[dropcap]T[/dropcap]he S&P 500 posted its best week of the year despite a lack of any significant good news. Fear surrounding Europe’s debt and banking crisis gave way to hope that policy makers will find solutions. An announcement of a plan to recapitalize Spanish banks is widely anticipated to occur over the weekend. The Fed acknowledged heightened risks for the US economy but abstained from new stimulus, disappointing some. Treasuries fell after yields hit record lows last week. Gold and oil also declined, with US benchmark crude dropping below $83 per barrel for the first time since October.
S&P 500: 1,324 (+3.7%)
MSCI EAFE: (+4.2)
U.S. 10-Year Treasury Yield: 1.63% (+0.17%)
Gold: $1,593 (-1.8%)
USD/EUR: $1.251 (+0.6%)
- Monday – US factory orders unexpectedly declined 0.6% in April, according the Commerce Department.
- Tuesday – Spain made its most explicit suggestion that it would seek help to stabilize its banks. Budget Minister Cristobal Montoro said the country was losing access to bond markets.
- Wednesday – ECB President Mario Draghi said the central bank is monitoring all developments closely and “stands ready to act”. Stocks rallied.
- Thursday – China cut interest rates by 0.25%, the first time since 2008.
- Thursday – Spain successfully sold €2 billion of new debt, easing fears the sale would experience lackluster demand.
- Thursday – In testimony to Congress, Fed Chairman Ben Bernanke cited risk to the US economy, but did not offer specific suggestions of new action. He explicitly left the door open for additional future stimulus measures.
- Friday – Ratings agency Fitch cut Spain’s rating by three notches.
- Friday – President Obama called on the euro zone to “take decisive steps to inject capital into its weak banks and deepen collaboration on its financial system and budgets to stem the financial crisis.”
- Friday – Reuters cited “senior” EU and German officials as saying Spain would formally ask the euro zone for help recapitalizing banks this weekend.
Not long ago, the thought of major bank nationalizations driving a stock market rally seemed absurd. But that was before 2008.
And if it feels a lot like 2008, that’s because it is. Spain’s banks are in trouble because they are loaded with bad loans made in a real-estate bubble. However, there are three key differences – one bad and two good:
- The Euro zone is much more complex. It has a weak central bank whose powers are unclear. Also, several governments with competing interests must agree before anything major can happen.
- There is precedence for success. The U.S. experience demonstrated that bold government action can work, at least in the short to intermediate term.
- The U.S. is more removed. European banks held a lot of U.S. sub-prime debt. Europe got hit with both the slowdown in the U.S. and severe direct losses. This time, the U.S. will be impacted by a slow-down in Europe, but the direct exposure is much more limited.
On Oct. 13, 2008, U.S. Treasury Secretary Henry Paulson summoned the CEOs of the nine largest U.S. banks and forced them to sell shares to the government. Some of them wanted it and some did not. It was perhaps the largest violation of property rights by the U.S. government (at least domestically) in the last 30 years. This was very scary for those who believe in the power free markets, as we do. In retrospect, however, for the most part it worked. The banking system didn’t implode. Equity investors felt awful for a while, but the world didn’t end.
This example is the hope which is now supporting stock markets. If the Euro zone can find the right levels of government support, it too may return to normalcy in coming years (note: the U.S. still has a large debt problem, so we don’t mean to imply the U.S. is now problem free). There will be many challenges, both short and long term.
Hopefully, a solution equally good for Spain and the euro zone will be put into action, and soon. This would provide further relief for fear driven equity markets. Expect volatility to remain high. In addition to Spain, the June 17 Greek elections are now just about a week away.