The three major indices posted decent gains on Tuesday despite several questions surrounding the economy in Europe. The gains were unusual since our markets have been so reliant on the day-to-day developments from the eurozone over the last four months. During this time the U.S. economy has shown no signs of approaching another recession, with consistent data and strong earnings from the largest of companies. And although the U.S. economy has its problems and isn't growing as fast as investors would prefer, it's still growing ever so slowly.
Yet, this fact has been irrelevant, with a potential default of several European countries controlling the global markets as the economy braces for the effects that a default within Europe could have on the global economy.
I am surprised that the news out of Europe on Tuesday didn't cause a major sell-off within the U.S. markets. Last Tuesday a 400 point loss on the Dow Jones was caused by Italian bonds reaching the crucial level of 7%, a level where Italy is assumed to not be capable of paying off its debt. Yet on Tuesday French, Belgian, Spanish, & Austrian 10 year yields climbed to new highs with Italian yields climbing 37 basis points to over 7% once again. Therefore, new fear was sparked as contagion continues to widen and fear that the financial crisis in Europe may be spreading too quickly to contain.
In addition, the economy grew only 0.2 percent which is not near fast enough to have any impact on its financial crisis, which is one reason why yields are increasing so rapidly. Yet, despite all of this discouraging news, the U.S. market found itself embracing its own progress and the markets posted modest gains to close the day on Tuesday.
After Tuesday posting gains and ignoring the problematic data out of Europe, investors may believe the markets have pushed Europe aside and will react to local data for future performance. And while it was nice to see the markets trade on U.S. data, I don't believe we should get used to it. Wednesday has the potential to result in either large losses or solid gains, and I believe there will be very little in between.
There are several U.S. economic data reports to be released on Wednesday morning that have the potential to push the market depending on the results. The U.S. consumer price index, industrial production, and home builders index are among the several economic indicators that will drive the markets on Wednesday. However, I expect the market moving developments to be European related on Wednesday, with the new Prime Minister Mario Monti attempting to form a new Italian government with the task of preventing an economic disaster in one of the largest economies in the world. I expect for this event to have more impact on the markets than any U.S. indicator to be announced on Wednesday. And I wouldn't be surprised if the reaction lasts for days since the outcome of this meeting will most likely show the direction of Italy's immediate future.
The last two trading days have been relatively quiet with lower than normal volume as investors wait and listen to all news coming out of Europe. And since I believe that Wednesday will result in strong movement within the market there are a few stocks that investors should watch. Below I have listed a few stocks that have traded with the market that investors should watch closely throughout the day on Wednesday. I believe that if news out of Europe is encouraging then these stocks will post large gains, but if it's discouraging then I fear these stocks could post large amounts of loss.
Caterpillar (CAT) has posted 15% gains over the last month, however it's lost 30% of its value from August to October as a result of strong selling within the market. Caterpillar is a stock that trades with the market on a regular basis; in fact, it would be difficult to find a day when CAT traded against the market. The stock is 86% more volatile than the market; therefore, if the Dow were to post large gains, I believe that CAT would post large gains as well. Investors should watch this stock and be prepared for its reaction following news out of Europe.
If the markets are not satisfied with Italy's attempt to create a new government we can almost guarantee that money center banks will post the largest amount of loss. And the two that I believe will be impacted the most are JPMorgan Chase (JPM) and Citigroup (C). I believe that JPM is a safer investment because it has shown some resistance at $32.40, although it could easily break below. However, the stock is trading at 70% of its book value per share and a P/E of 7; therefore, I expect limited loss.
Yet, I expect Citigroup to post large loss if news is discouraging out of Europe since it's shown no consistent level of resistance and it's roughly $6.50 from its 52 week low. The stock is trading at less than 50% of its book value per share with a P/E of 7.62; therefore, some may assume that its downside is limited. However, logic goes out the door with this stock, especially considering that most investors assume it has high exposure to sovereign debt because of its presence in Europe. I believe that Citigroup is the best long-term investment of the money center bank stocks, yet if the markets trend lower than it, and JPM, will trend significantly lower as well.
Transportation stocks have underperformed the S&P 500 YTD by nearly 500%. And FedEx's (FDX) 11% loss has led the way because of its high volatility and strong global presence. If I were investing in transportation stocks I would watch the market closely because most of the time the large companies within the sector trade very close to the market with higher volatility. And since FDX has little resistance, I believe it could have a negative impact on the stock if loss were to occur.
Alcoa (AA) has been reluctant to post gains after earnings that didn't meet expectations, however, it's been quick to fall on any bad news regarding the economy. The majority of the company's operations occur in North & South America, Australia, & China, therefore, its reaction to Europe has little meaning. But because it trades 108% more volatile than the market and hasn't shown resistance at any level over the last three months the stock will most likely fall following any discouraging news out of Europe. Therefore, this stock is worth watching and because of its ability to lose a large amount of value investors should be careful.
The only other industry that has performed as bad as the large financial institutions has been the auto industry; more specifically General Motors (GM) and Ford (F). And much like Alcoa, these two stocks trade much more volatile than the market and have shown little resistance. And with General Motors mentioning its weakness in Europe, I expect that any discouraging news out of Europe will be damaging to the stock.
Both of these stocks are trading with very low valuations and P/E ratios below 7 despite strong growth year-over-year. I believe that both of these stocks would make great long-term investments, but are not the best stocks for the short-term investor. Therefore, with the likelihood of heavy movement on Wednesday, I would either cut back on the position or wait before buying since large loss is possible.
There are many stocks that trade more volatile than the market that will most likely post large loss if news out of Europe is discouraging. These stocks are just a few that I have observed over the last few months that have shown strong movement on days when the market has heavy volatility. And although I believe the markets will fall by large margins on Wednesday, it's possible that news will be encouraging and the markets will rise which would result in gains for each of the stocks listed above.
Therefore, investors should be aware of the developments in Europe and know that just because the markets trended against Europe on Tuesday doesn't mean it will going forward.
