U.S. stocks began the week on a good note, rallying to extend upon last week’s bounce.  However, the session didn’t end as well as it began as the market gave back much of Monday’s early gains on news that every remaining AAA-rated country in the eurozone had been warned by S&P that they may lose that status.  (It wasn’t until after the close when we got the official announcement from S&P, explaining that 15 of the 17 euro-zone countries were on credit watch negative.

Such discussion would normally erase all the gains and then some, for no other reason than the whole EFSF (the bailout fund) framework is based on a AAA rating.  However, due to the view that the Fed will roll out another round of QE and Draghi will be taken over by the spirit of Bernanke and begin buying bonds with a vengeance (more on this below), such minor details of credit downgrades don’t matter as much.

Financials, tech and energy (crude closed at $101/bbl) led the broad market higher.  Health care and consumer staples were the laggards, but did manage to close higher.

On the European scene, Spanish and Italian-bond yields continued to rally yesterday as those yields have been driven 120-150 basis points lower in a week’s time (for those who don’t make a habit of watching bond markets, to say that these are enormous moves is an understatement).   One assumes last week’s coordinated action from several central banks along with the expectation that the ECB will funnel money through the IMF so that printed euros can participate directly in bond auctions is behind this move – the combination of these actions naturally incentivizes the market to position back into what became distressed bond prices (the Italian 10-year was trading at 83 cents on the euro on November 25 when it yielded 7.30%).

But we have seen such moves before (when it faked out the coast-is-clear audience back in early August and then again in late September) and the interbank lending situation remains pretty much frozen.  To wit, euro-zone banks deposited another €20 billion at the ECB yesterday – they’re unwilling to lend to one another (fearing counterparty risk) so they place cash in the lower interest-rate bearing but supremely safe ECB vault.  The central bank  moves of last week helped a lot, and we’re seeing it was very much needed to keep the system alive.

And speaking of central banks…

Market Activity for December 5, 2011

Sector Activity for December 5, 2011

…expectations are on the rise that the Fed will announce QE3 at the January 25 FOMC meeting.  There are a number of reasons for this, the greatest being that the FOMC (the decision-making committee) will be packed with doves (members eager to error on the side of easing) as the three hawks that currently reside as voting members will rotate out at the end of 2011.

In fact, of the 10 members that will make up the FOMC next year (there are usually 12 but the Board of Governors have been shy two members for a couple of years now as nominees can’t make it through Congress) four are ultra dovish – they are Yellen, Dudley, Pianalto, and for all intent and purpose as he is the architect behind these moves, Mr. Bernanke.  And unlike 2011, there will be no real hawks to dissent this go around.  (And yesterday we had the most dovish of the 2011 FOMC members – Charles Evans – stating, “[i]t is imperative to undertake action now.”)

This statement was no rogue Fed member going off.  It’s called strategy, setting the stage for the comments that will follow next week’s meeting.  That meeting will set the stage for what’s to come in January.

ISM Service Sector

The Institute for Supply Management’s gauge of service-sector activity slipped to 52.0 for November (expected to rise to 53.9) from the 52.9 recorded for October.  That’s the lowest print since January 2010, but back then it’s trajectory was one of ascent from the depths of the crisis.

The measure was driven lower by the employment gauge, which fell back to contraction mode – down four points to 48.9.  The other sub-indices held at pretty much the same level as the previous month.  New orders and inventories remained mildly in expansion mode, while backlog of orders didn’t sink further into contraction territory.

Overall, this is a below-average report (the historic average is 53.7) yet stocks rallied higher immediately following the release to the highs of the session.  Surely, traders were thinking about the Fed, as they know once this gauge sinks to contraction (below 50) more QE is a done deal.

Factory Orders

The Commerce Department reported that factory orders fell 0.4% in October (a bit more than the 0.3% expected) and the September result was revised down to show a 0.1% decline instead of the 0.3% increase that was previously estimated.  This results in no advance in factory orders for three months.

On the bright side, the report showed that October durable goods orders (a report that is released a couple of weeks prior to factory orders) weren’t as bad as previously expected.  Overall durable orders fell 0.5% instead of the 0.7% previously estimated; ex-transportation durable orders rose 1.1% instead of the 0.7% expected; and the capital spending number showed that it fell just 0.8% instead of the 1.8% decline previously reported.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900