Europe Still Dominating Market Sentiment
As the European debt crisis ebbs and flows, so too does the stock market's direction.
Europe continues to dominate market sentiment. As the European debt crisis ebbs and flows, so too does the stock market's direction. The shift last week was clearly more negative as the S&P 500 Index suffered a nearly 4% loss and is now back into negative territory year to date.
The table below highlights returns for major asset classes for the latest week, month to date, and year to date:
The plan to use the European Financial Stability Facility (EFSF) to bring order and stability to Europe has worked about as well as the Maginot Line. Six months ago, Germany and France were considered the backbone for resolving the European debt crisis and providing legitimacy to the EFSF. Now, French bond yields are starting to blow out, and a downgrade of its AAA credit rating looks all but certain. EFSF bond yields are also blowing out, and it could not sell the full amount of its latest debt offering, signs that global investors are now increasingly pricing in a more negative outcome for Europe.
As students of history know, it was the reparation demands placed on Germany post WWI that eventually led to the hyperinflationary conditions in the Weimar Republic of the 1920s and the collapse of Germany's financial system (and the eventual rise to power of Adolf Hilter and the Nazi Party). Ninety years later, the worm has turned, and Germany is standing alone in Europe as the last bastion against the sovereign debt contagion that has brought the rest of Europe to its knees.
It's now a question of whether Germany will muster the internal political will to sign off on the European Central Bank adopting its own quantitative easing policy (a la the Federal Reserve policy in the US), which would give Europe the monetary policy tools to inflate its way out of its excessive debt problems and devalue the euro at the same time. Given the lessons of history, it is understandable why gaining consensus within Germany to go down this path will not be easy.
For investors in the US, it is very frustrating to deal with a high level of weekly volatility and be subject to a situation in Europe where we have no control. Our economy is not doing great, but in the context of the European situation we look better. Continuing unemployment claims are grinding lower (but still not improving meaningfully), and the US real GDP profile for 2012 is forecast to be between 2% and 3% compared to an almost certain recession in Europe.
That being said, we have our own major debt problems here in the US. Unfortunately, it looks like Congress will fail once again in its latest attempt to prove to the world that it has the political will to make tough decisions to live within our means. Last week's large decline was certainly influenced by the fact that the Super Committee negotiations were clearly falling into disarray and acrimony. The Super Committee deadline approaches this coming week before Thanksgiving (please pass the Maalox).
It looks like both political parties are willing to accept more volatility and uncertainty into next year and let the American voters decide next November which fiscal policies the country should adopt to get our own fiscal house in order. Can anyone expect a less volatile environment under such a scenario?
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