U.S. stocks began the week lower as the hope balloon deflated yet again as more people realized over the weekend that the latest EU summit was one of empty and unattainable promises.  The latest industrial production number out of India didn’t help matters as activity continues to deteriorate – Asia is looking quite weak, which is a consequence of European recession.

So we sold off by 200 points on the Dow Industrials on Thursday, essentially made it back on Friday, only to lose 162 yesterday.  Still, equity markets hung in there pretty well considering yesterday’s tone – criticism that the euro-zone summit was vacuous was universal (why people viewed the thing in a positive light on Friday is beyond me) and the concerns over the EU banking system are definitely on the rise.  But traders appear to be expecting a big announcement from a central bank – namely, today’s FOMC meeting and the expectation that Bernanke will signal (not explicitly announce, but signal) more QE to come in early 2012 – so that is keeping the downside to a minimum for now.

Telecom, consumer-related (both discretionary and staples) and utility shares outperformed.  Financials, energy and basic materials led the losses.

Market Activity for December 12, 2011

Sector Activity for December 12, 2011

Draghi Behind the Scenes

So ECB President Mario Draghi disappointed markets Friday when he stated his earlier comments were misinterpreted – he didn’t really mean that the central bank was in favor of funneling money to the IMF so that it could be redirected to euro-zone bond auctions (such laundering would be necessary without an ECB rule change as they can only buy this debt once it’s trading in the secondary market).  No, on Friday he made clear that the ECB would not be engaging in a Bernanke-style QE experiment.

But it appears that The Draghi continues to work behind the scenes.  To wit, euro-zone yields have been back on the rise as French, Spanish and Italian debt sold off again (yields up prices down); although, a late-session rally helped those sovereigns close above the day’s lows.  This occurred even as the equity markets traded ugly, sliding in the final hour to close at the session low.

As a result, one cannot assume that a spate of euphoria drew investors back into euro-zone sovereign debt.  Thus, what else is one supposed to believe, other than Draghi coming in to save the day again?   He certainly understands that once Italian backs up to 7% again (and Spain closes in on that mark, and the French 10-year back to 4.0%, or blowing out to 200 basis points wider than German bunds) that a whole new level of nasty is likely to ensue.

So here’s the question, which isn’t so much a question as it is the current expectation.  Is Draghi’s talk of taking a monetary-policy high ground really to be believed?  Or is he simply more likely to cave and ultimately engage in full-blown QE.  I think the latter will be the route Draghi chooses.  This should result in some upside certainly for euro-denominated bond markets, and probably juice equity markets as well – especially if it is in coordination with Bernanke’s QE3 that will come early 2012.  But such soft defaults (printing away some of the debt problems) do nothing to solve the problem.  Or more appropriately, central bank manipulation simply foils the market’s price mechanism.  And that mechanism is a necessary condition in forcing governments into the fiscal positions that allow for the future growth we need to propel Western economies to escape velocity.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900