The stock market appears to be suffering from a bipolar condition. That is, it is being torn between two extremities.
On one hand, the US economy just finished a solid 4th quarter – consumer spending was equal to or better than expectations, corporate profits look OK and the FED continues to be very favorable toward stock investors.
On the other extreme, there are a number of red flags waving in Europe. They are large enough to dominate the attention of the stock market. For example, on a day like Friday, with a great jobs report, the Dow Jones dropped instead of soaring 100 or 200 points as we would have expected in normal conditions.
Italy has borrowed too much (way too much!) in order to keep their system afloat. They owe $2 Trillion or more. If Italy goes the way of Greece, then the Italian Government bond holders will lose enormous amounts. Italian and French banks own a big portion of these bonds. They could become insolvent. This possibility makes investors very concerned because no one knows what will happen if this occurs.
I carefully watch the yield on the 10 year maturity Italian Government Bond – an uptrend in the yield means investors are getting more and more nervous about the ability of Italy to service its debt. Many economists believe a yield of over 7% is unsustainable. This bond yield has risen each day this year and is now 7.13% .
Here is a link to the Bloomberg quote so you can observe its trend. There is reason to be cautious until the nervousness and yields in Europe start to decline.
All this nervousness and red flag waving could evaporate at the drop of a hat IF the Germans pledged some of their impressive reserves to back up the European banking system, the ECB, or the stabilization fund. If that occurred, the stock markets would soar, in my view.