Another Wild Week

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The stock market followed up the prior week’s strength with a sharp rally on Monday’s opening, which continued largely uninterrupted into Wednesday morning, producing a gain of 4.5% on the S&P 500. From there prices turned down and fell 5% to today’s low. A slight bounce and we ended up with a meager loss of 0.2% for the week. In Dow points it was about 420 up to the week’s high, 500 down to the low and an overall loss of just 44 points.

Just after today’s close the Federal Housing Finance Agency sued more than a dozen big banks for billions of dollars for alleged illegalities in conjunction with the securitization of subprime mortgages. The news was somewhat anticipated, but it is unpredictable how the markets will react to this added note of uncertainty.

Already weighing heavily on the banking sector, especially in Europe, is the specter of possible sovereign defaults. This week saw German politicians arguing publicly about the appropriateness of providing continuing support to struggling members of the Eurozone. The markets themselves exhibited great concern. All the equity markets were hit hard late in the week. And the major European markets have traced out declines ranging from 21% to 34% from their 2011 highs. Such unanimity of weakness testifies to the breadth of the economic malaise.

The poster-child for sovereign risk, Greece, saw its two-year note close today with an interest rate over 47%. Obviously, default is anticipated. More ominous, because of country size, are the climbing rates in Italy and Spain. Italian Prime Minister Silvio Berlusconi appears to be balking more stubbornly against the implementation of austerity measures mandated by the European Central Bank. Finland is demanding collateral for its loan to Greece. The International Monetary Fund says that the rescue will fail if collateral is required. Clearly rescue efforts are uncertain, and the problem will become more severe if economic growth continues to decline.

U.S. economic statistics are still deteriorating, and employment growth has ground to a halt. Economists and investment analysts are increasingly calling on the administration and the Federal Reserve Board to come up with some sort of rescue. With interest rates near zero in this country and the need to reduce debt widely acknowledged, further rescue options are limited and of questionable efficacy.

The introduction of new government rescue efforts could produce short-covering rallies, but the danger of severe financial system damage is very real. We continue to caution readers to limit risk assumption. Safe income is difficult to find, but we have been able to increase portfolio yield without sacrificing liquidity. If markets experience sharp declines, such liquidity could usher in short to intermediate-term profit opportunities in either stocks or bonds.