U.S. stocks traded flat in Friday’s morning session then rallied in the afternoon, right around the time the EU released results of their bank stress tests – 84 of the 91 banks tested passed, more on that below.  News that Genzyme was approached by Sanofi-Aventis and GE raised its dividend also helped the reversal.

For the week, the Dow gained 3.24%; the S&P 500 got back 3.55%; the NASDAQ Composite recouped 4.15%. Mid cap stocks gained 5.03% and smalls were up 6.60%.

It’s been an especially volatile 12 weeks, ever since the May 6 flash crash shook the complacency out of the market.  In six of these 12 weeks the broad market has moved at least 3.50% (in either direction). In all but one of these 12 weeks the market has moved at least 2.23% and has three 5%-plus weekly moves. 

Market Activity for July 23, 2010

EU Stress Tests

The results of the stress tests found that seven banks need to raise a combined 3.5 billion euros of capital.  That’s nothing and it has people really questioning the rigidity of these tests.  I think they do a better job shocking the tests on the GDP parameters, but are really dreaming with regard to potential losses from declines in sovereign debt prices. 

Regardless of what people think, the market will eventually send the true signals of what’s going on -- one wants to keep an eye on government-bond auctions.  These auctions had been going well, surely helped by the fact that the ECB is willing to accept these securities as collateral, no matter the credit rating.

Of late though, demand has weakened.  Last week a German bond offering garnered a weak 1.2 bid-to-cover and the latest from Portugal received just 1.3 (this gauge of demand has been running around 3.0), and the yield was twice that of the previous auction.  The fact that this has waned even with the ECB backstop is concerning.  We’ll keep an eye on it.

Banks themselves don’t appear to believe the tests were rigid enough.  Inter-bank lending rates, as measured by three-month Euribor (euro inter-bank offer rate) have jumped again and remain elevated (relative to the level at which banks can borrow from the central bank) – thus banks continue to rely heavily on the ECB for short-term funding.  That’s pretty much all we need to know.

The larger concern is the 877 billion euros banks need in borrowing to roll debt coming due this year, and 771 billion euros next year, according to the IMF.  And that’s the timeline of this situation playing out.  If things really go awry, we’ll know it over the next 12-18 months. 

ECRI Slides below the Dreaded -10

The weekly indicators gauge from the Economic Cycle Research Institute we’ve been watching very closely since late May has slid below that -10 reading – a level that has predicted each recession since 1970. 

Maybe this time is different, so many things are, but if its forecasting ability is as accurate as it has proven in the past then we’ll get a negative GDP print by the fourth quarter.  That’s sooner than I’ve expected, which was for GDP to turn mildly negative in the first half of 2011. 

Whether we get an actual negative reading or two or just really weak growth of 1.0%-1.5%, it doesn’t much matter.  We need real GDP growth of 5%-plus to get the job market growing in an aggressive and consistent manner that can bring the unemployment rate down to normal levels in a reasonable amount of time.  Currently, the Fed believes it will take until 2015 for the jobless rates to drop back to the 5.5%-6.0% level, and that’s assuming normal rates of growth – roughly 3.5% GDP. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900