Equities Lose Their Mojo

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Investors had plenty of noise to listen to last week with all the concerns over Italy, the European Union bank stress tests, debt ceiling negotiations, QE3 chatter, and a mixture of lethargic economic data. When the dust finally settled, all the domestic equity indexes were substantially lower for the past five trading sessions. The only two broad sectors that managed to close higher on the week were in the ‘risk off’ zone of gold and bonds. The dark cloud that is keeping buyers on the sidelines is obviously the Congressional debate over raising the U.S. Government debt ceiling. Currently there is some hardball politicking going on right now, and financial markets always tend to get more volatile when their destiny is left in the hands of politicians. This is also why the next two weeks before the supposed August 2nd deadline for the debt ceiling increase is so crucial.

As we continue to deal with the ongoing budget deficit crisis, the financial markets are scrambling to work out what a downgrade of U.S. debt would possibly mean for millions of investors, as well as banks, money-market funds and pension funds. Standard & Poor’s and Moody’s Investors Service have both warned that the U.S. may lose its AAA credit rating unless a credible plan is soon reached to reduce the federal deficit. The loss of the pristine AAA branding would likely shake the confidence of investors around the globe, and could cause a flight from riskier assets like stocks and commodities. In addition, downgrades would raise funding costs for municipalities and government agencies, while money-market and pension funds that are mandated to hold certain levels of AAA-only assets could be forced to sell their Treasury holdings, which would depress the prices and trigger the sales by other funds. In other words, it’s a huge mess that seemingly just won’t go away until we get some type of resolution from our Congressional leaders on this important matter.

For the past week, stock prices were broadly lower, with the Dow Jones Industrial Average snapping a two-week gain and finishing lower by 1.4% to a current level of 12,480. The broader Standard & Poor’s 500 gave up 2.1% on the messy week and has now fallen to a mark of 1,316. The Nasdaq Composite Index ended its three-week winning run and dropped 2.5% to 2,790, while the Russell 2000 index of smaller-cap stocks gave up 2.8%, and now sits at 829.

The year-to-date figures for some of the major indexes are still relatively decent, and currently rest at the following levels: the Dow, up 7.8 percent; the S&P 500, up 4.7 percent; the Russell 2000, up 4.8 percent. Meanwhile the tech-laden Nasdaq is up 5.2 percent thus far in 2011, thanks in part to the stock of Google, which was up 13% this past Friday alone.

Treasury securities are banking on the fact that there will be some type of an agreement to avoid a U.S. default, and obviously finished the week higher. The yield on the benchmark 10-year Treasury fell once again below the 3% mark, declining 11 basis points, to 2.91%. (A basis point is 1/100th of a percentage point.) Over the past two weeks, the 10-year yield is down some 30 basis points on continued concern over the U.S. economy. On the shorter-end of the Treasury market, which is largely influenced by expectations for Federal Reserve monetary policy and the future of money-market rates, the two-year note ended the week at 0.36%, down three basis points, but 12 basis points higher than the yield two weeks earlier. Second quarter earnings seasons begin in earnest next week with companies representing 4% of the S&P 500 market cap reporting their results. Investors will be focusing on the interplay between corporate profit growth and the current sluggish US economic expansion. Most pundits are expecting that S&P second quarter earnings will be in the range of $23.75, which would be almost a 12% improvement from the second quarter of 2010. This could also drive continued upside for the market if the accompanying management commentary is also reasonably positive. Companies such as Google, J.P. Morgan Chase, Yum Brands, Consol Energy, ConocoPhillips, and Citigroup all topped forecasts this past week amid an unexpected jump in revenue. This week we’ll get results from the likes of: Halliburton, IBM, Bank of America, Apple, United Health Group, Johnson & Johnson, Coca-Cola, Wels Fargo, Goldman Sachs, Intel, eBay Abbott Labs, Microsoft, General Electric, Caterpillar and McDonald’s, to name just a few. Let’s just hope that the earnings parade continues to bring investors more good news.

As we enter the ‘dog days of summer,’ enjoy the mid-July temperatures, and be prepared for another interesting and more than likely volatile week in the stock market.

Sources: Barron’s, Wall Street Journal, Yardeni Research, Associated Press, Gorilla Trading, Dow Jones & Company

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