Stocks Checked by Euro Crisis, As Earnings Beat Expectations

By Whitney Kisling, Nikolaj Gammeltoft and Inyoung Hwang - Dec 7, 2011 9:47 PM GMT+0700

Never before has the euro influenced U.S. stocks as much as this year, a sign that American equities aren’t going anywhere until Europe’s credit crisis is solved.

The link between the Dow Jones Industrial Average and swings in the currency reached a record on Dec. 2, according to data compiled by Bloomberg. The so-called correlation coefficient showing how much two markets rise and fall in tandem hit 0.85, the highest level since the euro was founded in 1999, data on 60-day rolling averages show. A reading of 1 means assets are moving in lockstep.

Speculation about whether Greece, Ireland and Portugal will avoid default is drowning out results from companies such as Akron, Ohio-based Goodyear Tire & Rubber Co. and Target Corp. in Minneapolis. While record earnings (SPX) and an improving economy should be pushing the Dow toward its October 2007 record of 14,164.53, they’re not because Europe is overshadowing the good news, said Kevin Rendino, a money manager at New York-based BlackRock Inc.

“What’s getting in the way is a bunch of politicians and a bunch of budget deficits,” Rendino, whose firm oversees $3.3 trillion, said in a telephone interview yesterday. “It’s all we think about. It’s all we talk about. It’s incredibly frustrating because in the U.S., we have a bunch of highly profitable businesses, an OK economy, companies sitting on a bunch of cash and earning as much as they ever have,” he said.

“And everyone is sitting on their hands because they’re waiting to see what happens in Europe.”

Biggest Rally

Signs of cooperation among governments pushed the Dow average (INDU) to its biggest daily gain since March 2009 last week. The announcement on Nov. 30 that the Federal Reserve would join five central banks in a program to make it easier for lenders to obtain dollars helped the Dow rally 7 percent in the five days ending Dec. 2, following the largest drop for a Thanksgiving week since 1932. The euro increased 1.2 percent against the dollar during the period, data compiled by Bloomberg show.

The Dow declined 76.10 points, or 0.6 percent, to 12,074.03 at 9:46 a.m. in New York today. The euro slipped 0.3 percent to $1.3363.

Recession Concern

Concern Europe’s debt crisis would trigger a global recession sent investors to the relative safety of the U.S. currency and Treasuries in the third quarter, dragging equity markets in 37 of the 45 countries in the MSCI All-Country World Index into bear markets, or declines of 20 percent from a peak. The Standard & Poor’s 500 Index dropped 19 percent between April 29 and Oct. 3 before paring the decrease to 7.7 percent. It’s up 0.1 percent for 2011.

“Money managers are getting whipped around,” Donald Selkin, the New York-based chief market strategist at National Securities Corp., said in a telephone interview. Selkin, a 35- year Wall Street veteran, helps manage about $3 billion. “We’re not going to set new stock highs even with these strong corporate profits, so obviously something is holding us back and that’s the crisis in Europe.”

Correlation between U.S. stocks and Europe’s currency has increased along with concern about the bailout championed by German Chancellor Angela Merkel and French President Nicolas Sarkozy. The Dow and euro have moved in the same direction 72 percent of the time in 2011, compared with 49 percent for the 11 previous years, data compiled by Bloomberg show.

Investor Toll

The swings have taken a toll on professional investors. Less than 24 percent of 542 categories of funds tracked by Morningstar Inc. have topped (GT) their benchmark indexes this year, the fewest since at least 1999. A Hedge Fund Research Inc. index of industrywide performance has fallen 3.4 percent in 2011. It’s only the third annual loss since 1990 and the biggest decline since 2008, when it plunged 19 percent, according to data from the Chicago-based firm.

Improving economic reports from the U.S. government haven’t always translated into higher stocks. October industrial production rose 0.7 percent, beating the median estimate of 0.4 percent in a survey of economists by Bloomberg, the Fed said on Nov. 16. The S&P 500 dropped 3.3 percent in the two days before a Nov. 18 confidence vote on Italian Prime Minister Mario Monti.

‘Schizoid’ Markets

“The last four months, it’s just schizoid,” Nick Sargen, chief investment officer at Fort Washington Investment Advisors in Cincinnati, which oversees more than $39 billion, said in a telephone interview. “How do you position your portfolios in this thing? For a lot of stock pickers, they throw up their hands because they say, ‘I’m trying to find good stocks within the market and the key driver is, is the euro-zone going to hang together or fall apart?’”

Corporate profits that topped analyst estimates for a record 11th straight quarter have done little to quell investor fears about Europe. While quarterly earnings for S&P 500 companies from Goodyear to Target (TGT) and Motorola Mobility Holdings Inc. have been 4.6 percent higher than analysts projected, shares tumbled on days when European headlines dominated.

Goodyear said Oct. 28 that third-quarter income topped analysts’ estimates as higher prices helped sales rise the most of any quarter. While the largest U.S. tiremaker advanced 4.9 percent that day, it lost 8.4 percent over the next two after then-Greek Prime Minister George Papandreou said he would put a European Union agreement on financing for Greece to a referendum. The S&P 500 lost 5.2 percent during the stretch.

Target Profit

Target, the second-largest U.S. discount retailer, climbed as much as 3.4 percent on Nov. 16 after posting third-quarter profit that topped analysts’ estimates. It ended that day down 0.5 percent. The S&P 500 slumped 1.7 percent after Fitch Ratings said that further turmoil in Italy, Portugal and Spain poses a “serious risk.”

“Picking stocks is very tricky now,” Ned Gray, chief investment officer for global and international value equity at Delaware Investments, said in a Dec. 6 telephone interview. His firm manages more than $160 billion in assets. “The policy- making in the euro-zone is leading everything,” he said. “The macro risk-on, risk-off decision is the only one that seems to matter.”

Unprecedented Swings

Equity markets have seen unprecedented swings this year, exacerbated by global economic concerns. The S&P 500 has moved an average 1.7 percent each day since July 2011, compared with 0.8 percent daily in the nine years before September 2008, when Lehman Brothers Holdings Inc. collapsed, according to data compiled by Bloomberg. The Dow alternated between gains and losses of more than 400 points on four days in August this year, the longest streak ever.

Because heightened volatility leads to correlated markets, investors should focus on finding stocks that have smaller swings and improving fundamental criteria, according to Birinyi Associates Inc. While Europe’s debt crisis is overshadowing profit reports today, those stocks will be more likely to outperform their benchmarks, according to Birinyi.

“Correlation is a function of volatility, significant volatility,” Laszlo Birinyi, president of the stock market research and money management firm, said in a Dec. 6 phone interview. “Ultimately it’s another handicap that you have to overcome, so investors will have to do what they always do but do more of it. You have to recognize that the market’s not at your back, so to outperform, you want to pick a stock that’s not as much a function of the market as other stocks are.”

Default Speculation

Eight of the Dow’s 10 biggest daily drops this year were driven by speculation about Greece defaulting or Europe’s debt crisis leading to another global recession, according to Bloomberg closing market stories.

“Whether it’s risk on or risk off today, correlations today to things that wouldn’t have even been on our radar screen five years ago are much higher,” John Canally, who helps oversee about $340 billion as an economist and investment strategist at LPL Financial Corp. in Boston, said in a telephone interview. “That’s something that the individual investor’s got to keep in mind,” he said. “It’s all a proxy for risk in Europe, which in turn is a proxy for whether or not we’re going to have another Lehman.”

To contact the reporters on this story: Whitney Kisling in New York at wkisling@bloomberg.net; Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net; Inyoung Hwang in New York at ihwang7@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net