Is the Eurozone rescue plan bullish for equities?

10th May '10 by Edward Croft

6 comments 3394 reads

Let's have a quick discussion on whether it's a time to be holding, buying or selling stocks.

Couple of good extracts from the Gartman Letter this morning:

SHARE PRICES ARE HIGHER... and they will be markedly higher as the day progresses, for the world has to understand that the monetary authorities in Europe are casting down any and all concerns about inflation and are instead responding to the concerns about “contagion” instead. New reserves... new cash... new stimulus is being pushed and will in the future be pushed into the banking system, and before that stimulus makes its way into the economy it shall make its way into equities. As we have said too many times previously, it is called a capital market for a reason, for capital that the central banks create finds its way into equity before it finds its ultimate way into plant, equipment and labour.

Being perhaps a bit too euphemistic, what we are seeing with the decision from its previous proscription against monetization and instead embracing it is what we shall call the “Zimbabwe- isation” of the global equity market. Remember that for a while, as the Zimbabwe dollar was plunging from near parity with the US dollar to trillionths of that value even as the Zimbabwe stock market was rallying monstrously, so too shall the equities markets around the world respond positively to this new monetary stimulus that the ECB is unleashing. Indeed, the trade probably is henceforth to own equities and to own gold in tandem, with one hedging the other.

There may be huge holes and flaws in the financial system, but the money is going to flow somewhere - GMO's Jeremy Grantham recently stated that there's a high probability of an equity bubble in the next 6 months ( Playing With Fire (A Possible Race to the Old Highs) ).

On the other hand - Alphaville reports that Marc Faber expects a 5-10% rally in stocks that he might use as a chance to open new shorts, while Citigroup says don't buy the dip.

The only certainty right now is a very high level of uncertainty - the game is certainly riskier - both to the upside and downside. We know that Tournesol went wisely into cash at the top - in the light of this massive bailout package should opinions now…

Unlock with Email

Unlock with Google

Already have an account?
Login here

Edward Croft

10th May '10

And another quote from the Gartman Letter:

We note that it was only last weekend... only last weekend... a mere eight or nine days ago!!!... that Mr. Trichet said emphatically that the ECB’s authorities had “absolutely no intention” of buying government debt. However, when the bank agreed to accept any and all Greek debt as collateral for future borrowing by the Greek government from the Bank the die was cast. This decision tells us unequivocally that the independence of the ECB has been utterly and completely compromised and that the political will of Brussels has trumped the economic will of Frankfurt.

marben100

The flaw in the Gartman Letter reasoning is explained here: http://ftalphaville.ft.com/blog/2010/05/10/224911/europes-qe-is-sterilised-and-sensitive/

The ECB is NOT creating any new money (for now): it is selling German Bunds and buying Greek debt. Can't do the ECB's P&L much good in the long run though. ;0)

Cheers,

Mark

emptyend

I'd see the weekend's deal as effectively allowing an unwind of the pressures that have built over the last month. Ultimately I think it is a neutral outlook for stocks, especially as my overall view is that stocks have "got ahead of themselves".

Just seen Trichet interviewed on TV. The decider for the ECB over the bond-buying policy was the market disruptions of last Thursday and Friday. IMO this points firmly towards a need to regulate and restrict the activities of leveraged entities that use automated trading systems.......these guys have far too much firepower available at present and can create destructive dynamics in the market - and on a global scale (now that everything is so interconnected) this risks bringing down the whole financial system, as has already come close to happening on several occasions with VAST costs to the public purse!

macroeconomix

"these guys have far too much firepower available at present and can create destructive dynamics in the market "

Isn't the problem that the central banks make money available to "these guys" at virtually no cost? Why not dramatically increase the overnight lending rate to cut off the leveraged speculation? Meanwhile keeping interest rates lower for ordinary retail punters .. A Glass Stegal type act would help here too.

And ideally there should be no central bank - but hey ho, what do I know.

Isn't the problem that the central banks make money available to "these guys" at virtually no cost? Why not dramatically increase the overnight lending rate to cut off the leveraged speculation?

Certainly the low cost is a major factor - low costs enable bigger bets to be taken!

What I had in mind re "destructive dynamics" though is a more structural issue - in the 1987 Crash there was in effect a feedback loop that developed as people running so-called portfolio insurance kept selling and selling in order to attempt rebalance their delta-hedging of portfolios that had resulted from the market discontinuity caused by the hurricane in the UK. In other words, leveraged sellers simply blew straight though the normal market depth because of they were following automated trading algorithms that demanded that they keep on selling.

I suspect that something similar happened last Thursday - though I don't know what would have caused it and it is also certain that (thanks to modern computing and rapid trading techniques) the timescale for this "feedback loop" became greatly compressed. I hear suggestions today that it may have something to do with different marketplaces having different rules for copiing with fast market conditions - but we'll have to wait for a considered view!

11th May '10

I'd just like to highlight a lengthy but very interesting NYT article about the US role in this package. The article highlights a key problem with the Euro:

...It was another of the all-night sessions that have come to epitomize the challenge of making decisions in Brussels, where 27 sovereign states with more than 450 million people sometimes painfully decide to share their sovereignty. The crisis most directly touches the 16 nations that use the euro. But it may also affect the fate of the single currency — a main symbol of the new European unity — and thus touches the entire European Union.

But the states that share the euro, which is controlled by the independent European Central Bank, do not share a single treasury, tax system or budgetary authority. The euro’s lack of coordinated financial backing had become excruciatingly evident after Greece admitted that its level of debt was much higher than previously reported, due to bad management and prevarication...

Will it prove possible to have a single currency without a central treasury function? It looks like we're going to find out. And if the answer is "no", as many economists suspect, will European governments find the consequences of a Euro breakup sufficiently dire to force them to cede sovereignty? I doubt that their citizens will let them. If they did go down that route, it would clearly lead to a "two speed Europe", with some EU members sharing a currency and some form of treasury and others outside that club.

Is the Eurozone rescue plan bullish for equities?

Unlock the rest of this article with a 14 day trial

About the Author

Edward Croft

6 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...