Weekly Market Commentary | Watching the Calendar

Highlights:

•The S&P 500 fell 2.5% last week, the biggest slide since January when the S&P 500 was in the midst of a 5-10% pullback.

•We believe the stock market is due for another modest 5-10% pullback that may present an attractive buying opportunity.

•The events surrounding Greece's debt crisis, China's efforts to slow growth, and the progress of the financial reform legislation are likely to continue to have market moving significance. We provide a summary of key dates we are watching surrounding each of these market drivers.

Watching the Calendar

Stocks fell for the first time in eight weeks as:

• Standard & Poor's cut Greece's credit rating to "junk" status and downgrades on Portugal and Spain last week fueling concern Europe's debt crisis is worsening.
• Financial reform advanced to debate in the Senate, propelled by the fraud charges against Goldman Sachs and the dropping of a pre-funded bailout tax. These events fueled concern over potential criminal charges and skepticism about future profit growth at major banks.
• Market participants feared China's strong economic data would elicit further tightening measures slowing global growth.

The S&P 500 fell 2.5% last week, the biggest slide since January when the S&P 500 was in the midst of a 5-10% pullback. The flight from stocks benefitted Treasuries and precious metals. Treasury 10-year notes ended the month with their first monthly gain since January and gold rose 1.9%, for the week.

The events surrounding Greece's debt crisis, China's efforts to slow growth, and the progress of the financial reform legislation are likely to continue to have market moving significance. A summary of key dates we are watching surrounding each of these market drivers.

Greece

Over the weekend, Greece accepted an unprecedented bailout from the European Union and International Monetary Fund valued at 110 billion Euros ($146 billion) to prevent default, by agreeing to unpopular budget cuts. These cuts include a three-year freeze in public wages and bonuses and an increase in the retirement age from 62 (the lowest among Eurozone nations) to 67. There will also be a government hiring freeze and a raise in the national sales tax by 10%. This will come on top of austerity measures already in effect, and is likely to result in further protests in Greece.

However, it is not over yet. The debt crisis that has engulfed the European Union is the most serious economic and political crisis in its existence. The conclusion to the Greek episode is likely in a week when the Eurozone leaders meet in Brussels. It remains to be seen whether this Greece fire will be put out or if it has spread to Portugal and Spain requiring additional aid. Below is a timeline of Greece-related significant events with market moving significance:

May 3: Approval - The European Central Bank and the European Union Commission will have to approve the terms of the aid package. This is a key step before Eurozone leaders can vote on it.

May 5: Strikes - Greek trade unions are expected to begin a strike of over a million members. If strikes are sustained, or if rioting intensifies, the Greek government could become unable to meet the terms of the aid package and derail the deal.

May 7: Germany votes - Germany is expected to seek parliamentary approval for the bailout deal by the end of this week. Although the final vote could take place on May 10, May 7 could bring a vote of the upper house and a deal between the parties that solidifies passage.

May 10: Summit - Eurozone leaders will meet in Brussels to assess progress and press for approval in Germany's lower house.

May 19: Due Date - Greece must pay off a 8.5 billion euro ($11.3 billion) 10-year bond that is maturing. If all goes according to plan, Greece should have the cash by then, if not the credit event would be very disruptive and could precipitate a restructuring or some sort of default that could produce shock waves across Europe and credit markets around the globe.

In general, a swift resolution to the Greece aid would be welcomed by the markets. Any additional delays or roadblocks would have increasingly negative consequences for European credit markets spilling over to other markets.

China

Over the weekend, China raised banks' reserve requirements, ordering banks to set aside more deposits as reserves for the third time this year. This action comes as the government seeks to deflate a building property bubble and rising inflation after property prices jumped by a record in March and economic growth surged 11.9% in the first quarter, as measured by Gross Domestic Product (GDP), the most since before the downturn began in the second quarter of 2007. In February, China's consumer prices rose 2.7%, the most in 16 months. In March, property prices rose 11.7% from a year earlier, the most since data began in 2005.

The timing of this weekend's move appears to be triggered by a report released late last week, showing manufacturing accelerated in April and material costs jumped, highlighting the risk of overheating economic activity. China's government is attempting to slow credit growth to 7.5 trillion yuan ($1.4 trillion) this year from a record 9.59 trillion yuan in 2009. In the first three months of 2010, banks lent 35% of their annual quota.

