Is the Euro Zone Doomed?

Since it’s time to talk about the market, it’s time to talk about the Euro zone. Here’s the latest.

Stocks were steadily grinding higher early in the week as the market looked forward to a rate cut from the European Central Bank. That came to fruition on Thursday, but quickly morphed into “buy the rumor, sell the news”, with the averages closing the day deep in the red and shedding most of the weekly gains.

But on Friday, help was on its way, coming in the form of an agreement between 26 of the 27 Euro zone countries to tighten their fiscal unity to combat the union’s financial problems. It served as a big catalyst for stocks, sending the averages sharply higher and into the green for the week.

No doubt it was great to see stocks rally on Friday, but taking a step back and looking at the big picture, everyone still wants to know if any of this matters in the long run. Is the Euro zone even fixable? Because so far, close to two years into the debate, not a single thing the regulators, politicians or central bankers have done has been able to stem the tide of financial erosion washing through the region.

Earnings and Valuations Support Stocks

But in spite of the uncertainty clouding the Euro zone, the averages are hanging pretty tough right now, with the Dow and S&P500 both back in the green on the year. That has everything to do with earnings, which are back to record levels from 2007. Back then, the averages were trading at a 20% premium to current levels, so the valuation picture looks compelling too.

Longer term, even if the Euro zone does manage to escape a wholesale implosion, its financial instability is expected to weigh on economic growth. That means we could be seeing GDP contractions in key Euro zone areas in 2012. We’ve also got China to worry about, which validated concern over slower growth by juicing its economy with a 50 basis point reduction in lending rates last week.

Domestic Q3 GDP came in at 2%, considered a fragile recovery at best in light of how hard the economy contracted in 2008. If the Euro zone and China slow, that will spill over into the domestic economy and put our tepid economic growth in question.

Looping back to earnings, we have also seen some companies warning about profit forecasts going into 2012. That is not something we have seen over the last two years as strong earnings growth drove the averages to big gains.

So really, the market is looking at a whole bunch of potential land mines right now. Not exactly a news flash but not great for sentiment either. For the time being, the Central Banks still have control of the market, but that doesn’t look like a sustainable model either.

So if nothing else, expect more volatility from the market. And if things get ugly, remember, the Central Banks will be looking to monetize (print), and that is usually good for stocks. So sadly, we might be looking at a situation where bad news for the economy is actually good news for stocks.

Let’s shift into some updates.

Updates:

With the market posting a small gain on the week, a number of stocks followed suit. McDonald’s Corp (MCD) continues to look like an all-star, adding 2% on the week and hitting a new 52-week high at $98.43.

CPFL Energy (CPL) was the leader of the pack, adding 5% on the week as the “risk on” trade pushed emerging market stocks higher. This Brazilian electric utility pays a solid 6% dividend but has also been strong on the capital side as well.

Apple, Inc. (AAPL) also finished in the green, adding 1% as shares move back within striking distance of the $400 mark. That has been the key level for Apple for the last few months, so if shares can close above this area the stage should be set for another leg higher and possibly into $500.

Shifting into the laggards, Baker Hughes (BHI) fell 6% on the week on no major news as energy stocks were once again volatile with the market. In the meantime, earnings and estimates continue to look great, so for the energy bulls out there these are the times to be buying more shares.

Cimarex Energy (XEC) fared better, adding 2% on the week as crude remains stubbornly glued to the $100 level in spite of concern about global economic growth.

That’s all for this week, but until next time, here is an interesting article that discusses how 401K plans are being regulated to reveal their costs for the first time in 2012. Hey, isn’t that an incredibly brilliant and novel idea? Making the big banks and financial companies reveal to their customers how much they are paying for their services? Now that’s what I call innovation. It’s just one more reason why everybody loves those big banks so much, nothing but a swell bunch of guy who hold client interests very close to their hearts.

It will be a great way for people to see how incredibly expensive 401Ks and mutual funds are while getting little support, transparency or relationship. Enjoy.

401K Fee Disclosure Coming in 2012

Your Investment Partner,

Mike

ABOUT THE AUTHOR

Michael Vodicka

Michael Vodicka is the president and founder of the Vodicka Group Inc., a licensed investment advisor (Series 65) and a financial journalist.