Ahead of Wall Street - November 10, 2011

Thursday, November 10, 2011

The Euro-zone debt crisis that started in Greece almost two years ago and subsequently spread to Ireland and Portugal has now reached the monetary union's core. Italy is now firmly in the eye of the storm. But Italy is quite different from the peripheral countries that became the first victims of the crisis. The most important distinction is its size - it is the 8th largest economy in the world and the third largest in the Euro-zone.

One often-used descriptive for the country is 'too-big-to-bailout'. But given the size of its economy and bond market, a more appropriate tag would be 'too-big-to-not-bailout'. It is difficult to envision the global financial system remaining functional in the event of Italian debt restructuring. We saw how the 'haircuts' to the Greek government debt created financial jitters. Going through a similar exercise with Italy would be in a league of its own.

The bottom line is that Italy will need to be helped, most likely by the European Central Bank. And there was growing evidence in the market today that the ECB was doing just that by buying Italian government bonds. The government of outgoing prime minister Silvio Berlusconi is making a strong push to pass through parliament a set of budget measures demanded by Euro-zone leaders.

Importantly, the Italian government was able to successfully conduct a bond auction today, providing further evidence that the high yields notwithstanding, the country's ability to raise funds from the capital markets was intact. A combination of these moves has helped reverse the uptrend in Italian yields, bringing them back below the 7% level. We also have the positive announcement that Greece has nominated a respected economist as the head of the new unity government.

On the domestic labor market front, we got a better than expected read on weekly Jobless Claims. Initial claims dropped a bigger than expected 10K to 390K, while the prior week's level was revised upwards to 400K from the original 397K. The four-week average dropped 5.2K to 400K.

The overall trend on the initial Jobless Claims front has been favorable, as they have been falling in recent weeks. With last week's data getting revised upwards to the 400K level, we have this key series unable to stay below this critical level since March, except for two weeks. That said, the overall trend on the labor market has unmistakably been in the positive direction lately. We want this trend to continue in the coming weeks for the recovery to gain traction.

We also have a number of positive earnings reports this morning from Kohl's (KSS - Analyst Report), Advanced Auto Parts (AAP - Analyst Report), and Viacom (VIA.B). Cisco (CSCO - Analyst Report) reported strong results after the close on Wednesday.

The Italian situation remains worrisome, but it may not be as grim as Wednesday's market action made us believe. This realization, coupled with the relatively favorable news on the home front, will likely help the market reverse some of those losses.

Sheraz Mian
Director of Research

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