Thursday, December 8, 2011

No big surprise - and this is a huge negative for the market - but the European Union's AAA rating may be cut by Standard & Poor's.

As expected, Standard & Poor's may cut BNP Paribas and Fortis.

Standard & Poor's has placed seven Portuguese banks on negative watch now. Expect more of this in the days ahead.

On this week's latest big summit, GS is looking for:

* further details on sanctions that will be imposed on countries which fail to meet budget deficit rules;
* clarification on private sector involvement;
* ESM to be brought forward by six months;
* a treaty change proposal; and
* more proactive purchases (over time) of sovereign debt (but no capping of spreads).

Germany denies that capacity limits will be raised for ESM and EFSF and denies that there will be a doubling in size of the financial firewall.

Investors will be inundated with a lot of eurozone leaks in the days ahead in front of Friday's meeting.

Reuters has just come out with a denial from Germany that the eurozone will raise the capacity limits of the ESM and EFSF facilities.

Also, the Financial Times has reported that the E.U. is considering a doubling in the size of the financial firewall.

Germany has denied both of these stories, and, personally, I expect the eurozone to live down to expectations on Friday.

The new argument this week is that the S&P downgrade to negative watch of 15 eurozone countries was a warning shot to Europe's leaders that will hasten and steel their resolve to fight the debt contagion.

My view is that we will get a rescue fund (over there) but the U.S. stock market will be relatively nonplussed as the heavy lifting of austerity and bank capital raising remains ahead, in the first half of next year.

We remain in a worldwide balance-sheet recession, and the outcome is an extended period of relatively slow growth. Subpar growth, both here and abroad, exposes the growth trajectory to exogenous shocks (in Europe, China, oil prices, geopolitical, and in U.S. politics).

By my calculation, the S&P Index is approximately 5% undervalued. But multiple economic possibilities render the precision of any valuation model -- including mine -- less certain than in ordinary times!