U.S. stocks closed flat on Friday as the ECB came in to rescue key European sovereign debt from widening yet further (for now) – French, Italian and Spanish debt spreads (their interest rates relative to those of benchmark German bunds) rose to new records on Wednesday; it was a distress signal and ECB President Draghi answered the call.

Utilities, financials and consumer staples were Friday’s winners.  Tech, energy and telecoms weighed on the market.

For the week, the broad market slid 3.81%, marking the second decline in three weeks.  The S&P 500 remains 8% above the recent low hit in August, but considering nothing has been solved – either in Europe or here at home as we’re about to go through the whole debt ceiling issue yet again – investors need to mentally prepare not just for another slide but for this up, down and ultimately nowhere activity to continue for some time.

More below…

Market Activity for November 18, 2011

Sector Activity for November 18, 2011

So the broad U.S. stock market failed to rebound on Friday, but at least halted the slide that occurred midweek.  European bonds rebounded from the lows hit midweek – and it just wasn’t a weekly low for sovereign debt as French, Italian and Spanish spread hit new wides.

The selloff among key euro-zone sovereigns was certainly a distress signal as the levels those spreads hit were crisis level against the benchmark German bunds.  The Italian 10-year had widened to 552 basis points as their 10-year hit 7.10% and what is supposed to be AAA France saw its spread widen to a record 190 basis points as their 10-year hit 3.75%.  But Draghi answered the call by aggressively intervening with bond purchases late in the week.  That buying did the trick (for now), as those yields have come down.  But Spain is showing what would have occurred if not for ECB intervention as those yields continue to widen, hitting a fresh record this morning – the ECB concentrated their purchases in Italian debt, which also helped the French who own gobs of this stuff.   Spain sits there waiting and wishing for their interest rates to be manipulated lower – they’ll get that wish, but just not yet.

So where do we go from here.  Well, the market clearly wants to take euro bonds lower (higher in yield) as banks need to sell and other investors need an interest rate that comes close to compensating for the increased risk.  But a Draghi-led ECB is not going to watch these bonds tank because the damage will end the eurozone as we know it – an event that is inevitable, but policymaker will do what they can to delay it.

The problem with this is not only the unintended consequences that money printing will have on Western economies down the road, but such interventions distort the market.  The market’s price mechanism is intent on forcing governments to get their fiscal houses in order, which is ultimately what needs to occur before we can get things growing again.  Further delaying the inevitable simply keeps us trapped in this very discouraging cycle.

What’s more, these actions distort expectations as traders universally expect the central banks of Europe and the U.S. to take a crisis-level move in bond and stock markets out of play.  However, if they fail to arrest this problem there will be a much deeper move in stock markets around the globe as those expectations go unmet.

Throwing more trouble into the mix is the fact that the so-called Super Committee (you know the groups of six Democrats and six Republicans that were tasked to find $1.2 trillion in budget cuts) have failed to do so.  It should have been obvious back in August when the debt-ceiling issue hit a crescendo that nothing material was going to occur – we’ve been talking about how this issue was only going to pop up again by November and here we are.

There is supposed to be an automatic trigger that cuts about $1 trillion from the budget just in case these mumbling idiots failed to get anything done.  Of course, like everything else no cuts will occur now, they don’t kick in until 2013 (and the $1 trillion number is over 10 year); what a laugh.   And I bet they’ll find a way to get around that one.  That is, until it’s too late and the cuts occur out of complete necessity.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900