Knight Reading

by CC July 12, 2011 12:35 am • Commentary


Economics: When we’re not freaking out about Europe, we’ll glance momentarily at:

  • 7:30 a.m. ET all times: We get the NFIB small-business optimism index. Small businesses create approximately 147% of all the jobs in our economy, according to small-business PR people, so this must be an important number. Sadly, it hasn’t been good since forever.
  • 8:30 a.m.: We get international trade data for May. How yawning will the trade gap be? Who will really care?
  • 2:00 p.m.: The minutes of the latest Federal Open Market Committee meeting are due. Take a drink every time you read the word “transitory.” Go ahead, it’s after noon.


Stocks sank the most since March while Spanish 10-year bond yields topped 6 percent for the first time since 1997 amid concern Europe’s debt crisis will spread. The euro tumbled, while U.S. Treasuries rallied.

The MSCI All-Country World Index of shares in 45 nations tumbled 2.1 percent, the most in four months, as of 5 p.m. in New York. The Markit iTraxx SovX Western Europe Index of default swaps jumped to an all-time high as Italy’s stock index tumbled to the lowest level in two years. The euro sank 1.7 percent to $1.4029 and reached the weakest price since May. Oil fell 1.1 percent while yields on 10-year Treasuries posted the biggest two-day drop in more than a year.


The S&P 500 opened the week with loss of 1.81%. Today’s close, however, was a weak bounce off the intraday low of 1316.42, which right on the 50-day moving average. The index is now up 4.92% year-to-date and 3.24% below the interim high set on April 29.

From an intermediate perspective, the index is 95.0% above the March 2009 closing low and 15.7% below the nominal all-time high of October 2007.



When demand increases prices go up, and when demand decreases prices go down.  It’s Economics 101 right?  Well, not in the US Treasury market.  

The chart below shows the yield on the ten-year US treasury before, during, and after QE2.  On 8/27/10, Fed Chairman Ben Bernanke first announced the Fed’s plans to buy what would amount to $600 billion in US Treasuries.  When a new buyer of that magnitude comes into a market, you would expect prices to rise.  However, in the ten months that transpired since the Fed first announced its plans, all the way to the final purchases of US treasuries on June 30th, treasuries slumped, sending the yield on the ten-year up by 52 bps.

Heading into June 30th and the end of QE2, there were widespread fears that interest rates would spike sharply higher.  In fact, in the days leading up to the end of QE2, the yield on the 10-year US treasury rose above 3% following a couple of days of strong economic data.  At the time, there were some commentators on CNBC and other outlets pointing to the rise in rates as a canary in the coal mine for what to expect after June 30th.  So what happened after June 30th when the Fed stopped buying?  Faced with the loss of their largest buyer and the potential for a possible default at the end of July, treasuries rallied, sending yields lower by 24 bps.  In fact, in the eleven days that have passed since QE2 ended, the yield on the ten-year US treasury has now given up nearly half of the yield increase that it saw during QE2.



In assessing sentiment heading into earnings season, there seems to be a dichotomy between analysts and investors.  As we noted last week, sentiment on the part of analysts has been in the dumps with a seemingly relentless stream of decreased optimism.

Investors, on the other hand, seem to be more optimistic.  On an anecdotal basis, there seems to be a popular view among commentators that last quarter’s strong earnings reports will carry over into this quarter and help investors forget about the debt issues going on in Europe.  However, while last quarter’s earnings results for S&P 500 companies was impressive (74% EPS beat rate), the results for all US companies was much less robust.  In fact, last quarter was the first time since Q4 2008 that the EPS beat rate for all US companies was below 60%.  So, while the largest companies in the US seemed to be cruising last quarter, among a broader universe of stocks, there were several more companies stalled out on the shoulder.


For a long while, Europe has managed to keep Spain and Italy out of the game. Portuguese 10-year bond yields have doubled since January. Ireland’s have also spiked above 13%—truly Greek levels. But since the beginning of the year, Spanish and Italian bond yields bounced around an elevated but manageable range. They had avoided any sustained increase. Until now. Over the past month, yields on Spanish and Italian debt have edge upward. Over the past week, they’ve spiked. Spanish 10-year bonds are now yielding close to 6%. The yield on 10-year Italian debt has jumped from 4.8% to over 5.5%.

The deterioration has been sparked by fears for Italian banks and for peripheral growth, as well as news of a scandal involving Italy’s finance minister. But this kind of scare was inevitable while growth remained disappointing and Europe failed to adequately address its debt problem—and its obvious institutional weaknesses.