Every passing day America looks as if it becoming the haves and the havenots.
Seventeen years later after a motley crew of young nerds from J.P. Morgan invented the credit-default swap —European politicians and bureaucrats—entered the scene, seemingly intent on killing off, or at least seriously wounding, the CDS market.
Here are the top financial stories of the day:
1) Stocks edge higher on retail spending gains-From USA Today
A day of broad swings in the stock market ended with modest gains Tuesday as investors balanced strong U.S. retail sales with Europe's lingering debt crisis. The Dow Jones industrial average gained 17 points.
The Dow ping-ponged between gains and losses for much of the day. It had been down as many as 78 at noon and up as much as 86 points during a late afternoon rally that fizzled just before the market closed.
Technology stocks had the biggest gains. Hewlett-Packard rose 3.4%, the most among the 30 stocks in the Dow Jones industrial average. Chevron Corp. fell the most, 2.9%.
Americans spent more on autos, electronics and building supplies in October, raising retail sales for a fifth straight month. Sales increased 0.5% from the previous month, a faster rate than economists expected.
In Europe, higher interest rates on government debt issued by Italy, Spain and other countries rattled stock markets. The market rate for Italy's 10-year bond jumped back above 7%. When rates crossed the 7% threshold last week, it raised worries about the country's ability to manage its debts. Greece, Ireland and Portugal were forced to seek financial lifelines when their borrowing rates crossed the same mark.
The retail sales report helped the U.S. stock market "show a certain degree of resilience in the wake of the negative headlines out of Europe," said Todd Salamone, director of research at Schaeffer's Investment Research.
The Dow rose 17.18 points, or 0.1%, to 12,096.16. The Standard & Poor's 500 gained 6.02, or 0.5%, to 1,257.81. The Nasdaq composite added 28.98, or 1.1%, to 2,686.20.
Traders remained cautious. The prices of assets investors use as havens from market turmoil, like U.S. government debt and gold, held steady. The yield on the benchmark 10-year Treasury note edged up to 2.05% from 2.04 percent late Monday. The yield has been below 2.10% all month, a sign of strong demand. Gold rose $3.80 to $1,782.20 an ounce.
In corporate news, sales at Staples Inc. fell short of analysts' expectations, and the company also cut its earnings forecast for the year. Its stock dropped 3.6%. Department store chain Saks Inc. rose 1.7% after reporting stronger sales
Two stocks rose for every one that fell on the New York Stock Exchange. Volume was below average at 3.5 billion shares.
Europe appeared to be souring on the chances of success of respected economist Mario Monti, who was tapped to replace Silvio Berlusconi. Given the sheer size of the task facing Rome, markets are now viewing developments there with skepticism and the country's key borrowing rate is spiking again.
The yield on the country's 10-year bond rose 0.36 percentage point Tuesday to 6.94%, hovering around the 7% threshold that stoked panic last week that Italy's finances were spiraling out of control.
It was that sort of rate that eventually forced Greece, Ireland and Portugal to seek multibillion-euro bailouts; the problem this time is that Italy is the eurozone's third-biggest economy and widely thought to be too big to save.
It's not just Italy that's facing rising bond market pressures. Spain's equivalent rate is getting uncomfortably high, too, rising a further 0.18 percentage point to 6.25%.
And France has seen its 10-year yield rise 0.18 percentage point higher to 3.66%. That the eurozone's second-largest economy — one considered part of the bloc's bedrock — is now feeling the pinch is stoking fears that the crisis has yet to swallow its last victim.
A report released Tuesday that rated the economies of the 17 countries that use the euro had harsh words for France, which it placed near the bottom of an assessment of overall health, in between Spain and Italy.
"Alarm bells should be ringing for France," the report from the Lisbon Council think tank warned.
"The results are too mediocre for a country that wants to safeguard its place in the top league."
All this is proving an uncomfortable backdrop for stock markets, which have suffered a sharp reverse.
"This is an extremely worrying time for Europe as contagion is starting to become a very real possibility," said Simon Furlong, a trader with Spreadex. "The stark reality (is) that there could very possibly be a Domino effect in Europe."
In Europe, Germany's DAX fell 0.7% at 5,943 while France's CAC-40 fell 1.8% to 3,054. Meanwhile, the FTSE 100 index of leading British shares declined only 0.1% at 5,514.
Energy prices also seemed to ride the pick-up in consumer sentiment in the U.S., with benchmark crude for December delivery rising $1.35 to $99.39 a barrel in trading on the New York Mercantile Exchange.
But Michael J. Woolfolk of Bank of New York Mellon Global Markets cautioned that the good news could be short-lived.
"With the 'double dip' scenario now off the table, market sentiment has recovered as the U.S. economic outlook has improved," he said. "That said, nothing fundamentally has changed. The U.S. and European debt crises remain, and are guaranteed to keep uncertainty high into the new year."
However, there's a growing worry that the eurozone will soon fall back into recession as the debt crisis spreads and that's weighing on the euro, too, which was down 0.5% at $1.3536.
Italy's Monti was also working to build consensus in parliament on Tuesday. Two major parties, including Berlusconi's, agreed to back Monti, but investors are still worried that they might pull their support in the future if austerity measures prove unpalatable.
Those reforms are needed to help drive Italy's borrowing rates down so that it avoids a big increase in its interest costs as some 200 billion euro ($273 billion) in public debt comes due through the end of April.
Earlier in the day, Asian stock markets were mostly lower. Japan's Nikkei 225 index lost 0.7% to close at 8,541.93. South Korea's Kospi index dropped 0.9% to 1,886.12 and Hong Kong's Hang Seng fell 0.8% to 19,348.44. Benchmarks in Australia, Taiwan and Singapore also retreated.
