From the August 01, 2012 issue of Futures Magazine • Subscribe!

Equities face steep fiscal cliff of worries in election year

Trouble in Europe 

The main uncertainty in the outlook for stock indexes, traders and analysts continues to be the outlook for Europe and the resolution of bank and sovereign debt problems there. “You’re dealing with a decision that Germany has to make here and it’s hard to determine exactly what that outcome will be,” says Steven Goldman, principal of Goldman Management Inc.

“I presume they prefer to kick the can down the road, but the market may not allow that,” he adds. “It may mean that the market has to come under a bit more of a crisis before Germany reacts. Ideally everybody would like for them to take some significant stance now, but the talk seems to be more of issues on an intermediate-term basis. They’re not focused on the short-term and that poses some concerns for investors.”

Goldman notes that the rally seen in June had recouped about two-thirds of the losses to the trough at the end of May and had been a very defensive-oriented market rally. “It was not a robust rally, not one that global growth stocks were rallying with but really more defensive stocks. So it looks like more time will be needed to form this base-building process. Valuations are pretty interesting at these levels, especially when you adjust that for credit risk and for interest rates.”

Such valuations are not used for timing but show the risk/rewards on an intermediate-term basis are favorable, Goldman says. “Right now it looks like it’s still going to be a process before we have anything more sustainable on the upside — unless there is something significant coming out of Europe. But I don’t know if that’s likely to occur just now.”

Spencer Patton, chief investment officer at Steel Vine Investments, is downbeat about equities because of continuing issues with Spanish banks. “That issue is not resolved and it’s likely to get worse,” he says.

Patton says that part of the problem with the European situation has been the reactionary and small incremental moves by European leaders, which the market has not responded to very positively. “Generally, the market is going to apply more pressure until a big enough solution gets presented. My core theory is that the Spanish debt situation is going to get worse before it gets better,” he says.

The situation eventually will be resolved, Patton says, noting that Greece was bailed out three times and that Spain had not been even officially bailed out once yet. “My theory is that we’re going to see the markets get quite a bit [lower] than where they are now over the Spain issue [this] summer,” he says.

As China goes…

The European situation also is creating headwinds for other parts of the world, like China, and for commodities that are used in products manufactured elsewhere and sold in Europe. “China is slowing more than people believe,” Patton says. “There have been a lot of rumblings over the last few weeks that the Chinese are flat-out lying about the data that they are putting out. They have a history of doing that — kind of masking the degree to which the economy is slowing down.”

This also is being seen in crude oil prices, with West Texas Intermediate trading below $80 a barrel in late June. “That is telling you that something is very wrong in the global economy — when you get crude oil falling $30 in just two months,” Patton says. “So that’s very concerning to me. U.S. growth is stagnant, and we’re building up to an election [that is] going to have big ramifications upon the U.S. economy. There’s not a lot to be optimistic about.” 

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