Measures to cool the pace of rapid growth and rising prices have included raising reserve requirements, a ban on loans for third-home purchases, raising mortgage rates, and down-payment requirements for second- home purchases. However, the Chinese government has yet to raise interest rates (which remain at crisis levels) and has yet to allow the currency to appreciate again after pegging the yuan to the dollar since July 2008 to aid exporters as the global economy was in recession. Below is a timeline of significant events in China with market moving significance.

May 9-13: Data - Key Chinese economic reports for the month of April will be released, including: housing prices, new loans made in April, money supply growth, trade balance, industrial production, retail sales, and consumer and producer prices.

May 10: Withdrawal - The bank reserve requirements are set to increase 50 basis points, effectively withdrawing 300 billion yuan ($44 billion) from the financial system.

June 10: Rate hike - The Peoples Bank of China may make their first interest rate hike following the June 10 report of the May Consumer Price Index which may reach the 3% threshold for action. Europe's debt crisis will likely delay this move from May into June. Europe is the largest market for China, the world's biggest exporting nation.

June 25: Yuan floats - China is likely to return to a steady appreciation in the yuan in June just before the June 26-27 G20 summit in Canada when China will face enormous pressure by trading partners if no action is taken, no matter how modest, to float the currency. A move is also supported by the recent move by U.S. Treasury Secretary Tim Geithner to have an unscheduled meeting with Chinese officials and move to delay a report that could name China a currency manipulator and prompt further trade disputes.

July 1: Property Tax - The start of the third quarter may result in the launch of trials for property tax pilot programs in Beijing, Shanghai, Chongqing and Shenzhen. The rapid rise of housing prices is one of China's most pressing concerns. It appears the new property tax pilot programs will be targeted toward luxury urban properties that have seen dramatic price gains.

China's actions are likely to continue to be viewed with concern that the sudden withdrawal of stimulus to one of the world's biggest growth engines may be premature and tip the global economy back into recession. A slower pace of economic growth, cooler readings on inflation, and a lack of additional policy announcements would be welcomed by market participants.

Financial Reform

The issue currently before Congress that has the most market impact is the financial regulatory reform legislation. After repeatedly blocking debate on the financial reform bill in the Senate, Republicans relented clearing the way for the bill and add-on legislation to be discussed. Some of these may make the legislation even tougher on the banks including requiring regulators to break up the big banks. There remains substantial risk for the Financial sector in the Senate process. Key dates that could move the market lie ahead.

May 3-7: Too big to fail - Senators Dodd and Shelby, the top Democrat and Republican on the Senate Banking Committee, intend to introduce an amendment to prevent future bailouts designed to moderate other amendments aimed at capping bank growth or splitting them up. Hundreds of additional amendments will be introduced adding to the uncertainty surrounding the ultimate outcome.

May 4: Amendments - Senate begins the negotiation process of voting on amendments to the bill.

May 18: Primary - Senator Blanche Lincoln, whose contribution to the bill includes banning banks from trading derivatives - faces a challenge in the Arkansas primary from a candidate running on her left. After the primary, the derivatives language will likely be materially revised or omitted from the bill clearing the way forward for a more moderate bill able to win some bipartisan support.

May 30: Senate vote - We expect a financial reform bill to pass the Senate by Memorial Day (May 31). Then the bill must go through the House process and joint conference before it is signed into law. There is a good chance of the bill passing into law sometime this summer.

With the banks still at the center of the healing from the financial crisis, legislation that impacts their profitability or raises the uncertainty surrounding their prospects will likely move the markets.

Pullback

The fading upward momentum in the stock market that we had expected and has been evident over the latter half of April is part of a healthy transition from recovery to sustainable growth. We believe the stock market is due for a 5-10% pullback that may benefit Treasuries and precious metals as these events unfold. Combined with fading earnings surprises as the earnings season matures, leading indicators peaking, and a Fed that is increasingly perceived as increasingly behind the curve on growth, we believe the pressure on stocks will continue in the near-term. However, we do not believe a larger pullback is likely and view the weakness as likely to be a good buying opportunity for long-term investors.

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