U.S. stocks recouped about 40% of the prior week’s losses as the market surged following European policymakers’ announcement they’ll go “all in” with regard to bailing out Greece and attempting to contain what sure appears to be a debt contagion. 

Industrial, financial and consumer discretionary stocks definitely liked the news – all were up more than 5% for the session.  Tech and basic material stocks rallied more than 4%.  Energy shares were up more than 3%.  Even the worst-performing group during the session, telecoms, managed a 2.4% gain.

“All in.”  I heard, or read, someone refer to it this way; that’s a great analogy. We are after all talking about a game of poker here; if the market gets a sense that the EU is bluffing, they’ll go right at the throats of the weakest sovereigns.  The stronger governments of German and France are definitely “all in,” the IMF is “all in,” and the ECB may or may not be “all in” – they haven’t yet expressed just how aggressive they’ll be buying up government and private debt as they try to avert what could have turned into a run on southern European banks. 

Market Activity for May 10, 2010

Europe’s Poker Face, cont.

The Eurozone’s plan to quell concerns and hit the confidence of those that seemed prepared to attack the weaker links last week better work.  If it doesn’t, where will a cash-strapped Europe find the resources to actually backstop troubled sovereigns; or more appropriately what will it cost them to fund this bailout?  What will the effect be on a fragile global recovery if interest rates in Europe are pushed much higher?  These are serious questions the equity markets may begin to ask, as it began to ask last week.  It appears currency traders’ temporary refrain from asking this question lasted all of 10 hours as the euro, which had rallied hard from last week’s plunge on Sunday night, has now been hammered back below Friday’s closing value. 

From a longer-term perspective, that is beyond the next 6-12 months, what has occurred in the Eurozone is the ultimate example of moral hazard.  Countries like Greece, Spain and Portugal would have had much higher borrowing costs if not for their Eurozone membership – this is why enforcing the Stability Pact (budget-deficit constraints) were of great importance.  But they didn’t enforce these rules (to keep deficits to 3% of GDP, the worst violators have ratios that exceed 10%) and now the troubled sovereigns threaten higher borrowing costs within the Zone’s leading economies. We’re watching the beginning of the end of the free ride.  But it is just the beginning, Sunday night Eurozone members kicked the can down the road – eventually you run out of road. 

The “Unlimited” ATM

Last week we talked about Freddie Mac returning to the till to request another $10 billion from the Treasury Department as quarterly losses continue – loans at least three-months late are rising.   Now Monday, Fannie Mae requested $8.5 billion from the old taxpayer as their quarterly loss came in at $11.5 billion.  But hey, this is just half the $23 billion loss recorded a year earlier. 

The rate of seriously delinquent loans (90 days past due) increased to 5.47% from 2.96% a year earlier, but did slow from the previous quarter when it was 5.59%.  They acquired 62,000 single-family properties via foreclosure in the first quarter, up from 47,000 in Q4 2009.  Fannie’s loan-loss reserves (a charge against earnings) fell $3 billion even as its pool of nonperforming loans grew by $7 billion.  If they would have set aside the level of provision to keep up with the increase in non-performing loans the quarterly loss would have been worse.  As we’ve talked about over the past few months, this is exactly what the banks are doing – living on the prayer the housing market will rebound in a sustained manner.  Well, there’s always hope. 

Today’s Data

We didn’t have an economic release yesterday, but get to it again this morning with the NFIB’s survey of small-business optimism, wholesale inventories and ABC consumer confidence. 

That NFIB survey has, and will continue, to be a key release to watch.  Small-business optimism has gotten clocked.  This shows the dichotomy between large corporations that have benefited from Asian stimulus and easy access to borrowing via the capital markets and small businesses that depend more heavily on domestic demand, bank lending, and are less able to absorb the future costs of health-care legislation.  The survey has been stuck below a reading of 90 for longer than any time in its history, it goes back to 1976.  And that number is just out as I type – it’s come in at 90.6, the first reading above 90 since September 2008.

We’ll also watch wholesale inventories for an early sign that sales and inventory building continued to improve in March.  This will set up for a business inventories report (includes retailers) that we’ll get on Friday.  GDP needs inventory rebuilding to keep the figure positive. 

Then we’ll get ABC confidence.  This reading ticked up last week but remained quite depressed. The Conference Board’s measure of confidence, which is viewed as the most accurate, is showing the same trend – improvement, but stuck at recessionary levels.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900