U.S. stocks continued their schizophrenic behavior as the S&P 500 trades wildly within this range of roughly 1090 on the downside to 1220 on the high end.  It was just a week ago when the broad market cut a new low-end of this current range, but after yesterday’s bounce it’s suddenly reversed to close in on the high end once again (see chart).  The latest catalyst is supposedly that German Chancellor Merkel and French President Sarkozy are finally serious about devising a plan that actually works to cure all that ails the eurozone.

Financials, energy and basic materials led the rally.  Consumer staples, utilities and telecoms underperformed.

It appears that the market is reliant on hope – the hope Europe finally has a quick fix in its bag of tricks --, but can investors collectively be this stupid?  I mean, Merkel and Sarkozy (let’s just affectionately call the duo “MerKozy” for short) met yet again over the weekend, but came away with only words.  The two remain deadlocked as the French appear desperate to leverage the EFSF (bailout fund) to the hilt, while Germany is unwilling to go further in debt -- a reality that comes along with them being the ultimate backstop.

More likely, the mere talk of action was enough to send stocks higher, not because market participants believe an agreement is imminent (or that such a plan would actually solve anything) but because there remain so many people short this market.  Thus, such headlines cause them to take profits and cover those positions (buy) for fear short-term moves go against them – it’s the classic short squeeze.

But strictly in terms of the situation with which the Europeans find themselves, I’m afraid we’re watching the next stage of the crisis unfold right in front of us.  Instead of MerKozy coming together to implement the next “solution” to their problems, I think signs are that tensions have increased – tensions that were bound to occur as France is not the backstop that everyone has believed them to be all along and the Germans are done with backstopping gross profligacy.  More below…

Market Activity for October 10, 2011

Sector Activity for October 10, 2011

One has to believe that the eurozone, and possibly all members within the European Union, will nationalize their banking system – they’ve just nationalized the French/Belgian bank Dezia, and that’s the canary in the coal mine.  It’s just not reasonable to believe otherwise.  In fact what we have here are short and mid-term scenarios setting up.

In the very short term, EU ministers will continue to grapple over whether or not to expand the powers of the EFSF, which is likely to result in another round of market turmoil.  But another push to new lows will cause EU policymakers to ultimately nationalize the banking system, at which point the market may just rally hard.  I’m, sorry to say, as I’ve attempted to explain for a couple of years now, that the gains will prove fleeting yet again as continued bailouts, backstops and issuance of more debt solve nothing.  Rather, such policy will only make the situation worse – but we should know this by now.

This Week’s Data and Legislative Docket

We were without an economic release yesterday on account of Columbus Day and the bond market was closed.  This morning we get back to it with the September results of the NFIB’s gauge of small business optimism, which is out as I type to show a slight improvement.  Still, the reading remains in recessionary territory and meaningfully below the level of 95 – the measure has been stuck below that 95 mark for longer than any time in its 37-year history.

From here, we’ll have to wait until Thursday for a major economic release, which will arrive via the trade figures for August and jobless claims for the latest week.  By Friday we get retail sales for September (expected to be up pretty big, although I’m not sure why) and the first gauge of consumer confidence for October.

It will also be a stacked week on the legislative front.  While the House is likely to pass trade agreements with Columbia, Panama and South Korea (trade pacts that have been held up since GW Bush was president), the Senate is likely to pass currency legislation, terming China a currency manipulator.

Of course, China is a currency manipulator, but who isn’t?  It’s kind of difficult for anyone to take this legislation seriously considering our central bank has implemented the most aggressive easing campaign in its history for the large part of a decade – the result has been a much lower U.S. dollar value.  Besides, this legislation only does harm as it may just incite a trade war and it involves meaningful import duties (taxes), which is reminiscent of what we did during the 1930s via Smoot-Hawley.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900