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October was a great month for the markets, with the S&P 500 rebounding by almost 11% after being down 7% for September. While the overall results for the month were positive, October’s markets were turbulent, with the Dow moving by over 100 points on all but 6 days.


While the many third quarter earnings releases coincided with the end of the month, the driving force behind the month’s volatility was the back and forth going on in the European Union as to how best to address the continued deficit problem in Greece, updates to the crisis coming to a head in Italy, and the euro zone periphery at large. Daily, the European Financial Stability Fund, European Central Bank, and euro zone leaders seemed to beholding yet another meeting and overcoming yet another hurdle on the path to averting both Greek and Italian defaults.


Greece


In the final days of the month, the EU finally appeared to have reached a comprehensive tenable rescue package for Greece. This package would have included further European Union bailouts of Greece, 50% haircuts on Greek bonds, giving the Greeks some relief from their heavy debt burden, but would have also imposed stringent and unpopular austerity measures on Greece. This package was not popular among the Greeks, who thought the deal was unfair and therefore resented the harsh austerity conditions.


In response to this unhappiness among the populace, on November 1, Greek Prime Minister Papandreou announced that he would hold a referendum on the EU’s bailout plan. However, facing pressures from other European powers, Greece was basically forced to drop the issue and again consider the proposed 130 billion euro bailout plan.


In a last effort to get the bailout plan passed, Papandreou formed a coalition with the opposing New Democracy party’s Antonis Samaras. Papandreou agreed to step down as Prime Minister, while Samaras agreed to support the debt deal in return. Papandreou is stepping down to be replaced by a temporary unity government, in which the Socialist Party and New Democracy will share power. The country was struggling to agree on a figure to lead the country in pushing the bailout plan through parliament within the next few months, but they finally came to consensus on Lucas Papademos.


While this addendum to the scene in Greece is positive for markets that crave progress, or at least some sort of headway on a solution, stalemate still seems to grip the country. It appears that no matter the composition of Greece’s government, a challenging road still lies ahead, especially in terms of the economy.


Italy


Now into early November, the same, but potentially worse, can be said for Italy, which is facing more struggles of its own and bringing to fruition the prospect of contagion in Europe. In contrast to Greece, frighteningly, is Italy’s role as the third largest economy in Europe. A full blown debt crisis in Italy threatens the entire region. Just in the last week, Italy has managed to take center stage in the European crisis. 


Following suit with Greece, Italian Prime Minister Silvio Berlusconi fell to outside pressures and has agreed to step down, just as long as Italy’s parliament passes a not yet solidified austerity plan. Unfortunately, this change didn’t generate much optimism for the struggling country, and the Italian bond market reflected such. 10 year bond yields reached above the already too-high 7%.


The European Central Bank scrambled to buy Italian bonds, but it is unclear just how much the ECB can or will do to help the situation. We could imagine the ECB dramatically increasing the amount of Italian bonds it purchases (by about 7x), but that raises the question of just how much banks will be willing to deposit to the ECB at low interest rates. There is also the potential for Quantitative Easing, or increasing money supply for purchasing Italian bonds, although the ECB has declined to take such action historically. 


To put things into perspective, Italy’s debt totals around 1.9 trillion euros, a level that is difficult to address in full with even dramatic action, let alone action that requires agreement among 17 separate nations.


Volatility Prevails


Because of the “tip-of-the-iceberg” fears that accompany daily updates on the state of the euro zone, markets have been marked by extreme volatility. It is difficult for investors to believe that a change in government leadership is the be-all and end-all solution to the euro zone’s problems.


However, each progressive step seems to help quell fears in the market, albeit temporarily. While GreeceItaly, and the rest of the euro zone are facing largely systemic issues that most assuredly cannot be resolved over night, it is a move in the right direction in terms of acting with initiative to get austerity plans passed. We have confidence in outside policy making bodies, such as the International Monetary Fund, that understand the severity of the situation and are working aggressively to act as a team and stop the spread to other European countries by increasing the leverage of the European Financial Stability Fund. The fact of the matter is that those nations and institutions that are involved generally want to help the state of the euro zone, and there are measures that can be taken to do so—the largest hurdle is agreement and collaboration among many different bodies. Investors continue to see the United States bond market as an entity of safety, and while we are certainly affected by Europe’s economy, we are grateful for fundamental stability, domestically.


We will continue to watch attentively as the situation unfolds, and we are hopeful that current deadlock will be resolved before the end of the year. After all, these problems in Europe are by no means new, and the global economy continues to move forward with slow growth.