Seeking Alpha
Long/short equity, registered investment advisor, portfolio strategy
Profile| Send Message|
( followers)  

Good Morning. I was speaking with a colleague yesterday afternoon and was asked, "Are you doing anything differently in your portfolio systems these days about Europe? It seems that this thing could get solved soon. But, if they don't get this mess straightened out in the near future, we may be in for big-time trouble." The response that came out of my mouth was a combination of stuff I'd put in the "Duh" category and then, surprisingly, a rather concise and simple outlook. So, I thought I'd share.

First and foremost, I said I was playing the game more conservatively. Matthew then asked, "How exactly are you doing that?" I replied that there are three key components involved with money management (timing, selection, and beta - or leverage) and that I was trying to use the lower end of the spectrum in each category.

I mentioned that in the timing department (i.e. when to buy and sell), I was "staying in the game" but not taking any unnecessary chances. Before I could move on, he asked, "Why stay in the game? Why not just move to the sidelines in this miserable environment and stay there until this Europe mess blows over?"

Although I wasn't trying to be rude, I chuckled in response to the question. I said, "Okay Matthew, that sounds like a great plan. And quite frankly, this is about the 10th time I've heard somebody say that in the last week. But here's the problem." I paused for effect and then added, "When will you know that a crisis few people truly understand is actually over? What's the metric you'll use to tell you that it's okay to get back into the pool?"

Matthew's almost stunned response was something along the lines of "Uh, good point." But before he could get another word in, I mentioned that unless you think the world is going to come to an end, it is probably best to stay in the game to some degree - because you just don't know when this crummy period will end. I further opined that while holding a good chunk of cash makes sense, if the bottom of 2009 taught us anything it was that you've got to be "in it to win it" with at least a small portion of your portfolio when things improve.

With my point made, I moved on. "But," I said, "This is the time to be playing small-ball. In this type of insane, headline-driven environment, you need to stick to your strategy but 'play smaller.'" I added that position sizes should be reduced, cash should be raised, stops should be implemented, and that leverage should be avoided - for as long as the game remains this difficult.

For the record, this was the stuff I'd place in the "duh" category, so please accept my apology if this was overly simplistic. But then we moved on to the good stuff.

I said that in looking at the situation in Europe, it actually seems pretty simple right now. I'm not talking about the idea of central banks lending money to an international agency that would then invest in an SDR in order to buy some newfangled bonds with guarantee certificates issued by the EFSF. No, I'm talking about the idea that the problem of rising rates can potentially be solved. And I said that the market may be sensing this right now.

Put ever-so simply, the new President of the ECB, Mario Draghi hinted Thursday that the central bank would be willing to play a larger role in solving the crisis if the ECB had assurances that the countries that had overspent and over borrowed wouldn't keep doing so in the future. Enter the concept of the "fiscal compact" or the "stability union".

Assuming the EU leaders can, within the next couple of weeks, cobble together a legal structure that would have some enforcement bite in overseeing and approving the budgets of each individual country, it appears that the ECB would then start getting serious about lending money to the PIGIS. Armed with a bazooka, the ECB could then attack the problem and keep borrowing costs down to reasonable levels. Presto, problem solved. (No, not the debt problem - the problem of credit contagion.)

So, as I told Matthew, it's really pretty simple. If EU leaders can draft a "fiscal compact" AND the ECB is willing to fire its bazooka, then the U.S. stock market could actually escape this miserable environment. But if not, well, the outlook is still pretty simple - albeit ugly.

Turning to this morning ... French President Sarkozy went public with a call for the "fiscal compact" after the close Thursday while the wires are reporting Friday morning that the ECB will be lending money to the IMF. This combination is causing rates to fall in both Italy and Spain, which the markets are taking as a positive in front of the Jobs report.

On the Economic front ... The Big Kahuna of U.S. economic data has just been released. The Labor Department reported that Nonfarm Payrolls gained 120,000 in the month of November, which was above the consensus for a gain of 117. Last month's total was revised to a gain of 100K (from 80K). The Unemployment Rate fell to 8.6% from 9.0%.

Thought for the day ... Best of luck on this Friday and be sure to enjoy the weekend!
Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell ...
  • Major Foreign Markets:
    • Australia: +1.36%
    • Shanghai: -1.09%
    • Hong Kong: +0.20%
    • Japan: +0.54%
    • France: +1.81%
    • Germany: +1.73%
    • Italy: +2.44%
    • Spain: +1.93%
    • London: +1.50%
  • Crude Oil Futures: +$0.81 to $101.01
  • Gold: +$19.70 to $1759.50
  • Dollar: lower against the Yen, Euro and Pound
  • 10-Year Bond Yield: Currently trading at 2.117%
  • Stock Futures Ahead of Open in U.S. (relative to fair value):
    • S&P 500: +13.18
    • Dow Jones Industrial Average: +120
    • NASDAQ Composite: +24.75
Positions in stocks mentioned: None
Source: Daily State Of The Markets: It Seems So Simple