Remember Europe? Investors Turning Their Focus Elsewhere

While Europe's debt crisis is likely to play out for months if not years ahead, US investors seem to be over it—at least for the time being.

A trader at the New York Stock Exchange.
Photo: Oliver Quillia for
A trader at the New York Stock Exchange.

A 10 percent correction in the market is being seen by analysts as the proper market reaction to the sovereign debt issues that threaten Greece, Spain and other European Union nations.

So with that in the past, Wall Street appears to be turning its attention to jobs, financial reform and global issues elsewhere such as China and its burgeoning real estate issues and slowing economy.

"We need to put a little more risk back in the market after a 13-month bull rally. This was a good catalyst for doing it," says Paul Zemsky, head of asset allocation at ING Investment Management in New York. "The market's repriced to a higher probability of a bad outcome and not the certainty of a bad outcome. That's kind of gotten out of the way for the moment."

The most obvious sign of the debt crisis came in the form of a dramatically weakened euro and a much stronger dollar, both of which were negative for US stocks.

But in the past two weeks that trade has changed. Since May 25, stocks are up about 2 percent while the euro has dropped 1 percent.

At the same time, credit spreads also have tightened both in high grade (by 0.09 percentage points) and high yield (by 0.02 percentage points), according to BofA-Merrill Lynch Global Research.

While not dramatic moves, the trends have signaled that the markets are moving away from the Euro fear trade.

One reason could be that currency swaps of US dollars for euros have helped quell liquidity concerns; another is a belief that the US markets have priced in at least near-term fears about what is next for Europe.

"Clearly risk assets are benefiting from easing funding pressures despite the fact that the euro remains under pressure," BofA-Merrill said in a research note. "While we continue to view funding pressures as contained due to the ECB/Fed currency swap lines, the main risk to our tactical long credit positions remains any disorderly declines in the euro, as that would undermine the credibility of the ECB to contain the sovereign crisis."

To be sure, those fears about the European Central Bank's effectiveness in calming the debt turmoil remain, and could yet cause another leg lower in US markets.

The market got a taste of that last Friday, when pre-holiday selling converged with Fitch's downgrade of Spain's debt to squelch an attempt for a market rally.

"The shocks have not even begun to appear," says Peter J. Tanous, president and director at Lynx Investment Advisory in Washington, D.C. "Some of the major shocks may be a year away. But the simple bottom line is that there is more debt out there in Europe than will ever be repaid. That's across the board."

Any further quakes out of the Eurozone economies most certainly will felt in the US, Tanous says.

"There is serious risk out there," he adds. "From a portfolio strategy, we advised clients to lower their allocations to European-country equities because there was a double hazard. Stocks may go down and the euro may go down, which is a double whammy to American investors."

Indeed, US markets are far from calm. But with only a smattering of headline risk posed for the time being from Europe, investors seem more focused elsewhere.

Thursday's trading saw yet another rally snuffed outafter growth in the services sectorfailed to impress, jobs numbers were a mixed bag, and ratings agencies began to team up on BP and its failed efforts to stop the Gulf of Mexico oil spill.

"They're focused on the disconnect between US economic data, which generally seems to be pretty good, and fears of a downturn in China, fears of how much impact the European sovereign debt will have on demand," says Uri Landesman, president of Platinum Partners hedge fund in New York. "What we could see this year is a reasonable divergence of returns in various markets."

The result, then, could be that even if the European fears have faded, the summer could still be rough going.

"Overall, some stage-one panic is over now," ING's Zemsky says. "Now people will focus on the fundamentals. There's going to be positive and negative. We'll probably have a pretty choppy market between now and over the summer.

The market could spend much of that time trading between its near-term resistance on the Standard & Poor's 500 of 1,104 and support at 1,040, says Landesman, who believes the market could take out support before breaking through resistance.

"The market's been in a relatively narrow range but with very high day-to-day activity," he says. "It's not good for money managers. It gets people scared of the market, and with good reason."