Tuesday, November 8, 2011
With the third quarter reporting season largely over and nothing major on the domestic economic calendar, stock market movements today will effectively reflect developments on the European front. The focus remains on Italy, where a routine budget vote in parliament has the potential to morph into a confidence vote on the government of prime minister Silvio Berlusconi. The market is rooting for Mr. Berlusconi’s departure, but he appears in no mood to quit on his own.
By its sheer size, Italy is a big deal. Ever since the start of the Euro-zone debt crisis, the market has been apprehensive of contagion spreading from the peripheral and much smaller economies of Greece, Ireland, and Portugal to the Euro-zone core of Italy and Spain. Those fears are threatening to come to fruition now as the market loses confidence in the Italian government’s ability to manage the country’s finances. This lack of confidence is showing up in yields on Italian government bonds, which have moved to a Euro-era high of above 6.5% and are inching towards the critical 7% level beyond which lies bailout territory.
A simple answer to rising Italian bond yields would have been for the European Central Bank (ECB) to come up with its version of the U.S. Fed’s quantitative easing program, where the central bank purchased a boatload of treasury bonds to keep yields (or interest rates) in check. The ECB has been making some purchases, but the recent uptrend in Italian bond yields shows that its effort is far from effective. German reluctance to go this route has been a major hurdle in the ECB going this route.
The two-week old Euro-zone had provided for increasing the firepower of the rescue fund (the EFSF), but many critical details of that plan still need to be worked out. The initial hope of attracting contribution from China and other cash-rich emerging economies to that end has also not panned out. The bottom-line is that the Euro-zone debt story is refusing to go away. Last week it was about Greece and not it is about Italy. The departure of the Berlusconi government will likely improve market confidence and bring down bond yields. But if the incoming government, assuming there is a change of political control, fails to come up with a viable long-term plan, then the respite will likely prove short-lived.
On the earnings front, we have results from Toyota Motors (TM), whose operations have been hit hard by natural disasters; first by the Japanese Tsunami and now by floods in Thailand. The auto giant’s global vehicle sales for the six month period ending September 30th were down more than 18% from the year-earlier level. In other earnings reports, Priceline (PCLN) came out with solid EPS and revenue beats after the close on Monday. WMS Industries (WMS), the maker of slot machines, came short of expectations.
Sheraz Mian
Director of Research
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