Daily Market Reports | Jul 12 2011
By Greg Peel
The Dow fell 151 points or 1.2% while the S&P lost 1.8% to 1319 and the Nasdaq dropped 2.0%.
European bank shares were slaughtered last night with some of the biggest names losing 5-10%. Italian banks were at the forefront as rumours escalate that they will fail the upcoming 2011 stress tests imposed by the ECB – speculation denied by the Italian central bank. The Italian stock market fell 4% and contagion losses across the continent's financial sectors saw London lose 1%, Germany 2.5% and France 3%.
The response on Wall Street was straightforward. The Dow opened down 150 points and, on little volume, stayed there. Action in the S&P 500, which is weighted almost 20% to financials, was similar. The Dow held up better than the broader market given the defensive names therein, while the Nasdaq is a riskier index. US bank stocks were all down around 5%. The VIX volatility index jumped 15% to 18.4.
European officials are currently meeting in Brussels and it was Greece, not Italy, that was supposed to be on the agenda. One assumes the agenda has altered slightly. To understand what's suddenly gone wrong, see European Crisis Escalates from yesterday.
The one saving grace about a debt crisis in the eurozone's third largest economy is that the bulk of Italian sovereign debt is held by Italian banks and insurers. In other words unlike Greece, the debt holders of which are mostly French and German banks, Italy's problems are not so likely to lead to eurozone contagion. Indeed, Italy's government debt to GDP level is much lower than that of Greece and the other peripherals. The problem is, nevertheless, that while the percentage is low the euro value amount of debt is significant and Italy has substantial bond rollovers due over the next couple of years.
Last night the yield on the Italian ten-year bond jumped 33 basis points to 5.98% to widen to a 3.3% over the equivalent German bond. The line in the sand is considered to be a 7% yield, after which point Italy's annual GDP will not be sufficient to cover interest payments. Experience shows that once a country's yield reaches 6% the slippery slope of bond vigilante selling will accelerate that country's bond sales down to junk levels. This is what has happened in Greece, where the ten-year yield is in the teens, as well as in Portugal and Ireland.
The Italian crisis comes at the same time eurozone officials, led by Germany, are considering allowing a partial default of Greek debt. This means a voluntary haircut for Greek bond holders but it also means Greece's debt is reduced rather than extended, which was the basis of the earlier French plan. All up it was a night of “Get me out of Europe”, with the ramifications flowing to all global financial sectors irrespective of their direct exposure. For Australian banks, for example, the issue is to what extent the latest crisis will inflate offshore borrowing costs, just as those costs are otherwise close to peaking.
The US Congress may be stuck in a stalemate over America's debt problems, but in a time of European crisis the flight to quality still means buying US bonds. The US ten-year yield last night fell 12bps to 2.92%. Currency wise, the euro is down 1.4% after having traded lower, and having hit an all-time low against the Swiss franc. The US dollar index is up 1.1% to 75.97 and the Aussie is down 1% to US$1.0654.
Such a big move in the US dollar might have impacted dollar gold, except that European buying pushed gold up to record levels against the euro. In dollar terms, gold is up US$10.10 to US$1554.40/oz.
The same can't be said for the real commodities however. Silver had its industrial hat on last night and fell 2.6%. Copper and lead were down 1%, aluminium and zinc down 2% and nickel down 3%. Brent crude fell US$1.09 to US$117.24/bbl while West Texas fell US$1.08 to US$95.13/bbl in a rare coordinated move.
So what happens now? Well, while many in the market had felt that the Greece-Portugal-Ireland issue could be contained, they were worried about the much larger economy of Spain and just didn't want to contemplate Italy. Spain has been dragged in, with the recent ECB rate rise a kick in the teeth to struggling Spanish property owners aside from the contagion issue. Italy is now in the frame, and markets are very nervous. The meeting in Brussels is ongoing, and will move into tonight when EU officials meet with eurozone finance ministers.
For Wall Street, hope still rests with the June quarter earnings season. Earnings forecasts are ambitious but there have been very few guidance downgrades leading into the season despite expectations of such. Alcoa was one company which did downgrade guidance, from an EPS of US36c to US32c and that's exactly what its result was after the bell last night. Alcoa beat on the revenue line but Wall Street wanted a beat in earnings as well. Alcoa shares are down 1% in the after-market and the US earnings season has begun.
The real test will be later in the week when the big banks report.
Yesterday in Australia the market was responding first to Friday's weak US jobs report, which according to the futures was worth 40 points down, and, one presumes, offshore selling as a sign of dissatisfaction with a carbon tax. But the Italian news was a story in our zone yesterday, so there were potentially several factors behind the big drop in the ASX 200.
Last night, the SPI Overnight fell 39 points or 0.9%.
The results of the European bank stress tests are due on Friday night. After last year's stress tests, accusations were made by the market that the ECB set the parameters to ensure almost a full pass. If the pass rate is equivalent this year, no doubt the same accusations will fly. But if the Italian banks do pass, then perhaps this latest crisis may just be a storm in a cappuccino. Yet as we know with Europe, just when you think it's safe to go back into the water someone makes another sequel.
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