to disperse funds, the European Union has announced no concrete plans to help other nations should aid be needed. The Euro currency weakened to the lowest in a year. In short, policy makers are failing to get ahead of the curve. This is no longer a problem about Greece or Portugal, but about the Euro system.
The euro dropped 1.5% to $1.3183 (versus the U.S. dollar) yesterday, taking its decline for the year to 8%. The biggest risk now is that the market investors speculate against every single indebted peripheral country, and that could lead to a sovereign debt crisis in short, the contagion risk is real.
Bonds plunged as Standard & Poor’s lowered its rating on Greece by three steps to BB+ (junk) from BBB+ and warned that investors could recover as little as 30% of their initial outlay if the country restructures its debt. The shift came minutes after the rating company reduced Portugal by two steps to A- from A+. The moves by the rating agency exacerbated concern that Portugal and other nations trying to cut budgets will be left to fend for themselves by an EU that took 2 months to agree on a plan for Greece (and the money still hasn’t moved).
Greece is clearly struggling to convince investors it can push its budget deficit below the EU’s limit of 3% of gross domestic product from 13.6% last year. The yield on the Greek 2-year note rose by 5.05% to 18.99% yesterday. Greece, which faces 8.5 billion Euros in bonds coming due on May 19, must still agree on terms for its rescue package, which will be co-financed by the Euro region and the International Monetary Fund (IMF). Greek Prime Minister George Papandreou last week activated the aid package and is facing fire from investors who say his budget steps need to go further and from voters who are staging strikes to protest further austerity measures (this is a dilemma as neither option is a desirable solution).
The crisis exposes the weakness of having a single currency with no single fiscal authority. “There is no economic cause for a contagion discussion,” Governing Council member Ewald Nowotny said. Still, Ireland’s deficit was 14.3% of GDP last year, the highest in the EU. Spain’s was 11.2% and Portugal’s 9.4%. This will likely end badly for Greece as there must be a “moral” hazard in place for countries that constantly abuse the rules.
The Canadian stock market fell from a 19-month high as investors bailed out of stocks across all industry groups after credit ratings for Greece and Portugal were slashed. Heavily weighted financial shares slid 1.46%, while energy issues dropped 1.83% as the downgrades sparked a flight-to-safety U.S. dollar rally that pressured commodity prices.
The decline in the market was not completely unexpected as stocks have had a good run latterly. The one area of strength was in gold-mining stocks, as worried investors sought a safe haven in the metal.
In the United States stocks tumbled as well. Compounding things in the United States was the grilling of Goldman Sachs on Capitol Hill as this heightened the possibility of financial reform. Stocks posted their worst day in nearly 3 months and the Chicago Board of Options Exchange (CBOE) VIX or volatility index, jumped about 31%, its biggest 1-day move since October 2008. The move came as Senators hammered Goldman Sachs Group executives for taking advantage of the housing bubble and making billions off that market’s collapse. The hearings coincided with lawmakers’ efforts to pass strict regulations for banks.
Goldman’s stock rose 0.7% but the S&P financial index dropped 3.4%. Although Goldman’s stock bucked the market’s sharp downtrend it’s still down nearly 17% from its recent closing high on April 15th. This was the night before the U.S. Securities and Exchange Commission filed civil fraud charges against the company.
The S&P 500 broke through a technical resistance level and chartists now look at 1,180 as a near-term support. Mid-term support is seen at around 1,150, the peak the benchmark hit in January. Major U.S. stock indexes posted their worst losses since Feb 4th, when the S&P 500 fell more than 3% and the Dow briefly fell below 10,000, also on concerns about the fiscal stability of Portugal, Spain and Greece.
U.S.-traded shares of the National Bank of Greece dropped almost 16% to $2.60, just above a session low of $2.56, their lowest since March 2009.
This morning stocks extended their global slide overseas, while yields on Greek 2-year notes jumped to a record 26% and the Euro traded near a 1-year low against the U.S. dollar as sovereign-debt concern spread. The MSCI World Index of 23 developed nations’ stocks fell 0.8%. Greece’s ASE Index rebounded 1.8% as the securities regulator banned short- selling on the Athens bourse. Portugal’s PSI-20 Index dropped the most since October 2008. The extra yield investors demand to hold Greek 10-year bonds instead of benchmark German bunds surpassed 8%.
Futures on the Standard & Poor’s 500 Index rose 0.3% while oil prices did recovery slightly. Going forward I would expect headwinds but corporate earnings are consistently beating expectations and many companies are revising their outlooks. While the global rally restored more than $21 trillion to equity markets since March 2009, investors are growing more nervous about the Euro region, which combined makes up the world’s 2nd largest economy behind the U.S. The Euro Stoxx 50 Index has fallen 4.3% this year on concern about growing deficits across the region. The MSCI Asia-Pacific Index gained 4% in 2010 and the S&P 500 increased 6.2%, according to data compiled by Bloomberg. Companies in the S&P 500 may increase profits 29% this year and 19% in 2011, the biggest 2-year advance since 1998, estimates from more than 1,500 analyst compiled by Bloomberg show. The index is priced at 14.8 times the average prediction for 2010 income. Should the forecasts prove accurate, the S&P 500 would be trading at its lowest multiple since the 1990s.
Regards,
Wilfred Vos Bcs, FMA, CIM, CFP, FCSI, DMS, CBV, MBA, CFA
SVP & Partner
