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Like so much market turmoil since 2010, today's sell off is rooted in Europe--and it's hard for me to see a quick reversal of the current downward trend
04/10/2012 2:51 pm EST
That the logic this morning in what I’d call the second shoe dropping sell-off after yesterday’s decline in U.S. stocks on Friday’s weaker than expected jobs numbers.
In Europe the German DAX index is down 2.5%, the Spanish IBEX 35 down 3%, the French CAC 40 down 3.1%, and the Italian (Milan) FTSE MIB is down almost 5%.
But the worst damage actually didn’t take place in EuroZone stock markets today.
That distinction goes to the Spanish and Italian bond markets. The yield on the Spanish 10-year bond climbed 0.2 percentage points today to 5.985%. That puts the bond knocking at the 6% level that earned the title “crisis” back in December. The yield on the Italian 10-year bond rose to 5.691%. (The euro dropped another 0.9% to $1.3094.)
Yields on “safe haven” bonds—government bonds from the United States, Japan, and Germany—all fell as investors decided to pay up for safety and liquidity.
I don’t see a quick end to the rout in EuroZone bonds and stocks. The Italian government has a heavy schedule of bond auctions this week and next with each auction offering a chance for fewer bids than expected and higher yields. The Spanish government is desperately fighting for budget deficit credibility—and failing to earn it. Both countries saw yields on their debt drop as domestic banks used some of the 1 trillion euros lent by the European Central Bank to buy government bonds. Credit Agricole calculates that EuroZone banks bought 250 billion euros of Spanish and Italian government debt between the third quarter of 2011 and the first quarter of 2012. But without another European Central Bank loan program—which seems very unlikely—banks won’t be able to duplicate that performance. And there’s certainly no reason for the financial markets, which decided not to buy Italian and Spanish debt in recent auctions, to start buying now without a big run up in yield.
And as far as I can tell this absolutely predictable return of the crisis has caught EuroZone leaders without even the beginning of a plan. Yes, a permanent rescue fund will go into operation ahead of schedule according to recent agreements, but ahead of schedule means July. The Germans are fixated on saying No to raising the limit on the rescue fund or to more bank loans by the European Central Bank or to a Eurobond.
I think that leaves this round of the EuroZone crisis to play out in the financial markets until China or the United States demonstrates that fears about the economic slowdown in those countries are overblown. (Assuming that they are.) And that could take a while.
We do get GDP numbers from China on Friday but even if they’re better than expected, I don’t think they’ll be enough to end worries about the slowdown there. The United States will report first quarter GDP growth on Friday, April 27, and it’s likely to be a relatively weak number. Earnings season isn’t going to help if growth turns out to be as low as expected.
I see this decline ending when the Federal Reserve and the People’s Bank of China move to stimulate growth and support asset prices with another round of quantitative easing and the first of China’s interest rate cuts. Those moves, plus a retreat to attractive prices for stocks, would put an end to the decline. So far, technical analysts say, the most likely support for the Dow Jones Industrial Average would be at either 12,500 (a 38% retracement of the gains in the recently concluded rally) or 12,258. The index was at 12,744 at 2 p.m. New York time today. I think a retreat to 12,258 is more the more likely scenario of those two. (That level is also the 200-day moving average for the Dow.) A drop to 12,258 would be a retreat of another 500 points on the index or about 4% and it would bring the total drop from the April 2 high of 13,264.49 to 7.6%.
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