December 8, 2023

Doubt About U.S. and European Leadership Threatens Market

With deficit reduction talks all but dead in Washington and several bond auctions by fiscally shaky governments on the Continent this week, market specialists say the coming days may well be treacherous, especially if legislators in the United States do not agree on a plan to reduce the deficit.

That prospect looked increasingly likely. Despite the occasional sharp sell-off in the markets, investors have mostly been hoping for the best. In the United States, that means a blueprint for savings and a respite from wrangling over government spending, while in Europe the hope is that the European Central Bank will do more to shore up faltering borrowers like Italy and Spain.

But in each case, the likelihood of bad news outweighs the chances of a breakthrough, said Adam Parker, Morgan Stanley’s chief United States equity strategist.

“It should make people nervous,” Mr. Parker said. “There is a feedback loop between Europe and the rest of the world and that can slow growth. And the political polarization in Washington is also worrisome to investors.”

As trading volume thins before Thanksgiving on Thursday, all these concerns increase the odds of volatility on Wall Street, said Ronald Florance, director for investment strategies at Wells Fargo Private Bank. “It doesn’t take much to have big moves,” Mr. Florance said. “It wouldn’t surprise me to have 1.5 percent or 2 percent swings in the next few days.”

Stocks closed slightly higher on Friday, after a sharp sell-off earlier in the week caused by rising worries about the impact of surging borrowing costs across Europe. A big bond auction in Spain on Thursday was met with lackluster demand from investors, with yields nearing 7 percent, a record. Meanwhile, yields on Italian bonds also remained stubbornly high, finishing the week at 6.6 percent.

The rising yields increase the likelihood of a recession in Europe, and that could affect some sectors in the United States more than others, said Tobias Levkovich, Citigroup’s chief equity strategist.

“People should be selectively more nervous,” Mr. Levkovich said, noting that for the overall Standard Poor’s 500-stock group of companies, only 9 percent of revenues come from Europe. But that figure is much higher for sectors like automakers, with 30 percent of sales tied to Europe, and household and personal products at 17.5 percent and pharmaceuticals and biotechnology at 15.5 percent. Still, many sectors will be barely affected by a deeper European slowdown in terms of revenues, including telecommunications, food staples and retailing, he said.

While yields have been rising across Europe, threatening economic growth there, for the United States the key is to keep the contagion from spreading west and raising rates here.

That has not happened, Mr. Levkovich said. In the months leading to the collapse of Lehman Brothers in 2008, he noted, borrowing costs for investment-grade corporations in the United States leaped 2 percent. This time, despite the anxiety abroad, rates for big corporate borrowers have increased by less than 20 basis points, about one-tenth as much as before.

As for the special Congressional panel’s effort to find $1.2 trillion in deficit cuts by Wednesday, investors were already discounting the likelihood of a breakthrough. If the committee cannot agree on a plan by then, which seemed to be a near certainty on Sunday, the $1.2 trillion in cuts over 10 years are supposed to take effect automatically beginning in January 2013, with deep reductions in the Pentagon’s budget and domestic programs.

The markets will also be weighing the implications of elections in Spain on Sunday. Polls indicate a victory for the opposition, whose candidates are more likely to impose the austerity measures investors want. A victory by the opposition could give markets a boost, some analysts said, but this is likely to be fleeting because it does not resolve the bigger questions hanging over the euro.

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