Markets Slumped in May Under Political Indecision

Big, bold action is needed to help fend off further market turmoil

   

There’s just no way put a positive spin on the past month. The glaring lack of leadership among European and American politicians is being fully reflected in the corrective action of stock markets around the globe. Lack of conviction to address Germany’s advancement of Eurobonds to hit the fiscal crisis with a bazooka keeps that situation in full flux, where any incremental steps taken are like trying to put out a forest fire with a garden hose.

The markets now are pricing in Greece’s future exit from the euro. If that country does leave, then it only keeps the red flag of caution at full mast as to whether that move leads to further systemic problems for Spain and Italy — two countries whose balance sheets are reflecting rising stress.

Meanwhile, France is posturing to take the lead in the campaign for a “United States of Western Europe.” That has a nice ring to it and takes on the model of establishing a federal government of sorts — something that may morph into reality, but not anytime soon.

But the plan on the table that Germany supports is the only one that matters, and it involves financial support for a commitment to balanced budgets that includes austerity coupled with a new, fresh consideration for stimulus. This is the current balancing act that simply cannot drag out, as markets have started to run out of patience. The risk of a major flight of capital out of the euro into dollars already is underway. If this isn’t addressed, the situation will only feed on itself.

The euro is trading now at roughly 1.24 to the dollar, which is not all bad: A weaker currency helps trade and tourism. However, the downside is that a rapid decline pushes sovereign yields higher and puts further stress on debt repayment.

Restoration of confidence is Job No. 1 for German Chancellor Angela Merkel. And she can’t continue down the same road of pure austerity and rejecting the structure of a pan-euro debt issue that brings in all member nations as a collective force to deal with what are now country-specific crises. I don’t see any other alternatives that will stem the outflow of capital and light a fire under those markets so that relief rallies will last more than a day.

On Friday morning, Europe saw modest gains: The DAX was up 0.4%, the IBEX 35 gained 0.5%, the CAC 40 gained 0.8%, and FTSE 100 led with 0.9% gains. The yields on Spanish and Italian debt are ticking lower: The Spanish 10-year yield is at 6.44%, and the Italian 10-year yield is at 5.81%.

While these yields are still high, the move off yesterday’s highs is an incremental positive. There weren’t any major economic developments out of Europe, but most of the data that was released came in better than expected today. Eurozone CPI was slightly better than expectations, and a decline in Germany’s unemployment rate also surpassed expectations. We’ll take it.

Here in the United States, the story is much better but losing some of its momentum following the economy’s firm start in the first quarter. This week’s economic calendar proves that consumers and businesses also are waving the caution flag. Like the rest of us, they’re unsure as to the ramifications of the year-end fiscal cliff issues that involve the triggering of $500 billion in spending cuts, the elimination of the Bush tax cuts and Congress hitting the debt ceiling, which would threaten the funding of just about everything imaginable.

Americans don’t want rhetoric and dialogue. They want to see budget committees working overtime to reach accord on these issues now, and the latest set of data supports this.

Last week’s round of economic reports looked like this:

  • Case-Shiller 20-City Index of home prices for March: -2.6% versus -3.0 consensus
  • Conference Board Consumer Confidence Index for May: 64.9 versus 71.0 consensus
  • MBA Mortgage Index for week of May 25: -1.3% versus prior gain of 3.8%
  • Pending home sales for April: -5.5% versus +2.0% consensus
  • ADP Employment Change Report for May: 133,000 versus 165,000 consensus
  • Initial jobless claims for week of May 25: 383,000 versus 365,000 consensus
  • Continuing jobless claims for week of May 19: 3,242,000 versus 3,250,000 consensus
  • GDP second Q1 estimate: 1.9% versus prior estimate of 2.2%
  • Chicago Purchasing Managers Index for May: 52.7 versus consensus of 57.0

From this  snapshot, there’s little to get excited about: The data supports the climate of high-level caution and a low level of leadership. If the Fed is going to consider further measures of quantitative easing to stem the slowing rate of GDP growth, then it would seem timely to bring that plan to action during the early part of June. Any further delay gets into the campaign season, and the Fed doesn’t like to be a part of that.

As to how the U.S. stock market is interpreting all of these moving parts, the month of May was the worst in terms of performance since September 2011, a time that also was associated with indecision in the eurozone. The flight to U.S. Treasuries remains unabated; the current yield is down now to 1.42%, a new historic low. Regardless of our economy muddling along at a 2% growth rate, investor sentiment simply can’t shake the quagmire of fiscal uncertainty across the pond.

One last note on an issue that I just can’t stress enough — and I’m not alone here: European Central Bank head Mario Draghi proposed the formation of a banking union in Europe, similar to that of an FDIC. He’s looking to implement more unified and centralized control over banks, including a deposit guarantee to prevent a major run on the banks. Again, we need to see big, bold, collective and coordinated action plans put into place right away to stave off further fiscal turmoil and capital outflows.


Article printed from InvestorPlace Media, http://investorplace.com/2012/06/markets-slumped-in-may-under-political-indecision/.

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