As I have noted before, the best plan that Europe can author for solving the sovereign debt crisis is not to devise a plan. Admittedly a facetious statement, the reality does not fall far from the tongue firmly planted in my cheek. Consider the brilliance of indecision; the markets have been so conditioned to negative news that it would take the default of a major country such as Italy - not going to happen - to shake investors from their positions. Even a "no deal" - unlikely - on Greece's debt swap, which would likely push the country into default, would only be a minor nuisance, a knee jerk sell-off before a collective sigh of relief that no more energy need be expended searching for that plume of white smoke signaling that a settlement has been reached. I can imagine the conversations between the EU ministers and bank CEO's over a glass of Chateau Margaux:
Venizelos: "I told them we were hours away last time. It's your turn."
Van Rompuy: "But I told them the time before that."
Juncker: "Don't look at me. I'm clearly not the optimist in this group."
Ackermann: "I guess I vill have to do it today since it's my shares that are trading down while you dumbkoffs play around."
Strangely, delaying any pronouncement (I'm trying awfully hard to avoid employing the now hated term "kick the can …") of a plan has been a key component of the recent decline in yields of Italy and Spain debt as shown below.
BUT the real catalyst, the primary catalyst by far, has been the LTRO. This has removed the threat of default and opened the credit markets. Oh, and it has also allowed the banks and sovereigns to both buy in their bonds and basically self-fund through the lending facility thereby driving down rates. Another important, albeit less critical component, has been the lowering of rates to 1% by the ECB.
All this points out how critical a central banker is to the economy. Trichet blew it through arrogance and stubbornness while Draghi, taking a lower profile, has been nothing short of spectacular in the role. In addition to the all-important LTRO, there have been other, more stealth like, moves by the EU and ECB to provide liquidity to what was a near frozen financial system including relaxation of collateral commitments for loans and lowering of reserve requirements.
Undoubtedly all these moves have happened with the approval of Merkel and Sarkozy while allowing them to stick with their tougher public personas preserving, to some extent, their political base back home.
And then the coup de grace will be the next LTRO later this month with the danger that high end expectations of a billion euros may prove disappointing should the final tally be similar to the first installment which was slightly sub-500 million. Nonetheless, any decline in the market will be a buying opportunity.
In the meantime, the Fed has pledged to keep rates low for an even more extended period of time, in my view an acknowledgement of a potential European spillover into our economy. (I am still appreciative of the comic relief offered by strategists that a U.S. economic revival would not be damaged by an EU recession. Pure folly. As evidence of this, one only needs to review this quarter's earnings period which were very mixed.) Bernanke's moves were more symbolic than substantive but he let the markets know that the helicopter is on the launch pad awaiting further instructions.
And China is not landing hard, or so they tell us. The commodities last year told a different story but now China is stepping in and reloading so shouldn't that be all we care about? It's the tooth fairy all over again. I'm not sure my kids ever cared if that flying munchkin was real or not as long as that dollar bill (we were not cheap parents!) was under their pillow when they woke up. The markets feel the same way.
All of this liquidity has brought rates to historically low levels and will ultimately draw money into equities - I swear it will. We have already started to see inflows and as more and more people and institutions realize that the increase in bond values has run its course that performance will no longer offset low yields and that fixed income instruments are fully valued.
So bottom line, for now I am bullish although not fully invested. I am more cautious as we head into the back half of the year since I do believe that austerity plans will bring Europe into a recession - Italy, the 3rd largest economy didn't grow in the good times, and enforcement of the new budgetary measures will be long in coming.
You can't fight the Fed, unless it's actually in a ring with a Budweiser logo on the canvas, and tougher to fight the combined might of the global central banks working in concert.
So there you have it. I am more invested than I have been for a while after shaving exposure after the initial 4% move. I am still not fully invested and largely staying away from the deep cyclicals although they will likely continue to move. Yield will still do well this year, again, although utilities will suffer from the warm weather. Natural gas, at this point, will not recover until we see more companies shut in production. Crude should trade lower once the Iranian situation calms down but not sure that will ever happen. With temperatures across the country remaining unseasonably warm, household spend on heating will decline putting more money in consumer's pockets. I continue to favor technology, see managed care as inexpensive, like other healthcare stocks such as Allscripts-Misys Healthcare Solutions (NASDAQ:MDRX) and high end retail. However, there is no need to be so precise since this will be a rising tide as flows drive the upside. As the Republican party rallies around Romney, the possible end of an Obama Presidency will bring further joy to the markets and corporations may even start to spend their largesse on M&A and hiring. Sure problems remain, but the market is generally an optimistic sort and the glass will continue to be viewed as half full.
My concerns go to the second half of the year when I believe China's leaky housing bubble will exhale more forcefully and the recession in the EU will deepen, including a possible default by Greece when the markets can better handle it. But no sense in dealing with that now.
Disclosure: I am long MDRX.