Little muscle out of Brussels

Expectations for last week’s European Summit ran the gamut from cautious optimism to cynical pessimism regarding the future of the Eurozone’s single currency experiment. Following the European Central Bank (ECB) 25 basis point rate cut and their easing of collateral restrictions and reserve requirements on Europe’s banks, investors were hopeful that this week’s European Summit would finally deliver a lasting solution to the ongoing debt crisis.

Being the fifth such summit in the past two years, it was hoped the fifth time’s a charm! In the end, all we got was a new accord or ‘Fiscal Compact’ that will not be unanimously adopted by all 27 EU countries.

The United Kingdom was the main dissenter who found the proposed taxes on the financial industry objectionable. All 17 countries that use the Euro currency did agree to sign on to the new agreement which puts a ceiling on fiscal deficit limits and requires each country to establish an “automatic correction mechanism” should they stray from their budget goals. The deal is a step in the right direction but it offers too little money, is short on implementation certainty, and shows deep fragmentation at the foundation of the EU. Stock markets gave a generally mixed and lukewarm reaction to the agreement since it followed hard on the heels of the disappointing news that the ECB remains steadfast against a Quantitative Easing program for which the markets had been hoping.

The focus on Europe kept investors from caring too much about the improving prospects in the U.S. economy. Consumer confidence in November soared to a five month high and weekly jobless claims were lower than expected again reflecting a drop in firings that may signal the job market is on the mend.

In Canada, the Bank of Canada kept its overnight interest rate at 1.00%; exactly where it has been since September 2010. Citing a more pronounced recession in Europe than had been anticipated, Governor Mark Carney said the current policy setting is a balance between the European threat to growth (1.9% expected in 2012) and inflation which has been higher than the bank’s 2% target. The Canadian dollar ended another volatile week following the broader market sentiment rallying from its weakest level this month. This week’s jump in U.S. consumer confidence has helped the Canadian dollar become the best performer over the past month among its 16 most traded counterpart currencies.

Euro Continues to Flounder

Two events last week spell continued weakness for the Euro currency. The ECB played ‘give and take’ this week. The ‘give’ was a 25 point cut to interest rates, relaxed collateral rules, and reduced reserve requirements for European banks. At the same time, the ECB dismissed the ideal of actual Quantitative Easing in exchange for a new fiscal agreement amongst EU members. Germany continues to object to the ECB buying up the debt of the troubled EU members, long seen as a resolution to the current problem. In the second event, the European leaders “agreed to” another stability pact during their summit. But like most of their recent summits, they were high on rhetoric and short on details. Apparently details will now be revealed in March of 2012.

The Trading Week Ahead

A busy week is in store as investors have made their lists and look for a Santa Claus Rally to take flight in earnest. This will be the final full week of trading with decent volumes prior to year end. With the holiday season rapidly approaching many traders and investors will soon commence their year-end holidays.

On Tuesday, Retail Sales should register another solid month in November. Auto sales rose to a cyclical high and judging by the Black Friday and Cyber Monday results, chain store sales should be robust. The final Federal Open Market Committee (FOMC) meeting of 2011 also takes place next week but there is little expectation of any bold changes to interest rates or how the Fed communicates its goals and longer term strategies. Notes from the FOMC meeting in November suggested that under current circumstances the Fed would have to engage in a third round of Quantitative Easing. Data points on employment prospects and consumer confidence have improved since then, so it will be interesting to see if several committee members persist in pushing for additional monetary policy accommodation.

PPI and CPI data should show that moderating fuel prices in November should result in an overall lower read on inflation as the year comes to a close. The industrial production should fall slightly in November as hours worked were down and auto production declined. Despite the soft month, the year over year trend in factory output is holding steady above 3%.

Things are pretty quiet on the earnings front, however enigmatic Research in Motion reports its fiscal quarter on Thursday. Conditions at RIM have been bad but they could get worse. Management has already warned on the quarter, but investors will zero in on expectations for the February quarter and beyond. Given RIM has missed expectations the past few quarters, they may further annoy investors by guiding more conservatively or refusing to give full year guidance.

Question of the week

Will there be a ‘Santa Rally’ in stocks this year?

Santa Ben and his global central bank elves showered the financial world with an early Christmas present last week. Investors are now wondering if that might be the start of the seasonal ‘Santa Rally’. A Santa Rally would finish out what has been a very difficult year for investors due to high intraday volatility we have been experiencing and the anemic growth in the global economy. The anticipated “Santa Rally” typically occurs because of a high volume of cash changing hands due to holiday shopping and investors closing out trades before the end of the year for tax purposes. It’s further fueled by institutional and hedge fund managers hoping to pretty up their portfolio returns in advance of that big year-end bonus. The stock market often goes vertical during late December as market players position themselves for the seasonal “January Effect” which continues the Santa Rally into the first month of the New Year.

The 2011 holiday season is off to a little different start as the European debt crisis has largely driven markets this year and so far has delayed any hopes of a rally. Since 1928, the stock market has posted a gain for the month of December in 63 out of the 83 years, or 76% of the time. While a December rally may seem implausible this year given the dire circumstances in Europe, such a bounce seemed equally unlikely back on October 4th when the stock market suddenly reversed and went on to post the third best October monthly gain since 1928. While the direction of the market remains uncertain, one thing seems highly likely: the extreme stock market volatility is almost certain to continue as we move through the rest of the year.

David Andrews is the Director, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @David_RGMP