France new fear factor

Stocks suffered crushing losses again on Wednesday as worries escalated France could get sucked into the eurozone debt crisis, sending bank shares on both sides of the Atlantic plummeting.
The focus on France started after rumours began circulating the country could be next in line to lose its AAA credit rating, following the downgrade of United States by Standard & Poor’s last Friday.
French bond yields spiked on the news, causing the spread between the country’s 10-year bonds and 10-year German bunds to climb to a record 87 basis points, even though both carry AAA ratings. France’s bank stocks also suffered, as new liquidity concerns arose.
Those fears spilled into U.S. stock markets, where the Dow Jones Industrial average endured another steep decline, losing 520 points, or 4.62%, with financials dragging heavily. That loss on the Dow vapourized Tuesday’s lofty 430 point gain, and accompanied similar losses on the S&P 500 and the tech-heavy Nasdaq.
John Lonski, chief economist with Moody’s Investor Services, said the concerns over French banks reflects the ongoing economic fears that have roiled financial markets.
“I would say that the probability of a double-dip, and with that of a tightening of credit, is on the high side, so you need to heed the implications of heightened financial market turbulence,” he said. “The longer this turbulence persists, the greater the risk that we’ll get to observe the notable and damageable further tightening of credit.”
So far, Mr. Lonski said, the turmoil hasn’t impacted credit markets in North America, given that spreads between investment grade corporate bonds and government debt haven’t widened.
The biggest losers on Wednesday were certainly bank stocks, especially in Europe, where rumours led to panicked selling and sharp tumbles for the continent’s largest lenders. At the centre of it was French bank Societe Generale, which saw its shares tumble as much as 23% at one point, before recovering slightly to end the day 15% lower.
The sell-off followed rumours that SocGen would require a bailout due to liquidity troubles but these were vigorously denied by the bank, which helped its shares rebound. S&P, Fitch Ratings and Moody’s also stepped in to reaffirm France’s AAA credit rating. U.S. Treasuries meanwhile gained for the third day as a result of the flight from stocks, while the euro lost ground against the U.S. dollar.
Mr. Lonski said that European leaders will need to decisively tackle the continent’s debt worries to prevent more roller coaster days like Wednesday for financial markets.
“That may require an effective consolidation of all the sovereign government debt in Europe,” he said. “That may be one way out. Not everyone might be happy with that solution … but they may have no choice.”
The Dow Jones has now retreated more than 2,000 points since July 21, a decline of almost 16% and well into correction territory. The S&P 500 and the Nasdaq have seen similar pullbacks.
But while volatility has dominated equity markets for the past three weeks, Bill Strazzullo, partner and chief investment strategist at Bell Curve Trading in Boston, said it could soon be over.
“All these markets have come back to fair value,” he said. “The levels that we have retreated to now all make sense, and the reasons that we’ve had this big sell-off make sense. The only thing that surprises me is how quickly we corrected.”
Mr. Strazzullo said that he now expects U.S. stock markets to stay range-bound for the rest of the year, predicting the S&P 500 could rally back to 1,250, with a low-end outlook of 950-1,000 for 2011. The index closed down 52 points, or 4.42%, to 1,121 points on Wednesday.
Richard Jenkins, portfolio manager at Black Creek Investment Management in Toronto, said that panic rather than reason might be steering markets at the moment, and that sentiment could shift when a clearer economic picture emerges with second-quarter data.
“It’s not to say that all these macro concerns aren’t serious, I think they are serious and they are being recognized, they’re in the market, they’re in prices today,” he said. “So if the numbers turn out not to be as bad as everyone thinks, we could have one heck of an upside.”
Source: National Post