After three weeks of losses driven by Europe’s debt crisis, political gridlock in the U.S., and the slowing global economy, the S&P 500 rallied 7.57% in the final three days of November to finish the month down only 0.22% on a total return basis.

Europe’s debt crisis continues to intensify, yet there still is no consensus on a solution.  At the beginning of the month, German Chancellor Angela Merkel and French President Nicolas Sarkozy said for the first time that a country could leave the euro areas if it fails to live by its rules.  About a week later, panic conditions spread to Italy – the world’s third-largest debt market with debt exceeding that of Greece, Spain, Portugal, and Ireland combined – which caused global markets to decline 9.9% over a two-week period.  Making matters worse, the European Financial Stability Facility (EFSF) bailout fund is struggling to come up with funding to provide insurance to troubled countries without sacrificing France’s AAA bond rating.

In the U.S., the debt-reduction “supercommittee” failed to reach an agreement, thus triggering $1.2 trillion in automatic spending cuts starting in 2013.  The inaction poses an immediate threat to the economy in early 2012 due to the expiration of temporary reductions in payroll taxes and jobless benefits.  It also signals that any major deficit-reduction agreement will likely be delayed until after the next presidential election.  The latter consequence led to Fitch Ratings joining the other two major credit rating companies by lowering its outlook on U.S. debt to “negative” from “stable.”

The Federal Reserve policymakers concluded at their November meeting that additional easing may be necessary if the economy worsens, potentially setting the stage for a third round of quantitative easing (QE3).  They noted, however, that any action would likely have less impact than in the past – no matter how much money the Fed pumps into the financial system, they can’t force consumers and businesses to spend and borrow nor can they force banks to lend.

The one bright spot of the month was slightly improved U.S. economic data.  Gains in manufacturing and homebuilding, combined with leaner inventories, suggest the economy will continue to grow in 2011.  Higher consumer confidence readings and a strong start to the holiday shopping season also provided reason for optimism.  The National Retail Federation reported Americans spent a record $52.4 billion during the Thanksgiving weekend.  According to ISI Research, there is an 89% correlation between holiday sales and stock market performance between September and December.  However, there is little evidence at this point indicating that consumers will be able to carry the momentum into 2012 given the reduction in the savings rate, expiration of payroll tax cuts, stubbornly high unemployment, and stagnant wages.

The positive economic data and a coordinated effort from the world’s major central banks to provide emergency U.S. dollar loans to banks in Europe spurred a wave of buying in the final days of November.  With one month remaining in 2011, Europe will continue to be the primary focus of market participants.  In particular, the European Central Bank’s (ECB) ability to provide liquidity will be a hot topic.  Many people believe that the ECB should act as a lender of last resort, similar to the way the Fed has been printing money via quantitative easing (QE).  Today, ECB President Mario Draghi hinted at potential increases to its current bond purchase program, but the ECB doesn’t want to be seen as subsidizing governments.  ECB is legally banned from such activity according to the European Treaty.  Changing the treaty would be a lengthy process, but may become a necessity if the euro is to remain intact.

Here's a link to some performance tables, something I don’t always do, but thought made sense given my lack of recapping that particular data.

Peter Lazaroff

St. Louis, MO

www.acrinv.com