There was no grand plan as a result of the EU summit but in true European fashion they were all smiles about their new plan to make another plan.
I am not surprised the EU leaders came up with another plan suggestion. It was better than throwing up their hands and achieving nothing like our super committee did last month. What I am surprised about is the market reaction. Obviously maximum pessimism was priced into the market and Friday was a relief rally the euro zone did not self destruct.
Did everyone forget about S&P and their threat to downgrade everything in Europe including countries, banks and bailout vehicles if a grand plan was not achieved? Friday's rally on the hope for future improvement in Europe almost makes you wonder if the Fed was in the market buying futures at the open.
What really happened in Brussels on Friday? Basically the leaders cobbled together a "potential" fiscal stability pact for "up to" 26 of the 27 nations. The UK said absolutely not and will not take part in future discussions. Late Thursday night it was like a play by play announcement of progress in the meeting. There are 23 of the 27 nations agreeing to the pact. An hour later there were 24 of 27. A couple hours later 25 of 27, etc. The official tally at the end of the meeting was 26 of 27 with the UK the sole objector. However, just because a country's representative loosely agreed to go along with the plan to make a plan it does not mean they will actually vote for it later.
The EU leaders now have three months to actually put a plan together to be signed in March. Depending on what gets added to the rough draft there may be far less than 26 countries agreeing to put it to a vote. That also does not guarantee that the individual governments of each country will actually approve it once a final plan is presented. Ireland, Hungary and the Czech Republic are already voicing concern over potential provisions. Surprisingly nine of the non euro zone countries agreed to go along with the plan to force fiscal responsibility.
Under the proposed plan each country would agree to pursue a tougher budget discipline with automatic sanctions for those with deficits over the allowed 3% of GDP. Nobody knows what those sanctions will be or how they will be enforced. The original Maastricht treaty 20 years ago to the day had rules for fiscal responsibility but everyone ignored them when budgets grew tight and politicians needed votes. Under the proposed plan each country would have to present their budgets to the European Commission for approval.
Obviously if the 26 countries can actually institute a budget with only 3% deficit spending across the entire European Union it would create tremendous financial stability. However, as we all know just having a rule does not make everyone follow it. I still can't conceive of countries like Greece, Italy, Spain, Portugal, etc actually living in a 3% world. I think we will see some really novel ways develop for getting around the rules. The plan would require individual countries to make constitutional changes to implement an "automatic correction mechanism" that forces spending cuts when budgets exceeded the deficit targets. Good luck with that! The blueprint would require "more intrusive control" of taxing and spending by the European Commission on governments that exceed the 3% limits. I can't even imagine that actually working at any point in the future. FYI, Germany was the first country to violate the spending limits in the first treaty but since Germany was the strongest in the euro zone the debt limit sanctions were never applied. When Germany got away with it everyone else followed suit.
They are going to do this with an intergovernmental treaty in hopes of speeding up the approval process rather than modifying the original treaty, which would be blocked by the UK. The EU leaders could meet again in January to go over the first draft and then meet again in March to approve the final draft.
As part of the deal the European Stability Mechanism (ESM) will be capped at 500 billion euros and launched in July. However, Finland and Slovakia are already talking about pulling out of the agreement if the requirement for unanimous approval on all actions is removed. The originators want to lower the approval process to a qualified majority of 85% to avoid problems like they had earlier this year. Finland would not approve the bailout of Greece unless the country put up collateral for the bailout loan. That was eventually resolved but they don't want to fight that battle again in the future.
The EU countries in total also agreed to provide up to 200 billion euros in bilateral loans to the IMF with 150 billion coming from euro zone countries.
The EU leaders also affirmed there will not be any further haircuts for private sector involvement in the debt markets. They agreed the 50% haircut required of private investors in Greek debt was handled badly and adversely impacted the market for debt from all European countries. In the future they will follow the IMF guidelines for debt restructuring. This was a positive for European debt. Investors had been fleeing the debt on worries a further decline in economic conditions could see their investments be restructured as part of some new bailout. EU President Herman Van Rompuy said, "To put it more bluntly: our first approach to private sector involvement, which had a very negative effect on the debt markets, is now over."
ECB president Mario Draghi said the overall agreement was a "very good outcome" and that is a dramatic change from his very pessimistic expectations for a deal only the day before.
