Monday, January 16, 2012

Markets in the U.S. are closed today in observance of the Martin Luther King Jr. Day. But Friday’s rating downgrades by Standard & Poor’s are playing out in the Asian and European markets today. Not unexpectedly, the rating agency stripped France of its coveted triple-A rating, while leaving Germany with its triple-A rating. Eight other Euro-zone members got downgraded, with Italy, Spain, Portugal, and Cyprus moving down by two notches each.

The impact of the rating action on France’s funding costs is expected to be limited since the country’s fiscal problems were well known to the markets already. And it will likely have limited impact on the credit worthiness of the European Financial Stability Facility (EFSF), the EU rescue fund. Though the fund still has Germany at its core with its rating intact, the rating downgrades to nine member countries will likely result in it losing its triple-A rating as well. But as we saw with U.S. rating downgrade last summer, the bond market may listen to what the S&P has to say, but it otherwise prefers to dance to its tunes.

The most important consequence of the rating downgrade is the psychological impact it carries the equity markets. European headlines had generally become less threatening, helping stocks consistently eke out gain in recent days. This action reminds stock market investors that we may be in a New Year, but this problem from last year is still with us. And as we all remember from last year, negative European headlines have a way of trumping anything positive that may be happening on the domestic front.

The focus on the home front will be the fourth quarter earnings season that gets into high gear this week. On the economic front, this week brings inflation and housing related readings and an early look on the manufacturing sector through the Empire State and Philly Fed surveys. The PPI numbers come out on Wednesday, while Thursday brings the CPI. We get the Existing Home Sales on Friday, while Housing Starts come out Thursday morning. The December Industrial Production numbers will also come out on Wednesday.

On the earnings front, J.P. Morgan (JPM) gave an underwhelming start to big bank results, likely further lowering expectations from Citigroup (C) and Bank of America (BAC) that report this week. The bank’s weak capital markets results foretell what to expect from the Goldman Sachs (GS) report on Wednesday.

While earnings expectations overall have been quite weak ahead of this reporting season, expectations for Goldman have literally been in a free fall lately. The current fourth quarter Zacks Consensus EPS estimate for Goldman of $1.46 is down almost 20% in the past week and more than 40% in the past month. Things are clearly not looking good for Goldman Sachs.

Sheraz Mian
Director of Research

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