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After Euro Deal, Investors Brace for Big Moves

Sunday, 11 Dec 2011 05:09 PM

Europe's fiscal pact may save the euro from collapse and stave off worldwide financial panic. But the concerns of many investors are more personal: Will it lift my flagging 401(k)?

The answer from the stock market on Friday was hopeful. As a summit of European leaders concluded with an agreement to deal with their debt crisis, the Standard & Poor's 500 index rose 1.7 percent, capping a second straight week of gains.

Then again, stocks have rallied after other summits — more than a dozen in two years — only to fall again. And the reaction to the deal from even the optimists isn't particularly reassuring.

Hank Smith, chief investment officer of Haverford Investments, says stocks could rise "sharply and quickly" — but only if there's more "good news" from Europe. And that assumes you agree that Friday's deal was good at all.

In that deal, all 17 countries that use the euro agreed to allow a central European authority to oversee their future budgets. They also agreed to automatic penalties if they spend too much.

But the deal won't help cut debt today, which in Italy, Greece and Spain has driven government borrowing costs close to levels considered unsustainable. All eyes are now on the European Central Bank, and whether it's willing to buy enough national bonds from those countries to keep interest rates down.

The frustration for investors is that Europe has drowned out a string of good news in the U.S. that should have moved stock prices higher. U.S. companies are making more money than ever, signs are growing the economy is recovering and stocks are cheap compared with earnings.

So far this year, investors have endured stomach-churning moves up and down in stocks. But in the end, not much has changed.

The S&P 500 has barely budged in the past 12 months. The Dow Jones industrial average, which includes some deeply troubled financial stocks not in the S&P, has performed better — up 5 percent.

Jim Russell, equity strategist at US Bank Wealth Management, is befuddled.

"Stocks are bad — sell them," he says, mocking the prevailing attitude in the markets. "It doesn't matter if you blow out earnings."

Russell is hoping that Europe's latest deal means U.S. investors will forget about the region for a while, focus on the fact that big U.S. companies have increased profits by double-digit percentages for 10 consecutive quarters — and maybe even start buying again.

But the only thing he's convinced is sure to come is more wild stock moves.

Since August, S&P 500 stocks have gyrated by 1.7 percent a day, more than twice its average over two decades. The Dow index of blue chips stocks has seen similar volatility.

The culprit: Europe.

Early last month, the Dow plunged by 389 points on news that squabbling Greek politicians might not be able to push through needed reforms. A few days later, the Italian Senate passed a new austerity budget and the Dow rose 260 points. Then it dropped 326 points over two days on fears that U.S. banks had bet too heavily on Europe continuing to pay its bills and on news of a sudden spike in Italian borrowing costs. Then, another reversal. Several central banks announced they would make it easier for European lenders to borrow themselves, and the Dow jumped 490 points.

In addition to tighter controls on spending, Europe's new "fiscal compact" calls for the launch of a permanent eurozone bailout fund in 2012, a year ahead of schedule. The deal also will send 200 billion euros ($267.41 billion) to the International Monetary Fund, which controls another emergency fund for countries in crisis.

Jeffrey Sica of Sica Wealth Management thinks the pact is inadequate, and stocks could fall 15 percent once investors wake up to that fact. He doesn't think the European Central Bank will buy enough bonds to keep borrowing costs down. And that means banks in the region holding government debt will suffer big losses, with some collapsing. U.S. banks will also get hit with losses, and the economy will struggle for years.

"We had all this anticipation leading up to the meeting," he says. "But nothing much happened."

Sica, who manages $1 billion for clients, sold all of his stocks in August, and put proceeds in U.S. Treasury bills and into so-called "short" bets that stocks will fall.

His view is a nightmare, but even if you don't buy it, there is plenty to worry about.

U.S. companies have generated record profits in part by cutting costs. But there's a limit to how much they can squeeze suppliers and pile work on remaining workers. The other path to riches has been to sell more abroad, but there are signs that may prove difficult soon, too.

This past week, Europe's biggest economy, Germany, reported its exports plunged in October. That followed bad news from a widely-followed survey suggesting that eurozone economy had likely contracted last month, which would make it the third monthly drop in a row. Many experts now think Europe is already in recession or will soon enter one.

This matters because S&P 500 companies get 14 percent of their revenue from Europe. Not surprisingly, some CEOs have been sounding more dour lately.

Many have slashed their guidance on earnings for next year. On Friday, chemical giant DuPont and semiconductor maker Lattice Semiconductor Corp. cut their financial outlooks for the current quarter. That followed a warning from Texas Instruments Inc. a day earlier that its revenue might fall short of expectations.

"We've seen the market highs for the year," says Peter Boockvar, equity strategist Miller Tabak & Co. "Europe will be in recession and corporate earnings here could be challenging."

Russell, the US Bank strategist, agrees that Europe is in trouble but he's still cheery about U.S. stocks. He thinks earnings at S&P companies might grow only 7 percent in 2012, half the rate this year. But he's still urging investors to buy.

Even at that lower rate, stocks are trading at roughly 12 times their projected earnings versus a long-term average of nearly 17 times, he says.

Translation: They're cheap.

"We think investors will like what they see," says Russell, assuming they "refocus on fundamentals."

Given Europe's troubles, it's a big assumption.

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Europe's fiscal pact may save the euro from collapse and stave off worldwide financial panic. But the concerns of many investors are more personal: Will it lift my flagging 401(k)?The answer from the stock market on Friday was hopeful. As a summit of European leaders...
Wall Street Week Ahead
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2011-09-11
Sunday, 11 Dec 2011 05:09 PM
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