[Chart courtesy of MarketWatch.com]
Markets finished moderately to the downside as the S&P 500 finished down 0.41% in a less volatile trading session. The dollar remained steady at $1.35/Euro, while commodities didn’t fluctuate much. Also, the VIX dropped 2.86% to 31.97.
However, the closing numbers don’t do justice to intra-day volatility. Our trailing sell stop in VTI was triggered after Monday’s market tumble, and this holding was liquidated this morning as the major indexes headed further south. You can see the details in my latest ETF model portfolio update, which will be posted tomorrow morning.
Once again, the 10-year Treasury dipped considerably, falling to a yield of 1.94%. While we haven’t seen an en masse flight to safety yet, there are signs that developed European and Asian investors as well as emerging markets investors will flock to U.S. Treasures if Europe goes to down.
Most likely influenced by the capital inadequacy of some major European banks and U.S. bank exposure to European debt, the Federal Reserve is set to conduct its 4th round of stress tests in 2012. Bernanke has made it clear that a contagion emanating from Europe could cause a deep capital shortfall if all goes wrong.
In addition, according to the FOMC’s November meeting minutes, the Fed intends on maintaining its 0-0.25% interest rate target level through mid-2013. Looks like QE3 is ready to go. Not to mention, the Commerce Department’s revised downward the 3rd quarter GDP from 2.5% to 2.0% to make matters worse. I believe there’s a high probability that economic recovery is a long way off.
Furthermore, we must consider the possibility of another U.S. ratings downgrade after the “Not-So-Super” Committee’s inability to agree on a budget deficit plan. It’s alarming to see how severely economic and financial problems can be compounded by political fumbling.
All the while, Italy and Spain continue to suffer as their respective 10-year bond yields rose to 6.78% and 6.58% respectively. Investors have good reason to be skeptical that Italy and Spain won’t overcome their debt burdens despite political change.
Considering that both countries are in a growth trap where they need to spend to get out of their economic quagmires, I don’t have much confidence in their ability to implement credible debt reduction plans. Spain’s newly elected People’s Party has put pressure on its European neighbors to help, arguing that Spain can’t afford to fund its debt if yields hit 7%. It’s safe to say there’s no time for siesta.
Frankly, the European situation irks me, and the writing on the wall contains nothing positive. I currently find no substantial basis to deviate from our current strategy with the exception of a select number of equity ETFs well above their trend lines. With the drubbing of the last couple of days, that selection has been sharply reduced.