Markets have shown dramatic shifts, reflecting the unfolding events in Europe and the ever evolving investor sentiment tied to the situation. Stocks surged to kick off last week as the Dow Jones rose over 405 points on news that European officials approved an estimated $1 trillion assistance package for struggling nations in the EU. Markets around the world climbed higher, as EU leaders demonstrated their strongest show of support yet for the region. Stocks came under pressure and volatility spiked by Friday as investors became skeptical about a sustainable recovery overseas and worried that Europe’s problems may hinder US recovery efforts. The market managed to climb higher overall for the week, with the S&P 500 up +2.3%, largely a result of Monday’s surge.

We maintain that this story is far from over and believe close observation is warranted. In recent weeks, we have lowered our exposure to the MSCI EAFE Index. That said we are somewhat surprised by the overall US market reaction to such events, allowing that these swings may represent more of an abundance of caution related to the events of the past two years as much as the specifics in Euro-land. For the better part of the last decade we have heard nothing if not the repeated siren song that the global economy has de-coupled from the US and a weak US economy has little or, dare we say, nothing to do with the health of the now flat global marketplace.

We are puzzled by the new market thesis calling for a US capitulation driven by a European crisis. According to most data releases, Europe accounts for approximately 20% of US exports. While not an insignificant percentage, we are hard pressed to see where Euro issues translate into a complete capitulation of a $12 trillion economy that has now shown several quarters of sustained recovery. Without question, the events in Euro-land have led to increased trading volatility (as measured by the VIX) but we continue to believe U.S. equities remain reasonably valued and the overall corporate earnings recovery thesis is intact.

The EU and the IMF approved the historic package on Sunday (May 9th) to bolster neighboring debt-laden nations Greece, Spain and Portugal. Details of the plan include a $570 billion government backstop to mitigate credit events in the European markets, the continuation of a nearly $80 billion stabilization fund and a contribution from the IMF to the tune of around $300 billion. Separately, the United States announced a program, in conjunction with central banks in Europe and Canada, to improve lending conditions between the US and European nations. The Fed’s program, called a temporary US dollar liquidity swap, resembles a plan similar to one that the Fed now has in place with the Bank of Japan. The premise of the program is to augment the EU package by providing dollars to foreign financial entities that require the U.S. currency to conduct business. Some fear there may not be an adequate amount of US currency abroad to match demand, which could further rattle the credit markets.

From a fixed income perspective, we have seen a widening of corporate and sovereign spreads as the flight to quality has resumed. We continue to believe quality should be the main underpinning of one’s fixed income holdings. Our preference remains for (taxable) short to intermediate U.S. Government and Government Agency issues and (tax exempt) general obligation or specific tax authority municipal issues.

We value our relationship with you and please do not hesitate to contact me or Melanie with any questions or comments.

David W. Price, CFA
Chief Executive Officer