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European elections signal end to market calm

By Edward Krudy

Elections in Greece and France over the weekend have ushered in a new period of uncertainty for financial markets that could stand in the way of the easy-money rally that boosted stocks at the start of the year.

For U.S. investors, it means a return to the volatile period that dominated the better part of last summer and fall, when fund managers scrambled to stay ahead of developments in Europe's debt crisis.

Now, just two days after voters in Greece and France chose candidates that rejected the austerity measures imposed to rein in Europe's debt crisis, markets are already swinging with the shifting political tides.

After largely taking the election results in stride on Monday, stocks and the euro fell on Tuesday as concern heightened over whether a new government in Greece will maintain a commitment to the country's bailout pledges.

And with more votes expected in Greece and other nations, the day-to-day anxiety is expected to rise.

"This really just prolongs the possibility of recovery because now there is going to be a political debate about what's the best way to proceed, said David Joy, chief market strategist at Ameriprise Financial in Boston.

Joy has cut back positions in economically sensitive stocks over the last two months as U.S. economic data showed signs of softening. Events in Europe are another reason for caution.

In Greece, a radically altered and highly fractured parliament is struggling to build a coalition, with fresh elections to come if it fails.

In France, Francois Hollande, a Socialist who campaigned on an anti-austerity platform, pushed out President Nicolas Sarkozy, bringing to an end a staunch partnership with German Chancellor Angela Merkel that has been at the heart of Europe's austerity drive.

The challenge to Europe's orthodoxy of austerity comes as Europe battles recession and dovetails with mounting concern about the trajectory of the U.S. recovery and slowing growth in many emerging markets .

After a mixed market reaction on Monday that left European stocks higher and the euro only marginally lower, fear returned on Tuesday. The Standard & Poor's 500 finance/markets/index?symbol=us%21spx">.SPX hit a two-month low, British .FTSE and French .FCHI benchmark equity indexes turned negative for the year, and a pan-European stock index .FTEU3 hit a four-month closing low.

Risk indicators in the equity and currency options market suggest increased worry.

Implied volatility of one-month at-the-money options in euro-dollar jumped to a more than one-month high in a sign of increased anxiety and concerns the euro may fall further.

In the stock market, the CBOE Volatility Index .VIX rose 10 percent to rise above 20 for the first time in two weeks.

For some investors there may be a sense of déjà vu after nearly three years of headlines about Europe's debt crisis. Each successive wave had a more muted effect on U.S. markets; some believe that pattern will play out again.

Ken Fisher, founder of Fisher Investments, which manages about $38 billion in equities, said the events change little and he is sticking to his bullish view for U.S. stocks this year - a view that has been borne out, at least in the first quarter.

Fisher, like a growing number of investors, is of the view that the political switch could end up benefiting markets if opponents of austerity can make good on their promises to deliver measured growth and prevent a further slide into recession.

"We have seen this movie about 15 times, we should be ashamed of ourselves to fall for the same movie three years in a row, he said. If this isn't priced in, I don't know what is."

So far, at least in Greece, uncertainty is weighing more. The Athens SE General Index .ATG lost 10 percent in just the first two days of this week, with deepening uncertainty over whether Greece will avert bankruptcy and stay in the euro.

Antonis Samaras, leader of the conservative New Democracy party, which won the biggest share of the vote on Sunday, failed within hours to cobble together a government.

Radical Leftist Alexis Tsipras is now trying to form a Greek government, but his threats to nationalize banks makes his chance of success slim - something that would necessitate another round of elections.

"All these challenges in Greece and France will weigh on the eurozone and won't really change anything until we see a long-term solution to the debt crisis, said Richard Batty, investment director for multi-asset investing at Standard Life Investments in Edinburgh, Scotland, which manages $240 billion.

"So what we are doing is continuing to underweight the euro, to be underweight European equities and underweight eurozone bonds including Germany."

Waiting for election results will add tension to markets. The French will go to the polls again in June to elect a parliament. A conservative parliament could act as a counter balance to Hollande's policies or could introduce a less workable government.

The prospect of more spending could hit European fixed income securities, even Germany, where the benchmark 10-year yield hit a record low on Tuesday. A number of investors interviewed said they were reducing positions in euro-denominated sovereign debt and are negative on the euro itself.

"The prospect of austerity being off the table combined with a perceived increase in the propensity for further deficit spending is certainly not a positive for trading levels in European corporate as well as sovereign debt, said Bonnie Baha, portfolio manager at DoubleLine, with $33 billion of assets under management.

DoubleLine does not hold any euro-denominated debt.

[Reuters]

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