Breaking Commentary: Fed Gains Disappear
Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.,
Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research, and
Michelle Gibley, CFA, Senior Market Analyst, Schwab Center for Financial Research
August 10,Ā 2011
Key points
- Stocks fell sharply again today (August 10), continuing the extreme volatility seen recently.
- Concerns over the state of the financial industry in France drifted into the United States, contributing to the sell-off.
- Confidence appears very fragile right now and investors should use this volatility to judge their level of risk tolerance and adjust long-term allocations as appropriate.
Yesterday's sharp gains are nothing but a memory now as equity investors endured another day of aggressive selling, with the Dow plunging over 500 points, and financials getting hit the hardest on European bank contagion fears rearing up again. Meanwhile, investors again flocked to Treasuries, pushing the 10-year to below 2.10%. One of the positive sides to these record low yields was reported today as refinancing activity surged 30.4% last week, the most since March 2009. Lower house payments, combined with lower energy costs, can help consumers' pockets as we continue to look for a bit of an economic upswing in the coming months, but further deterioration in confidence can damage that outlook.
To us, the story remained somewhat familiar today as already shaky confidence appeared to be exacerbated by rumors of financial problems popping up in France, including concern they may lose their AAA-credit rating much as the US did last Friday. Although the ratings agencies quickly denied they were looking at downgrading France, it appears confidence is so tenuous that investors are selling first and asking questions later.
Europe back in the spotlight
The downgrade of the credit rating for the US has been a complicating factor for Europe in our opinion, as France has maintained its AAA-credit rating, which some view as inconsistent with the US rating and may be unsustainable given the possible implied liability of funding bailouts for other European sovereigns. Additionally, the current bailout fund for the region, the European Financial Stability Facility (EFSF), is likely dependent on the AAA-rating for Germany and France to access capital, which in turn is used to provide aid to the weaker countries. Concern could also be seen in the currency markets as the euro fell sharply, with questions about growth and the very viability of currency long term seemingly creeping into some traders' minds.
Just as Italy and Spain are likely too big to bailout given the current structure of the EFSF, it is destabilizing when doubts begin to creep up about the stability of France. We believe France will make whatever necessary adjustments needed to calm markets, and will be more proactive than other nations so far, as they've demonstrated a leadership role during recent weeks. Of course an upcoming election and unpopular decisions don't usually mix well, so nothing is guaranteed.
Meanwhile, the rolling crisis of confidence appears to continue to infect European banks. There is a question of the chicken or the egg here, but the interaction between banks and governments appears to be reinforcing this negative feedback loop. Reasons include large holdings of sovereign debt by banks, which may end up having write-downs, governments tend to be the backstop for banks, banks can have funding issues if they are using government debt as collateral for loans, etc.
