Yields on Spanish and Italian sovereigns are on the rise again and equity markets around the world have come under selling pressure. Are stock markets headed for contagion redux or is this a welcome opportunity to buy into US stocks?

In the face of a lost regional election to the socialists/unions, newly elected Spanish Prime Minister Mariano Rajoy is walking back his country’s quid pro quo to shave its national deficit in return for more dough from the EU. Italy’s top technocrat Mario Monte is in the same boat as his country’s powerful unions press him to water down employment reform (no one hires because once hired one can’t be fired!) . Perhaps both men have taken a lesson from Wisconsin’s Scott Walker as to the downside of cutting into union largess. Nonetheless their backpedaling has interest rates and default swaps on the rise in those countries along with uncomfortable memories of ‘RISK OFF’. But for investors there lies a distinction with a difference.

Boil down continental solutions from Athens to Brussels and one finds a goal of austerity (because the money ran out) without a credible path to growth. It’s obvious why. Distressed pols of all stripes instinctively reach for the low lying fruit:  in this case an ephemeral attempt to turn off the money rather than confront the very painful challenge of structural reform and the potential of early retirement. Sound familiar? The same two step is playing here in Washington at the federal level.

The difference is thankfully we have fifty different state governments, each with their own agenda whether the sovereign likes it or not. Feds close down drilling in the gulf – we lose 100,000 jobs. Pennsylvania and North Dakota decide to drill – we gain 100,000 jobs (and more). This is the beauty of our federalist system! What this means for stocks can be summed up in a tale of three stock markets.

Spanish shares have been in a ripping bear market for over 2 years despite the short selling of banks being ruled verbotin. The Madrid Stock Exchange Index (MADX) is a stone’s throw from its desperation low of 2009 and Italian shares are close behind. Seeing no respite Investors continue to flee the inevitable destruction of wealth. Contrast with our markets which have rallied back to their 2011 highs.

In the long run policy is everything. US shares are benefiting by some states willingness to challenge the federal largess – whether on health, energy, or the right to build an airplane where you want to. One may be tempted to sell Spain and Italy while buying the U.S.

Technical outlook comes under more pressure to start the week as the jobless number released on Good Friday continues the string of disappointing recent economic data. Short term markets around the globe are now pretty oversold and we should see a bounce at some point in the near future.

Market internals are showing their biggest weakness since this uptrend got underway early in January. It should be interesting to see how far this correction goes and whether it turns into something worse.

Markets
Stocks were mixed for the second consecutive week despite suffering their biggest single-day loss in three months on Tuesday. The large-cap indexes were flat to modestly lower, while the small-cap Russell 2000 regained some of its sharp drop in the previous week. A disappointing growth forecast from the Chinese government weighed on sentiment early in the week, as did continuing worries over high oil prices. Traders looking for a chance to take profits following the market’s recent rally may have also contributed to the sell-off. The major factor weighing on markets, however, appeared to be concerns over whether Greece’s private debt holders would agree to a reduction in the amount owed them (a so-called haircut) in order to avoid an outright default.

Eventually, fears that the debt deal would fall apart proved unfounded because well over 80% of the participants required agreed to its terms by the Thursday deadline. Investors continued to welcome good U.S. economic news. Most notably, the closely watched monthly payrolls report showed that employers added jobs at a healthy pace in February, while strong figures from the previous two months were adjusted upward. Earnings also saw a healthy increase, holding out promise for gains in consumer spending. In corporate news, Apple—the largest U.S. company by market capitalization and thus heavily weighted in the indexes—released the highly anticipated new version of its iPad on Wednesday. Following some initial skepticism, a generally favorable response to the new device from investors helped the indexes—and particularly the Nasdaq—move back higher at the end of the week. (T. Rowe 3/9/12)

Technical Outlook
Market continues its intermediate term uptrend and is now somewhat overbought in the short term. The risk trade seems to be on as equity markets around the globe were higher on Friday. In fact pretty much all asset classes across the board were higher from Gold to the dollar to Treasuries to High Yield Bonds to Emerging markets. On the downside, volume continues to lag in the U.S. equity markets and while internals are improving, overall not great currently.