Summer officially begins next week and many investors expect this to be a bullish period for stocks. Markets are trying to rise from a very oversold condition, so early summer shouldn't disappoint. The underlying problems that created the recent sell off are still with us however and they are likely to weigh on the markets once again.

The debt crisis in Europe and the drop of the euro have been the major force controlling market action for the last couple of months.  The euro (NYSEArca: FXE) has traded down from an intraday high of 151.27 on November 25th to a low of 118.79 on June 8th. It has been rallying the last few days, but despite mainstream media reports about improving economic conditions in Europe, the reasons are technical. The bad news has not ended either, but perhaps it is now expected and already priced in the market. Yesterday, Moody's downgraded Greece's credit rating four notches to Ba1. S&P had already downgraded Greek debt to junk status on April 27th, so Moody's move shouldn't have been surprising. France also announced a three-year budget plan to cut its deficit to GDP ratio to 3% by 2013. It will be around 8% this year (still less than the estimated 8.8% in the UK). Budget cutting is pervading EU countries in an effort to maintain the maximum 3% deficit limit, which was established during rosy economic times and became impossible to meet because of the Credit Crisis. Eurozone leadership apparently made no contingency plans in case anything went wrong, nor do they seem capable of handling a crisis when one occurs.

The other issue weighing on the market this spring has been BP's deep-sea oil spill in the Gulf of Mexico. This is already the biggest oil related environmental disaster of all time and the oil leak is not likely to be stopped anytime soon. Fitch downgraded BP six notches today to BBB (still above junk). President Obama will be addressing the nation tonight and will demand BP provide $20 billion in funds that will be used to pay off damages. This should be considered only a token sum of the actual final costs. Many of the biggest potential lawsuits against BP haven't even been filed yet. It took 20 years to resolve all the litigation from the Exxon Valdez spill, so BP could be in court until 2030. BP leadership apparently made no contingency plans in case anything went wrong, nor do they seem capable of handling a crisis when one occurs.

Budget cutting in Europe is only going to hurt the still fragile and highly socialized economies of the Eurozone. A return to recession is quite likely there if the cuts are actually implemented. In the U.S., reports indicate that the Federal Reserve is now putting together plans on what to do in case of a double dip recession.  So far, the good GDP numbers have been based on inventory restocking (or even inventories dropping at a lower rate) and not an actual growth of the U.S. private sector. The American economy has been expanding with the expansion in federal government deficits. The economic numbers could easily turn south again in the fall, as the deficit is supposed to decrease for fiscal year 2011 (beginning this October 1st). At least the Fed is making contingency plans in case something goes wrong, but it is not clear that they will be capable of handling a crisis when one occurs.

In the short-term though, the stock market seems to want to trade on the technicals, with possibly a little money pumping from the major central banks helping it along. The euro is overbought and needs to rally to resolve this condition and the U.S. trade-weighted dollar (DXY) is oversold and has hit major resistance in the 88 area so it needs to sell down. The period around the July 4th holiday is usually a positive one for U.S. stocks. Late July can be quite negative however. It is best to look at the markets with a short-term perspective at the moment.

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

Contributing authors’ opinions do not necessarily reflect the viewpoint of ETFguide or the ETF Profit Strategy Newsletter.