The EU leaders need to accelerate these plans as quickly as possible. Euro-area countries have to repay more than 1.1 trillion euros of debt in 2012 and about 519 billion consists of Italian, French and German debt in the first six months alone. European banks have 600 billion euros of debt coming due over the next six months. If leaders can't get the treaty signed quickly all of those debtors will be paying much higher interest rates to renew that debt.
Official press release of the European Council
There is still the threat of the S&P downgrade. The company said it would study the summit implications and "impact on the growing systemic stresses we identified." While a "unified stance" could prompt a delay in our decision, rating cuts remain possible.
To bottom line the summit results the countries KNEW there were downgrades coming soon if they didn't enact something. This plan to make a plan sounds good in theory but I foresee major problems in getting it enacted. What this did was buy another three months of time if they are lucky. They succeeded in kicking the can a little further down the road but the loose agreement is a very long way from a done deal. This is a broad agreement in principal only and negotiating the actual details will be a really contentious task.
I think the market rebounded in relief the meeting did not deteriorate into a breakup of the euro zone. The zone gained another three months of life and that was good enough for traders to abandon short positions. I believe most traders believed as I did that it would be increasingly harder to get 17 countries to agree to anything, much less all 27. The potential for failure was huge.
The market wants to rally and any excuse to kick Europe out of the headlines was all that was needed. Frankly I would be thrilled at any plan that kept Europe out of our headlines and I would not have to write about it again until March.
In the U.S. soaring Consumer Sentiment boosted the market at the open and helped to overcome the earnings warnings by DuPont and Texas Instruments.
Consumer sentiment for December rose +3.6 points to 67.7 and the highest level since June. That is also well off the 55.7 low in August. The present conditions component was basically flat at 77.9 vs 77.6 in November. The expectations component rose nearly +6 points to 61.1 from 55.4.
Jobs are starting to increase as we saw in the nonfarm payroll report last week. Gasoline prices are still relatively low compared to the highs back in May. During this survey period there were many headlines suggesting Europe was going to find a solution. Holidays also tend to improve sentiment but that tends to decline in Jan/Feb when the credit card bills come due.
Consumer Sentiment Chart
The economic calendar for next week is headlined by the FOMC meeting on Tuesday and the Philly Fed Manufacturing Survey on Thursday. The Fed is expected to remain on hold and not change their current monetary policy. The improving U.S. economy gives them that option. The lack of a disaster in Europe will also allow them to wait until January and see how the new fiscal compact formation is progressing.
The Philly Fed Survey is seen as a proxy for the national ISM released at the beginning of every month. The headline number ticked down slightly last month from 8.7 to 3.6 and analysts are mixed on the outlook this month. The Philly headline dipped to -30.7 in August, -17.5 in Sept and +8.7 in October. It was due for a rest after that strong rebound.
OPEC meets on Wednesday and no change in production is expected. The last meeting ended in a brawl with no official quota change announced. Iran and Venezuela wanted a cut in production and Saudi Arabia, Kuwait and the UAE wanted to expand quotas to offset the decline in production by Libya. They could not agree and with Iran holding the rotating OPEC presidency at the last meeting it became a battle of wills. Iran and Saudi Arabia are enemies. Iran took the opportunity to enforce its will at the meeting but could not arrive at a consensus. After the meeting Saudi, Kuwait and the UAE raised production on their own to compensate for the lack of Libyan supply. There is no change expected at this meeting. Countries are able to sell all the oil they can produce at high prices and Saudi is actually getting record prices for some of its lower grades due to high demand. Some analysts will claim there is an excess of production but producers could not sell their oil at record prices if there was a surplus. The facts speak for themselves.
Du Pont (DD) joined the list of disappointments when they warned on Friday of lower earnings because of slower than anticipated sales growth in Q4. They reduced their profit guidance to $3.87 to $3.95 from $3.90 to $4.05. The company said they were seeing slower growth in certain segments during the fourth quarter, driven by global uncertainty. The uncertainty is contributing to conservative cash management in some supply chains.
A Jefferies analyst lowered his 2011 guidance and his 2012 guidance saying DuPont will probably warn as did 3M (MMM) for the first half of 2012. 3M cautioned on the outlook for consumer electronics in early 2012. Companies are starting to react to the outlook for slower growth in Europe as a result of forced austerity and cash hoarding by European consumers afraid of future bank disasters. DuPont will hold an investor conference next Monday and Tuesday. DuPont shares fell -3% on the news.
