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Market Update

Another Rough Quarter for Europe

With bond yields going up, the markets going down, and savage austerity measures imposed on struggling economies, Europe investors were understandably rattled.

Yet another EU summit in Brussels (the 19th meeting of EU leaders since the start of the region's debt crisis) on the last two days of June finally outlined a plan that at least helped stocks end the day on a strongly positive note. (More on that below.)

Though the quarter ended well, one would have to say that the markets had a pretty rough three months overall. Rocked by the debt crisis, equities across the continent tumbled as Spain emerged as the latest flashpoint in the seemingly neverending saga.

With bond yields going up, markets going down, and no solution in sight apart from savage austerity measures imposed on struggling economies, investors were understandably rattled.

An uneasy calm brought on by the Greek bailout in February gave way to panic selling, notably on April 11, when the FTSE fell 128 points after Italian and Spanish bond yields rose to worrisome levels. Toward the end of May, Spain's IBEX 35 closed at a nine-year low at 6812.10 points, down almost 3% on the day. The last time the index had closed lower was on Oct. 2, 2003, when it fell to 6762.40 points.

The nationalization of troubled Spanish lender Bankia SA sent government bond yields even higher, and the prospect of a Greek exit from the 17-nation eurozone weighed like a colossus on the markets for much of the quarter. With citizens angry over steep budget cuts and the region in political turmoil, investors were further spooked when Greece needed to conduct two elections in the space of six weeks to form a government after the first round of polls yielded a hung parliament.

France also went to the polls in mid-June, voting incumbent Nicolas Sarkozy out of office as the socialists won control, handing Francois Hollande the majority he needs in order to be able to pursue a tax-and-spend program.

The ratings agencies provided no respite, with Standard & Poor's, Moody's, and Fitch all downgrading Spanish banks. As a result, in the second quarter the country's benchmark borrowing rate hit its highest level since the adoption of the euro currency. The bond rate, which is seen as an indicator of a nation's financial health, reached perilously close to 7%, almost at the level that Greece, Ireland, and Portugal all required an international bailout.

Economic data from the eurozone also showed a mostly flat trend, with business and consumer confidence pretty stagnant, while factory data also proved discouraging.

With so much weighing on the equity markets, investors sought refuge in safe-haven assets such as gold, the U.S. dollar, as well as U.S., Germany and U.K. government bonds.

Equities Hammered
Expectedly, Greek stock markets underperformed the region as they tumbled 34.4% in just three months, while Germany and France also figured on the list of worst performers, falling nearly 20% and 17%, respectively.

Among the major markets, London's FTSE was the best performer, but still logged negative returns of 7.5%.

Expectedly again, financial stocks underperformed, sliding 18.5% along with the IT sector, which fell 18.8%, followed by resources and industrials, down 16.8% and 16.6%, respectively.

Had it not been for a rally on some positive news from the eurozone on the last trading day of the quarter, financials would have been the worst performers by a stretch. Even still, banking shares were big losers with  BNP Paribas (BNP),  Societe Generale (GLE),  Credit Agricole (ACA),  Commerzbank AG (CBK),  Deutsche Bank (DB) and  Royal Bank of Scotland (RBS) all down between 15% and 30% for the quarter.

Shares of U.K. banks turned in one of their worst weeks ever as  Barclays PLC (BCS) was fined a record GBP290 million after it admitted its traders attempted to manipulate the London inter-bank offered rate benchmark, or Libor, by deliberately submitting inaccurate data during the financial crisis.

Following an investigation into the case, the Financial Services Authority said it also found "serious failings" in the sale of interest-rate hedging products by four major banks, namely  HSBC (HBC), RBS,  Lloyds (LYG), and Barclays. The FSA did not impose any fines but confirmed settlements saying the banks have provided personal assurances to compensate complainants.

Information technology shares were hit by recessionary pressures, and their valuations weakened. Reports indicate that European tech firms continued to remain prime takeover targets for U.S. companies as business growth remained stagnant.  Alcatel-Lucent (ALU) fell about 25%. Semiconductor firm  ARM Holdings  lost over 15%, while  Infineon Technologies (IFX) fell 33%. In software services,  Capgemini (CAP) was down about 18%, while German enterprise applications specialist  SAP AG (SAP) gave up 11%.

Auto firms also fared badly as the sector reversed almost 25%.  BMW (BMW) fell 17% and  Daimler AG (DAI) was 23.6% lower.  Renault SA (RNO) backed off 23% while  Peugeot (UG) fell 38%.

Health-care firms outperformed, logging a loss of just 3.5%.

EU Deal
After more than 13 hours of talks ending June 29, eurozone chiefs agreed to relax austerity measures for emergency loans to Spanish banks and also offered possible help to Italy. In addition, they agreed to recapitalize lenders once a single banking supervisor was set up for all of Europe. Stocks and bonds in Spain rose on the news, while the euro also rallied.

EU leaders agreed on a number of measures to promote growth, chief among them the decision to fund the European Investment Bank with about 120 billion euros. The EIB lends money to long-term business projects.

Investors will be hoping that this will prove to be just the sort of catalyst the markets had been waiting for.

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