World Week Ahead: Selling on Spain

Monday 31st May 2010

Most investors are looking forward to the month of June - and for good reason. The Dow Jones Industrial Average posted its worst May since 1940.

For the month, the Dow fell 7.9%, the S&P shed 8.2% and the Nasdaq lost 8.3%. The declines were the worst for the Dow and S&P since February 2009 while the Nasdaq suffered its worst monthly drop since November 2008.

And it wasn't much better in Europe. The Dow Stoxx 600 hit an eight-month low on May 25, and Friday's decision by Fitch to downgrade the credit ratings of Spain suggests more tough times lie ahead.

Fitch cut Spain by one notch to AA+, assigning it a “stable” outlook, according to a statement from London on Friday. Spain has held the top rating at Fitch since 2003. Standard & Poor’s lowered Spain’s ratings to AA on April 28. The cut came days after Spanish lawmakers approved a round of austerity measures by a single vote.

“The process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term,” Brian Coulton, Fitch’s head of Europe, Middle East and Africa sovereign ratings in London, said in the statement.

The downgrade set aside news from a day earlier that China continued to view Europe as a key investment area, comments which sparked rallies across Europe and on Wall Street.

Yet, in keeping with the wild swings in volatility that seem to have become the norm recently, investors on Friday opted to sell.

The Dow Jones industrial average dropped 1.19%. The Standard & Poor's 500 Index fell 1.24%. The Nasdaq Composite Index declined 0.91%.

For the week, the Dow slid 0.6%. The S&P 500 gained 0.2% and the Nasdaq added 1.3%.

"Up until now it's been mostly Greece and the threat of Spain and Portugal and Ireland," Terry Morris, senior equity manager for National Penn Investors Trust Company in Reading, Pennsylvania, told Reuters. "With Fitch actually downgrading Spain, it seems as if it is no longer a hypothetical, the contagion is now real."

Finance ministers and central bankers from the Group of 20 wealthy and developing economies will gather in South Korea this week to review Europe's debt crisis, financial reforms and efforts to rebalance the global economy. The meeting will lay the groundwork for a summit of G20 leaders in Toronto later in June.

With both the UK and US markets closed on Monday because of holidays, many investors will have a few more days to think about where to place their next bets.

In terms of the economic outlook, the U.S. recovery appears to be shifting back a gear after rebounding at a faster pace earlier in the year.

This week there’s a glut of US data.

On Tuesday, there will be a report on construction spending in April and the ISM manufacturing index for May.

Wednesday's reports include Challenger layoffs data for May and US pending home sales for April with the latter seen rising 3.3%, according to a Reuters poll.

Thursday's data includes the ADP national employment report, forecast to show an increase of 51,000 and the government's weekly initial jobless claims.

Later that day, April factory orders, expected to rise 1%, and the ISM services index for May, expected at 55.6, will be released.

The US non-farm payrolls data will round out the week on Friday. The government report is expected to show 425,000 new jobs for the month, up from 290,000 in April, with the unemployment rate falling to 9.8% from 9.9%.

The US dollar is expected to fall against the euro in the coming week with investors betting that most of the bad news on European fiscal woes is already priced in with the single currency's 7% decline in May.

Euro zone sovereign debt concerns remain in spite of a near US$1 trillion safety net set up by European officials to ward off any contagion from Greece, but investors are willing to bet that at least for now, the euro has touched solid support.

This was so particularly after China's Central Bank this week discounted a Financial Times report that Beijing was concerned about its euro zone bond holdings.

And though the monthly US jobs report is scheduled for Friday, investors are only likely to take their focus from Europe if tensions on the Korean Peninsula explode into conflict.

"It's probably dollar down a little bit with the fire put out for now in Europe," said TJ Marta, chief market strategist at Marta on the Markets in Scotch Plains, New Jersey.

"The euro could see a short covering rally but all bets are off if there is more risk." The euro last traded at US$1.2347.

For the week, the euro fell 1.6% against the U.S. dollar, while the US dollar rose 0.7% against the yen. For the month, the euro fell 7.2% against the US dollar, while the US dollar fell 3.2% against the yen.

Any escalation from rhetoric to a border skirmish in Korea would rattle investors and prompt a flight into the relative safety of the US dollar. The yen would also gain, analysts said, with investors seen selling euro against yen.

Businesswire.co.nz

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