U.S. stocks, as measured by the S&P 500, closed down for the first session in five on Friday despite more ugly news out of Europe.  Nevertheless, it was a good week as the broad market rose 0.8%, which followed the 1.6% increase during the first week of the year.

All 10 of the major industry groups closed down for the session, with consumer staples, telecoms and utilities outperforming.  Financials, industrials and tech were the biggest losers.  Energy finished in the middle of the pack even as the price of crude bounced a bit, returning to $99/bbl (and back to $101 this morning).

Well S&P came in after the bell on Friday and cut a number of euro-zone credit ratings, which included France losing their AAA status – and since we’ve got two more Friday the 13ths by July, who knows where France’s rating will be by midyear.  Heck for that matter, Italy and Spain will be junk by that time, if you could draw such a line of connection.  But most of this was already expected as those interest-rate spreads I’ve been posting and talking about for a couple of months now have signaled.   The market drives the ratings agencies, not the other way around.

The important question when markets closed on Friday was what’s this French cut mean for the EFSF and ESM (short and long-term bailout funds)?  Well, it means those ratings were cut too (which occurred yesterday), from AAA to AA+ -- France alone is responsible for 21% of the guarantees for each of those two funds, and that’s where their rating now sits.  And while we’re talking about the bailout funds, the laugher is that Italy (seven notches below AAA, and just two from junk status) and Spain (five notches below) are responsible for a combined 30% of those guarantees.

The downgrades leave just five euro-zone members with the top-notch status – Germany, the Netherlands, Luxembourg, Finland and Estonia.  Although, four of the five are very small economies, accounting for just 8% collectively of the bailout guarantees, so effectively Germany is the only AAA that matters.   The bailout funds should probably be A at best.

Making euro-zone matters worse, talks broke down between the Greek government and private bondholders as they were negotiating the so-called “soft” default that wouldn’t trigger a CDS event.  One has to think that odds favor some sort of agreement on this issue, but if that doesn’t occur quickly, a hard default will occur – and Greece will leave the zone on that event.

European markets have traded very nicely over the past two sessions despite all of this – stock and most bond markets recording nice gains.  Portugal is the exception as their bonds have tanked, sending their 10-year yield up 175 basis points to 14.16% over the past two sessions.  Certainly the ECB’s LTRO (unlimited three-year loans to the banking system) is helping to offset the harsh reality, but no one can tell for how long those markets will remain stable.  And what’s with Portugal?  Has the ECB decided to leave them to wither?

Market Activity for January 13, 2012

Sector Activity for January 13, 2012

Import Price Index

The Labor Department reported that import prices fell 0.1% in December (fourth decline in five months) after the 0.8% increase in November.  The petroleum and food/beverage components both slid 0.4% for the month.  Excluding fuels and foods, import prices gained 0.1%.

For the year, the import price index fell 8.5%.  That’s down from the 10.1% in November and the recent high of 13.7% hit in July.

Trade Balance

The trade gap widened well-more than expected in November, which along with the latest retail sales numbers we’ve seen, is not going to be kind to Q4 GDP.

The nominal trade gap came in at -$47.8 billion (expected to come at -$45.0 billion) after the -$43.3 billion in October.  That’s the reading that hits the headlines, the one that counts for GDP is the real (inflation-adjusted) figure.  That number came in at -$47.5 billion, which puts the quarter on pace to post a slight narrowing relative to the previous quarter.

That quarter-over-quarter result though had been expected to narrow by much more, and with Europe in a world of hurt, by the time we get the December reading we may just find that the trade gap widened relative to Q3.  That means trade will weigh slightly on growth.

So, just as economists expected consumer spending to be much stronger in the final three months of the year, they also expected exports (thus forcing a narrowing in the trade gap) to remain strong.  But they apparently ignored the economic mess the eurozone is in (exports to Europe fell 6% in November), and I can’t see those exports rebounding in December.   What started as a 3.5% expectation for Q4 GDP has surely dropped to the 2.5-2.7% range and that means full-year 2012 growth will come at an anemic 1.5%.

U of M Confidence

The University of Michigan’s gauge of consumer sentiment rallied big according to its preliminary look for January (they release a final reading at the end of the month), up 4.1 points to 74.0.

This makes for five-straight months of improvement after the reading matched the recession low hit in November 2008.  This latest print just about gets us back to the post-recession high of 77.0 hit last February.

Hopefully consumers aren’t bum-rushed by another bout of bad news that slams this measure back down again, but my take is that’s probably inevitable at this point.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900