Morgan Stanley (MS) downgraded expectations for Potash (POT) and Mosaic (MOS) saying farmers are apparently becoming more conservative in their fertilizer buying patterns. The analyst said conversations with farmers did not indicate there was a sudden drop in buying but they were just unsure when those buys would take place and in what amount. The analyst said farmers were hoarding cash and holding off on purchases until they could see the outlook for the 2012 growing season. However, some farmers would prepay in 2011 in order to reduce taxes from record 2011 profits. The analyst cut the price target on POT to $66 and MOS to $85.
Stocks of both companies have been depressed due to sporadic sales influenced by bad weather over the 2011 growing season.
Altera (ALTR) cut its earnings guidance again and said revenue would decline by -13% to -16% in Q4. In October they said to expect declines of -7% to -11%. Altera shares dropped sharply at the open to $33.84 but rebounded to close positive at $35.89.
Lattice Semiconductor (LSCC) warned they saw "further softening of demand primarily in the communications business" in December. They now see revenue down -14% to -17% sequentially compared to a -4% to -9% decline. Lattice shares declined -4%.
Earnings warnings are helping to push estimates for Q4 earnings even lower. The current outlook for S&P earnings for Q4 is 10.1% growth and very close to falling into single digits. On July 1st the estimate was for +17.6% growth and on Oct-1st that had declined to +15% growth. Earnings in Q3 were up +17.9%. Estimates are plunging thanks to some of the big names with big profit declines. Expected revenue growth has declined to +6.6% from +11.1% in Q3.
The materials sector is taking the biggest hit. Earnings for materials are now expected to decline by -1.4% compared to early October estimates for a gain of +25.6%. Financials are now expected to see earnings growth of 18.3% compared to October estimates of 26.6%.
Sears Holdings (SHLD) was cut to a sell at Imperial Capital. The company put a $6 price target on Sears with the current price at $56. That is a seriously negative outlook. The analyst said the pension plan was significantly underfunded and operating performance was deteriorating. Sears posted a larger Q3 loss than anticipated on sharply higher raw material costs and rising economic fears. Personally I don't see $6 in my lifetime simply because their real estate is worth several times that amount. Sears is taking steps to rejuvenate operations. One of those steps is the spinoff of the Orchard Supply Hardware Stores chain. The 89 store chain will trade under the symbol OSH on the Nasdaq. The distribution will occur on Dec 30th and every 22.14 shares of sears stock will receive one Class A share and one preferred share of the new company.
Sears Holdings Chart
GE rallied +3% on Friday after raising their dividend by +2 cents to 17-cents for the quarter. That is the fourth increase in two years. That is still lower than the 31-cents paid in April 2009 before they had to slash the dividend to conserve $9 billion in cash. That was the first dividend cut since 1938. The dividend is payable on Jan 25th to holders on Dec 27th.
Financial stocks rallied on Friday as worries eased about a breakup of the euro zone and a European banking disaster. Since you can't short European bank stocks the U.S stocks were shorted instead to hedge risk in Europe. When Europe didn't self destruct those shorts were closed. Also, the increased liquidity through the coordinated central bank currency swaps and the new ECB rules and three year loans means there is far less counterparty risk from overseas banks. Large U.S. banks rallied about 3% each but that was still less than they declined on Thursday.
U.S. banks should benefit from the banking distress in Europe. The 115 billion euro recapitalization means less lending and the sale of assets and loan portfolios by European banks. U.S. banks are very well capitalized today and well positioned to benefit from those distressed sales and create new customer relationships as a result.
Warren Buffett named his successor during a 60-minutes interview this week. Warren said he wants his son, Howard Buffett, to succeed him as nonexecutive chairman of Berkshire Hathaway. Howard, a farmer with no college degree, would be a good successor according to Warren, because he understands the values of the company. Howard said he was open to the idea as long as he does not have to quit farming corn and soybeans. It will be interesting to see what shareholders think of that succession plan when Berkshire opens for trading on Monday. I know they love Warren but turning over the chairmanship of a $200 billion company to an uneducated bean farmer may not be the plan they had in mind. Obviously the chairman is not responsible for running the day to day company and making decisions on spending tens of billions of dollars on the next acquisition but he does have clout on the board. It should be interesting.
