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Merkel and Sarkozy’s comments regarding the recapitalization of banks are great for the markets in the short term as the markets are incapable of seeing the longer term bigger picture. Talking about recapitalizing banks is very bearish for two reasons.

First, the mere fact that banks need capital is scary. The recent failure of Dexia (OTC:DXBGF) looks kind of like the warning shot that Lehman’s failure sounded. After Lehman’s September 2008 bankruptcy, the market crashed hard only to bottom out six months later in March 2009 with the S&P 500 trading at 666. What is even worse about this crisis is that it is not just a crisis involving banks, but rather banks and entire developed countries. The announcement that France and Germany stand ready to recapitalize the banks is in no way positive. Instead, it highlights a shift in thinking by European leaders with the recognition that Greece will most likely default and the haircut that investors and governments will be forced to take will be much larger than previously discussed and agreed upon in July. A default is never an orderly, painless procedure, especially when developed countries are involved. Greece isn’t some tiny island in the Caribbean or a country in Latin America that the IMF can throw a few billion at and make the problem go away thanks to the rich developed nations. Greece is a behemoth with over $400B in bad debt plaguing the European banking system and markets.

The second reason that this announcement is promoting a fake rally is due to the fact that we have heard this song and dance before. I remember hearing this same promise and rhetoric over 9 months ago and yet here we are still with a problem that has only gotten worse with time. Greece’s problems cannot and will not be solved by kick-the-can bailout measures that just prolong the inevitable. Greece cannot reign in its deficit and start running a surplus without defaulting on the majority of its debt. Greece is in a depression with ridiculously high unemployment, an economy that is shrinking by over 5% a year (closer to 7%) and a population that believes it is their right to retire at 50 years old and receive numerous handouts and entitlements from the government. Revenues are falling and Greece is proving that they cannot pay their debts. Merkel and Sarkozy are prepping for a default.

This rally, like the last few rallies, is based on hope and no fundamentals. It ignores the bigger picture and problems with the eurozone as well as the fact that there is no easy pain-free fix to Europe's woes. In short, this rally will not last long.

Source: Market Rally Based On Hope And No Fundamentals