Spain Gets Off The Hook
As we thought might happen, last week’s European summit had a more notable ending than investors have come to expect. Whether the reality justifies the reaction is another question. In any case, markets seem pleased for a change.
Two developments were key to this meeting. First, a deal appears to relieve Spain’s government from responsibility for its failed banks. The most recent European aid, you may recall, included a German-driven requirement that the Spanish government guarantee loans made to its banks. The result was a huge increase in Spanish government debt and a rise in borrowing costs, to the point that Spain’s ability to tap the credit markets was in doubt. The new deal is not entirely clear, but the debt will somehow be shared among regional powers.
Anything resembling “shared” debt has been anathema to German Chancellor Angela Merkel throughout this crisis. Was Merkel finally defeated? We’re not so sure. The second development is that the agreement is predicated on the creation of a new Euro-area banking regulator. What the new regime will look like, and how much power it will have over national governments, is still being worked out. Spain, Italy, and other troubled nations may not be happy with whatever emerges.
The good news is that this meeting probably bought Europe some time, allowing everyone to take their summer vacations. U.S. investors and bankers are doing the same this week with a rare mid-week holiday. Volume was low today and will likely remain so on Thursday. Treasury bonds are calm for the moment, too. Friday may be a different story as the European Central Bank considers loosening its policy and the Bureau of Labor Statistics releases its monthly jobs report.
If you must have action and cannot wait, look at commodities. Crude oil snapped back from a two-month plunge. Gold bounced higher as well, but the best fireworks are in the agricultural group. A midwest heat wave is quickly turning into a drought and pushing grain prices higher. Can weather change as quickly as investor sentiment? Yes. More than a few farmers are hoping it will.
Telecom tops our Sector chart for the second week in a row. The group’s leadership seems not to be getting the attention it may deserve, perhaps due to a vehicle shortage. The popular Sector SPDR ETF family combines Telecom with Technology, rather than providing each sector its own vehicle. However, investors desiring targeted exposure have two good choices in Vanguard Telecommunications (VOX) and iShares DJ US Telecommunications (IYZ). Health Care solidified its second-place position, breaking out to a new 52-week high following the Supreme Court decision. Consumer Staples edged ahead of Utilities to take the #3 slot, though for practical purposes the two are essentially tied. Financials moved up to fifth place and is showing positive momentum. Consumer Discretionary lost ground and is now hugging the zero mark, along with Industrials, Materials, and Technology. A 10% rally in crude oil prices worked wonders for Energy stocks but still could not bring the suffering sector out of last place.
Our Style rankings represent a market in transition. The previous size-driven arrangement is giving way to something else, but what it will be is not yet clear. We see no distinct pattern yet. This is characteristic for our Style-based analysis. Once the groups fall into alignment, they tend to stay there for weeks or months with few relative changes, but it can take them a while to find their places. Improvement in the Small Cap categories, as we see today, may be an early clue – or may be statistical noise. Changes in the absolute strength can still be notable, however. Today only one category is in the red; last week ten were pointed down. Micro Cap is still on top.
Unlike the Style rankings, our Global chart shows no transition underway. Instead, we see more of the same, at least on a relative basis. Strong markets boosted every category higher in terms of absolute strength. The U.S. held its #1 position and is once again green. Japan and World Equity remain close behind, also sporting slightly positive momentum. Japan performed much better than we have seen recently. The U.K. is still in fourth place, followed by #5 Pacific ex-Japan. The EAFE developed-market benchmark had a strong showing, thanks to U.S. dollar weakness. Canada stayed unpredictable, losing ground despite the energy rally. Europe was the week’s biggest winner as the summit seemed to please investors. European stocks and bonds surged, as did the Euro currency. Latin America and China still hold the bottom two positions. Both had an excellent week but will need much more to break their downtrends.
“Without eurozone bonds or a change in ECB policy, Italy’s and Spain’s debt – and eurozone membership – is not sustainable. That was as true on Wednesday as it is today.”
Financial Times columnist Wolfgang Münchau, Sunday, July 1, 2012
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