World Week Ahead: Tolerance for risk taking a hit

Monday 8th February 2010

Fear has returned and it appears set to drive many investors’ trading strategies at least until there are clearer signs how Europe is coping with rising deficits and more data supporting the recovery in the U.S. economy.

The Chicago Board Options Exchange Volatility Index, or VIX, which is known as Wall Street’s ‘fear gauge’ has advanced more than 21% so far this month, and Friday’s activity on Wall Street may be reflective of what’s ahead this week.

On Friday, a late surge in trading helped lift the Dow Jones Industrial Average by 167 points, limiting losses to just 0.6% during the session. Stocks dived worldwide amid heightened concerns that Greece’s deficit troubles weren’t being adequately addressed and that Portugal and Spain would further ratchet pressure on the European Union.

“Whether we’re feeling aftershocks of the crisis or whether this is sign of a new crisis in development, the jury is still out,” Jeffrey Kleintop, the chief market strategist at LPL Financial in Boston, told Bloomberg News.

Last week, the Dow fell 0.6%, the S&P 500 slid 0.7% and the Nasdaq lost 0.3%, marking their fourth consecutive weekly drop.

While those losses don’t seem too dramatic, the Dow did dip below the 10,000-mark and there’s a sense that the global equities rally dating back to last March has run out of steam.

“I am in a camp that believes we're in a correction. The mood has turned short-term negative,” Eric Kuby, chief investment officer at NorthStar Investment Management Corp in Chicago, told Reuters. “The general trend for more than nine months has been for the market to rally, but now it seems as if the enthusiasm has abated, and it's hard for the market to move forward.”

The largest stock market decline in 11 months might worsen amid persistent U.S. joblessness and economic growth that trails analysts’ forecasts, Mohamed A El-Erian, chief executive of Pacific Investment Management Co. wrote in a column for Bloomberg. On Friday the U.S. government reported that the economy shed an unexpected 20,000 jobs in January and that the unemployment rate declined to 9.7%.

Investors have wrongly priced in an “orderly” withdrawal of stimulus measures, a rebound in bank lending and coordinated government policy to restore growth, El-Erian said. That meant Wall Street projections for gains in 2010 might prove incorrect, he said.

Not all hope was lost though.

There was some hope for Europe’s sovereign debt troubles heading into a weekend meeting of the finance ministers of the Group of Seven industrialised nations in Canada. It won’t be clearer until Monday’s session is over whether they said enough to assuage last week’s concerns.

European finance ministers pledged to help Greece and European Central Bank President Jean-Claude Trichet said the bank was “confident” the country would cut its gap below the EU’s limit of 3% of gross domestic product in 2012 from 12.7%.

“The message was clearly that the European members of the Group of Seven have confirmed the substance and significance of the plan put together by Greece,” French Finance Minister Christine Lagarde said. “The European members of the G-7 will make sure it is managed.”

Ahead of the weekend, traders were betting that the euro would extend its slide. The euro slid to US$1.3678 in New York on Friday. It nears a one-year low against the yen and an eight-month low versus the greenback.

Morgan Stanley, citing “internal strains in the euro area,” has cut its year-end forecast for the euro to US$1.24 from US$1.32.

As investors see more challenges than opportunities, equities could correct more. The S&P 500 could slide to as low as 1036, which would mark a 10% correction from its January 19 close.

Investors may look to the latest U.S. retail sales report on Thursday and Friday’s early February consumer sentiment reading for guidance. Sales climbed 0.3% in January, the third increase in four months, according to the median forecast of 51 economists surveyed by Bloomberg. In a separate survey, Bloomberg said the Reuters/University of Michigan preliminary sentiment index for February, probably rose to 75, its highest since January 2008.

On Wednesday, Ben Bernanke, chairman of the Federal Reserve is scheduled to testify on the unwinding of the financial stimulus to the House Financial Services Committee.

As the U.S. earnings season starts to wind down, earnings season takes hold in Australia and New Zealand.

Businesswire.co.nz

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