U.S. stocks ended a two-day bounce, following the European bourses lower (and they closed ugly, sliding in the final hour) as French, Italian and Spanish bonds came under pressure again.  The relative optimism that arose late last week, a view that just maybe new governments in Greece and Italy will find solutions to their debt problems, has begun to evaporate.

Despite the negative close on the major U.S. indices, some cyclical groups held up well.  Tech and industrials outperformed – tech was certainly helped as Buffett said Berkshire increased its IBM position.  Financials and energy led the decline.  So not all cyclical groups performed well on a relative basis, but we didn’t see a flock to the areas of safety either – utilities and health care were in the middle of the pack.

Crude pulled back by nearly 1%, but failed to fully erase Friday’s gain as it settled at $98.00/bbl.  Wholesale gasoline fell another 2.7% to $2.53/gal.   This underperformance by gasoline further reduces refining margins, as we referred to last week.  Refiners’ profitability has been slashed by 50% over the past month.  Either oil needs to fall, and in a big way, or refining output is going to get cut back – and you know what that means for the pump price.

More below…

Market Activity for November 14, 2011

Sector Activity for November 14, 2011

So the end of last week was all about yet another ebb in the concern over Europe’s debt crisis, but now we’ve got those concerns flowing again.  Many readers may remember that we’ve talked about this for well over a year now – this ebb and flow, risk-on/risk-off, is something we’ve said you’ve got to mentally prepare for as it’s here to stay.  It’s a function of the path policymakers have taken.  Instead of allowing the markets to take us to the point that forces austerity and debt reduction, they have delayed the process by manipulating markets and with that delay comes false hope.

There are two things that occurred late weekend and into Monday morning that have caused the recent cheer to disappear again.

The first was German Chancellor Merkel’s call to overhaul the European Union (EU).  This is the second time she’s made the comment.  What has some people a bit nervous is that while she stated that ties need to be deepened within the 27-nation EU within this new framework (no problem there), she also repeated that Germany rejects a euro-bond plan -- basically Germany accepting much more debt just so dangerously profligate countries can enjoy lower interest rates (big problem with that one).  This has people thinking that she is attempting to pave a way for a smaller euro-zone, moving to a more healthier zone with just the more responsible northern and eastern countries remaining.  That would mean farewell to Italy, Portugal, Spain and Greece – maybe not Ireland as they have taken harsh measures to get things right again – and with that possibility on the horizon European banks will accelerate the selling of those bonds.

The second is exactly the result of banks unloading this stuff, a re-widening that’s occurred in Italian, French and Spanish interest-rate spreads.

As we talked about last week, they (EU banks) have been dumping government debt as they must reduce their exposure – we’re past the early signs of a problem here.  And things moved to another level yesterday with UniCredit (Italy’s largest banks) posting a huge loss that will force it to raise more capital and that means selling more government bonds.

Italian spreads haven’t yet widened to new levels, but close to it this morning as that 10-year is back to 7.00%.  For France and Spain though, those spreads have hit new wides.

Don’t be at all surprised to watch these spreads blow out further later this week.  At which point, the ECB will finally capitulate and state they will engage in full-blown QE (buying government bonds en mass) Bernanke-style.  This will create all kinds of additional problems down the road, but it may just halt the rise in rates that particularly Italy and Spain cannot manage around.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900