Only mainland China's Shanghai Composite Index closed marginally higher at 2,529.76.
2) 41% of People Say American Dream Is Lost; 63% Say Economy Getting Worse: Y! Finance Survey-From Yahoo
A new survey by Yahoo! Finance shows Americans have a disturbing lack of hope and a frightening lack of retirement planning.
Among the highlights of the poll:
-- 41% of Americans say the 'American Dream' has been lost.
-- 37% of adults have NO retirement savings and 38% plan to live off Social Security.
-- 63% of Americans believe the economy is getting worse, including 72% of those over the age of 55.
These findings are consistent with broader trends The Daily Ticker has reported on in the past year:
Despite macro data showing the economy has technically recovered from the 'Great Recession', the majority of Americans just aren't feeling it.
Considering 49 million Americans are living in poverty, the "real" unemployment rate is 16% and millions of Americans are facing foreclosure, it's no wonder many believe the recession never ended.
Consistent with that sentiment, the survey shows a plurality of Americans are less willing to take on debt, feel less confident about buying at house, and are spending less yet have lower savings vs. 1- and 3-years ago.
Dan focused on the glass half-full findings in the survey, including:
-- 53% of Americans ages 18-34 still see America as the land of opportunity.
-- 45% of parents believe their kids will be better off than they are.
-- 68% of Americans say their currency financial situation is either "excellent" or "satisfactory."
Here too, the survey is consistent with trends we've reported on: In an era of rising income inequality, those doing well in America today are doing quite well, indeed.
3) Let's Give Some Credit To Credit-Default Swaps-From The Wall Street Journal
The birth of the credit-default swap has been well-chronicled. In recent days, though, we may have witnessed the beginning of the end for that controversial insurance policy against financial disasters.
It all began in Boca Raton, Fla., in 1994. A motley crew of young nerds from J.P. Morgan who would later become Wall Street heavyweights was on a "team-building" weekend.
Despite the high jinks and copious drinking (or perhaps because of it), their large brains came up with a way of reducing risks for bond buyers: a bilateral contract that, for a fee, enabled investors to pass on the risk of default to another party.
Since its conception in a Florida resort, the CDS market has grown to more than $15 trillion in "gross notional value"—the face value of the CDSs, excluding offsetting contracts—as pension funds, banks and hedge funds have flocked to the swaps.
Seventeen years later, a different motley crew—this one made up of European politicians and bureaucrats—entered the scene, seemingly intent on killing off, or at least seriously wounding, the CDS market.
Their attacks could backfire. In the current fragile markets, taking away insurance will only drive away investors, increasing borrowing costs for indebted nations and putting pressure on already-strained banks.
The first salvo was last month's proposal by the European Union to ban so-called naked credit-default swaps—those in which buyers don't own the underlying bonds.
Long seen by German politicians as the purview of "speculators," naked swaps have been blamed for many of the ills plaguing Europe's sovereign debt.
A week later, the EU crafted a plan to ease Greece's debt woes specifically designed to avoid triggering a payment of CDSs on the country's bonds.
The trick was simple: The EU "asked" bondholders to accept a 50% "haircut" and lose half of their investments in Greek debt. If implemented, such a "voluntary" exchange wouldn't qualify as a default, which has to be binding, and therefore no CDSs would be paid out.
The market's reaction? Let's just say the wordplay won't go down as the finest example of Greek sophistry. Despite reassurances that the "voluntary" ruse would be a one-off, investors concluded that the CDSs of other EU countries weren't to be trusted either. So when fears mounted over Italy's solvency last week, investors bailed out of euro-zone debt.
"A lot of large institutions are selling European sovereign debt and the corresponding CDSs because they don't feel like they have adequate insurance," says Mark Grant, of Southwest Securities, a Texas-based investment firm.
"If the CDS is not going to function when there is a 50% Greek haircut, then when is it going to function?"
Good question. Here is another one: If international investors flee the euro-zone bond markets, who will hurt the most?
Not to mention the ripple effects on the financial sector. If CDSs are seen as unreliable, U.S. banks' repeated statements about their "limited" exposure to Europe might sound less reassuring, especially if investors focus on warts-and-all "gross" exposures rather than the much smaller "net" figures that subtract the value of CDSs and other hedges.
As one witty Wall Streeter told me last Wednesday when U.S. bank stocks were catching the Italian malaise, "everybody is looking at gross, rather than net. And the result is gross."
Citigroup Inc., for example, has gross exposure to the PIIGS—Portugal, Italy, Ireland, Greece and Spain—of $20.6 billion, nearly three times its net position, according to regulatory filings.
Let's be clear. CDSs' appeal to investors is precisely their Dr. Jekyll/Mr. Hyde quality: They can be both a risk-reducing insurance policy and a speculator's dream tool to profit from corporate and sovereign misfortunes.
And there is no question that the market is unregulated, illiquid and secretive. But reforms should be aimed at shining a light on this dark corner of the financial markets through better disclosure, not banning or invalidating the instruments.
If, as even critics concede, CDSs can be a useful hedging instrument, then excluding "naked" buyers would reduce the breadth and depth of the market, putting "legitimate" hedgers at a disadvantage.
Similarly, undermining the validity of sovereign CDSs will roil markets and hurt borrowers, as per last week.
The good news is that investors get to have the last word in this debate, provided they have the guts to take on the EU.
If they don't like the Greek compromise, they should reject the "voluntary" offer, stand up for the sanctity of contracts and push for a proper default that would trigger CDS payouts.
It is the way it is supposed to work. Just ask those Boca Raton kids.
Harvey Mackay's Moral: You can't direct the wind, but you sure can shift the sails.
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