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Market Digest – Week Ending 6/1

Fear dominated capital markets. Attention in Europe shifted rapidly from Greece to Spain to the future of the entire European Monetary Union. Pressure mounted on Germany to endorse bolder action such as euro-area bonds or deposit guarantees, but there was no word from Berlin. News in the US was also bleak, as employment numbers disappointed and pending home sales fell. Stocks sank. Treasuries rallied pushing yields to record lows. Gold increased while other commodities fell.

Weekly Returns

S&P 500: 1,278 (-3.0%)

MSCI EAFE: (-3.2%)

U.S. 10-Year Treasury Yield: 1.46% (-0.28%)

Gold: $1,623 (+3.2%)

USD/EUR: $1.243 (-0.6%)

Major Events 

  • Tuesday – U.S. home prices fell 2.6 percent from a year ago, according to the Case-Shiller index. The modest decline was viewed as a sign of stabilization.
  • Wednesday – Pending U.S. home sales fell 5.5 percent, casting doubt on the U.S. housing recovery.
  • Wednesday – The European Commission called for joint Euro-area debt and deposit guarantees, challenging opposition from Germany.
  • Thursday – US GDP for the first quarter was revised downward to 1.9 percent.
  • Thursday – Italian Prime Minister Mario Monti and ECB President Mario Dragi publically pushed Germany for direct Euro-area assistance for banks. Monti also suggested a roadmap to common euro bonds.
  • Friday – U.S. employers added fewer jobs in May than expected and the unemployment rate ticked up to 8.2 percent.
  • Friday – European Economic and Monetary Commissioner Olli Rehn said the Euro area is at significant risk of breaking up.

Our Take

The time to determine the future of Europe has arrived. As expected, capital markets are not waiting for the next Greek election. Whether Greece remains in the Euro or not no longer seems like the main question. Money continues to flow out of weaker European countries into stronger ones and dollar based assets. This will not stop on its own.

Leaders must take bold action one way or another. Continuing to do nothing is probably the costliest decision. Pressure on Germany to allow euro-area bonds or deposit guarantees ratcheted up significantly, even coming from the usually non-partisan ECB. What conditions Germany and her fellow AAA-rated partners would demand in return, or if they will even entertain these ideas, remains to be seen. We should know more in the next couple of weeks. The possibility of the European Monetary Union breaking into several pieces remains a low probability event – but it has become much more real.

Friday’s poor employment report in the US is troubling and suggests America will not be immune to Europe’s problems.

Money has flooded into Treasuries and other “safe” government debt, pushing the 10-Year Treasury yield below 1.5 percent and driving record lows across the yield curve. Bond owners should beware that this tide could reverse just as fast.

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