You knew this was coming.
I promised you it would be a madcap and volatile ride.
Just like that, the market made an about-face, trimming its losses from last week in brisk fashion. As soon as the opening bell rang, U.S. stocks were up almost 400 points. The euro currency, which had been getting hammered, rebounded dramatically.
This response by the stock market is more than just another dead cat bounce where a market rises briefly before continuing to fall. This was a sign of relief, and a market endorsement of the decisive action taken over the weekend by European policymakers to set up a nearly $1 trillion loan plan to avert the spread of the sovereign debt contagion that has gripped the region.
It’s still a mystery why the European Union waited as long as it has to address this issue. But with Greece getting ready to implode because of its debt crisis, and other countries like Portugal, Spain, Ireland and even Italy dangerously on the verge, the E.U. had little choice other than to step up in a big way to avoid a regional economic cascade. Talk About Volatility
The emergency action should allow investors to return their focus to the improving global economy. About 70 percent of companies on the MSCI World Index that reported quarterly earnings since April 12 have beaten analysts’ forecasts. Employment in the U.S. increased in April by the most in four years.
At the end of last week, the VIX, as the Chicago Board of Exchange volatility index is known, jumped 23 percent to 40.47, the biggest single day rise since September 2008. The threat of a widespread E.U. financial meltdown caused stock volatility meters in Europe and Asia to mirror the VIX.
Today, following the news that the E.U. in partnership with the International Monetary Fund would back its weaker and faltering member states, the VIX plunged 36 percent to 26.46. This change in monitored volatility happened despite the fact that the S&P 500 registered its biggest intraday rise since April 2009.
The E.U. was under enormous pressure from the U.S. and Asia to stabilize markets. It gambled that a financial show of force would prevent the sovereign-debt crisis from spreading and combat speculation that the 11-year-old euro would break apart. In reaching this accord, which included a commitment of 250 billion euros ($320 billion) from the IMF, the E.U. finance ministers were going for “shock and awe.” So far, their strategy appears to have had the desired effect, at least temporarily.
Hardly United
Looking back from the edge, it should come as no surprise what took the E.U. so long to take action. While the E.U. may form a single trading bloc, it is far from unified. Germany, and to a lesser extent France, are and will continue to be the dominant players. Prior to this point, there was a growing chorus among leading politicians in several E.U. states to drop countries like Greece, Spain and Portugal whose uncontrolled debt threatened the overall financial solvency of the alliance as well as the trading value of the euro.
The $962 billion rescue plan is not the only factor that has given a boost to the region and its currency. The U.S. Federal Reserve agreed it would restart its emergency currency-swap tool by providing as many dollars as needed to European central banks to keep the continent’s sovereign-debt crisis from spreading.
In a swap, central banks exchange foreign currency with an agreement to reverse the transaction at a later date. The central banks will then lend the dollars at fixed rates to firms in their countries. Last week, dollar liquidity tightened in London amid concern financial institutions were holding too many assets of Europe’s most-indebted nations.
Before paring its advance today, the euro picked up about 2.6 percent from the value it sloughed last week. Since last Thursday’s 14-month lows, the currency has rallied 3.8 percent in value.
Although gold has pulled back about $20 from the highs it made last week, near $1,226 an ounce, it is still trading above $1,200, a sign that the markets continue to be fraught with a residual sense of uncertainty. Silver, however, has polished its luster trading above $18.60 an ounce. Unlike gold, the rise in silver prices may be as much about the insecurity in the markets as it is about renewed demand for its multifaceted industrial applications.
The EU may have seized the field and stopped the bleeding. But it still remains to be seen whether the E.U.’s action will permanently repair confidence the world has lost in the region or is simply more bubble gum and bailing wire on a systemic problem that ultimately may be beyond repair.
John Cohn is a senior partner in the Globe West Financial Group based in West Los Angeles. He may be contacted at www.globewestfinancial.com