Berkshire A Chart
The IPO market could be hot next week if those scheduled come off as planned. There are 13 IPOs scheduled and the most since November 2007. JIVE Software will launch on Tuesday with an estimated share price of $8-$10. Michael Kors will open on Wednesday with an expected price of $17-$19. Zynga will trade on Friday with a price of $8-$10.
If the markets exist to confound the wise they are fulfilling their purpose. The S&P rebounded on Friday from what seemed on Thursday night to be the brink of disaster. However, despite the rebound the S&P failed to recover all the losses from Thursday. The close at 1255 was well below solid resistance at 1265 and the market was losing momentum at the close.
Europe did not actually change anything. They simply kicked the can farther down the road using an elaborate scheme long on principle and short on details. Why the U.S. markets rebounded on this charade is a mystery. Obviously the hopium supply is overflowing. Were traders so sick of worrying about Europe they were willing to accept any news on face value and immediately dump their shorts?
Whatever the reason for the rally, Monday starts a new week. I continue to hear 1,300-1,350 as yearend targets for the S&P. I think the market reporters have mentioned those numbers so much they are becoming a sell fulfilling prophecy. Unfortunately, before traders can go skipping merrily down the yellow brick road to 1350 they have to get past the toll booth at 1265 first.
What is going to be the major headline that pushes us over that level next week? The Fed should not produce any surprises. They rarely make any moves in December and this meeting has even more reasons why they will likely stand pat. The opening paragraph of the 2:15 announcement will probably say the economy has improved somewhat but I expect the "significant risks remain" statement to also be repeated.
I suppose if the markets can rally +200 points on the bogus EU deal they could rally another 200 points if the Fed removed the significant risk statement. The bulls will read the announcement with rose colored glasses and only see bullish comments.
When the market wants to run you either get out of the way or go along for the ride. I would buy a breakout over 1265 but I will always be looking out for that headline out of Europe that shatters the illusion of an iron clad agreement.
Support on the S&P is 1,235 and resistance 1,265. That gives us a broad 30-point range to wander while we wait for that next headline.
The Dow closed less than 50 points from a five month closing high at 12,231. Considering all the negative news from Europe and earnings warnings this is a minor miracle. If anything it is an illustration of how strongly the markets want to rally into yearend. Bad news is being ignored and every dip quickly bought. A move over 12,231 should trigger short covering and price chasing by funds anxious to own winners at month end.
Support at 12,000 held and the next move could easily be a test of overhead resistance to see if a breakout can succeed.
The Nasdaq rebounded off critical support at 2600 to post a +50 point gain past resistance at 2625. The 200-day at 2670 is the next resistance battle. That 200-day resistance has held for two months.
There were only two Nasdaq stocks that lost more than $2. Those were PCYC and OYOG. On the plus side there were more than 100 gaining more than $2 with DMND, GOOG and ISRG gaining more than $10 each.
With three warnings in the chip sector you would have expected the Nasdaq to be negative or at least lackluster. If you want logic don't look in the stock market because the semiconductor index also closed higher for the day. This is another example of traders buying bad news. What will happen if we actually get a day without bad news?
Support is 2600, resistance 2670.
The Russell rebounded more than 3% and was the best performing index on Friday. I believe this was a result of the heavy shorting on Thursday when it appeared the EU summit was spinning out of control. The small caps are normally the best performers in December and a break over 750 would be a buyable event.
Europe is out of the headlines. At least that is what most investors will think. For next week I suspect the number of articles will decline sharply and be replaced by U.S. news, OPEC and China. That does not mean the European problem has been solved. It just means without an active summit in progress there will be few high profile events to report. The real work will now be done by the staff working for the public figures and they don't normally generate headlines.
If Europe is out of the headlines next week we should see buyers return unless of course some new disaster appears. The FOMC meeting would be the likely place but I don't see anything coming from the Fed except an upgraded statement on the economic progress. They rarely make any kind of move at the December meeting.
The market will be left to its find direction on its own and with investors and funds trying to find a place to put the yearend bonuses and retirement contributions to work the most likely market direction will be a retest of resistance at 1265 on the S&P. There are multiple analyst meetings next week hosted by UTX, HON, GE, DD and CSX. Best Buy (BBY) has earnings on Tuesday before the open. FedEx (FDX) has earnings on Thursday along with Adobe (ADBE), Discover (DFS), Accenture (CAN) and Pier One (PIR). Darden Restaurants (DRI) has earnings on Friday.
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