- - Thursday, October 13, 2011

ANALYSIS/OPINION:

Anyone who looks at a price chart for the S&P 500 over the past three months will likely paint a picture of a roller coaster in their mind, and that would be a fair characterization. During these past weeks, the S&P 500 has experienced four climbs, followed by four drops, a few of which much like a world-class roller coaster have been steep and quick.

Fueling these gyrations has been the economic recovery, eurozone, China and jobs chatter du jour, and I would argue that a slow week for economic data this week has given way to the start of corporate earnings and what appears to be progress on the eurozone debt crisis. As such, the S&P 500 is in the midst of its fifth climb, but the question remains as to whether it will reach sufficient escape velocity to break free of the trading range it has been caught in since mid-August.

Despite the current upward move, there have been more than a few European alarm bells that have gone off in the last week. Fitch Ratings downgraded its sovereign-debt rating for both Italy and Spain, the eurozone’s third- and fourth-largest economies, respectively. In particular, Fitch noted that Italy’s high level of public debt and low rate of potential growth renders the regions third-largest economy especially vulnerable. Keep in mind, too, that Fitch’s downgrade of Italy followed a three-notch cut by Moody’s Investors Service, which also cited a fragile market and other uncertainties that affected Italy’s outlook.

Recently, too, we learned that German factory orders weakened for the second consecutive month. To me, this simply serves as a reminder that there are two issues dogging the eurozone — debt and the underlying economy — and while one has been featured in the headlines of late, the other remains a risk. This risk is evidenced in data this past week from Greece’s Finance Ministry that showed Greece’s central government deficit continued to grow for the first nine months of the year, despite a series of austerity measures designed to raise revenues. According to the ministry, the cause of the 15 percent increase in the deficit was the deeper-than-anticipated recession.

While a slowing economy calls into question a number of assumptions, including the ability to repay outstanding debt and related interest payments, recapitalizing the banking sector may not necessarily lead to a vibrant economic recovery. We need look no further than our own economy, which continues to move along at a tepid pace, as measured by the most recent Institute for Supply Management manufacturing and services data and sticky unemployment rate despite the number of bailouts and attempted stimulus plans over the last several quarters.

Turning our attention toward corporate earnings this week, it’s candidly too early to tell how good or bad this reporting cycle will be as we are less than a handful of days into it. What we have heard thus far has been good from companies such as Costco and PepsiCo that reported solid performances for the quarter, and disappointing from the likes of Research in Motion, Alcoa and ConAgra Foods. There also appears to be what I would call companies that deliver solid results for the quarter but still raise some concern.

While Yum Brands posted September quarterly results that were aided by its strong presence in China, higher wages and commodity costs in that region are beginning to take their toll. This has reignited the debate over a hard or soft economic landing in China as signs that economic growth is cooling while inflation concerns persist. On Thursday, weaker-than-expected export data from China was reported, which reflects the slowing consumption in U.S. and European economies.

Back to the initial question: Will the market break out of its trading range this week? It could, but even a betting man would have to admit the odds do not look that favorable.

Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity-research and corporate-access firm in the Washington, D.C., area. He can be reached at cversace@washingtontimes.com. At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.

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