Europe Ratings Cut Unlikely To Have Lasting Effect on Stocks


Like the downgrade to the U.S. five months ago, reports of expected ratings cuts to at least five European nations Friday sparked a selloff in stocks and rally in credit markets.

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But the well-telegraphed action by Standard & Poor's may be little more than a short-term trading move than a harbinger of the stock market's bottom falling out.

U.S. stocks gave up less than 1 percent on Friday, while Treasury bond prices rose but were off their session highs following reports that the S&P downgrades were coming after the close on Wall Street. Those downgrades came as expected after trading closed in the U.S.

French bond yields also widened moderately against German bunds — about 0.12 percentage points by mid-day — another sign that the markets didn't foresee an earthquake coming.

""The market loves transparency, loves clarity and likes certainty, and it seems to be feeling that," says Dave Lutz, managing director of trading at Stifel Nicolaus in Baltimore. "Looking at the credit spreads, this is well-telegraphed and well-priced."

"If this would have happened in the fourth quarter or anytime last year, we could have been down 3 to 4 percent," Lutz added.

When the U.S. downgrade came on Aug. 5, it triggered a 600-plus-point selloff in the Dow Jones Industrial Average, sending investors into a tizzy that another Lehman Brothers-type event was occurring.

But markets from there endured a choppy two months and then a rally as Europe fearsfaded into the background and focus turned more toward U.S.-centric events.

Even some with a more bearish outlook don't think the European downgrades will be a huge market mover.

"The initial thrust to the downside, in terms of the overall price action today, looks like a knee-jerk reaction," says Brian LaRose, analyst at United-ICAP in Jersey City, N.J. "People anticipated an event. Once the event hit the news wires, people took profit. It's simply a day trade."

In fact, LaRose thinks that in the short-term the Standard & Poor's 500 is poised to gain a bit more — with 1300 a likely price target — before running into a wall.

"Whether this translates into a longer-term downtrend, we're going to need to see price action to confirm," he says. "Any further upside potential from here is going to be extremely short-lived. January is going to represent likely the highs of the year. Any further upside will be a sell opportunity in terms of equities and commodities."

In the debt markets, the U.S. 10-year yieldslumped to 1.84 percent and the 30-year long bond gained more than a point in price to send the yield plunging to 2.89 percent.

But bond-watchers felt that there would be little further appetite for such anemic yields and have priced in a great deal of economic slowdown and European turmoil already.

"Equities maybe are a bit more nervous just with respect to the whole eurozone situation and concerns that the headwinds are going to slow growth significantly here," says Kim Rupert, managing director for global fixed income analysis at Global Economics in San Francisco.

"Treasurys are at pretty rich levels. Guys that I speak to don't want to chase the market now," she adds. "You have the headwinds overseas and this three-day weekend, so there's a little bit more short-covering, save-haven buying in Treasurys on those factors."

The U.S. economy, after all, is showing some incremental improvement, with modest job growth and surging consumer confidence helping fuel expectations that a recovery is in place.

How tenuous that recovery is, and whether U.S. investors can separate what is happening in Europe from its potentially pernicious effects closer to home, is likely to be a stronger influence on stocks than a downgrade event that many investors saw coming.

"It's news and it's going to affect trading, no doubt," says Jim Paulsen, chief market strategist at Wells Capital Management in Minneapolis. "But how we react to Europe is going to depend on how the U.S. economy is doing. If the U.S. economy is doing OK or better than expected, we're just not as vulnerable to Europe. But if the U.S. economy starts to fade, then Europe becomes big."

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