The deal behind stocks' latest roller coaster ride

Europe’s leaders finalized a deal in the wee hours of October 27. It avoids a default by Greece, addresses banks’ capitalization and “ring fences” Italy and Spain against contagion. At least, that’s what it’s supposed to do.

Markets reacted with euphoria. Stock markets in the U.S. and Mexico staged strong rallies on the 27^th. The Dow soared 2.9% and the IPC, 8.1% in dollars. That day the cost of a dollar fell to its cheapest price in five weeks, a 2.2% appreciation.

Of what does the deal that awakened such hopes consist? First, investors holding Greek government bonds accepted a 50% reduction in the value of the bonds. Second, European authorities agreed that the core capital requirement for banks will be raised to 9%. Third, using leverage, governments will increase the size of the European Financial Stability Facility (ESFS) from the pre-agreement 440 billion Euros to 1.0 trillion. That should backstop Italy and Spain’s borrowing needs, preventing a run on those two countries. 

The “sugar high” didn’t last. Stocks pretty much held their own on the 28^th then, on the next and final trading day of the month, the 31^st, gave around 2 percentage points. 

Even so, October was a very good month in markets that hadn’t really seen a good month since the first quarter. In fact, October was one of Wall Street’s best months in years. The Dow’s 9.5% gain was its largest in nine years; the S&P 500’s 10.8% climb was its biggest since December 1991; the Nasdaq’s 11.1% jump was larger still, its best in thirteen months. The IPC did best, posting a hefty 13.0% gain in dollars in October.