The whiff of hope arrived yesterday in the form of rumors and a short-squeeze. The rumors consisted of somewhat fanciful speculation that eurobonds may come to the rescue of the Greek impasse, while Europe and China will embark on new pro-growth programs. Both came to a market ready to drink anything at all after the dreary desert it's been slumping through in recent weeks. As prices rallied from steep losses Wednesday, profit-taking set in amongst some of the shorts and the market completed an impressive-looking reversal.
All well and good, but three elements will decide the near-term direction of the markets: EU policy, specifically German; the direction of the global economy; and the ability of the market to generate some helium on hope, even if it's nothing more than fairy tales that skim along a technical reversal.
Consider EU policy and Germany. If you want to avoid bitter disappointment, you must understand that eurobonds are not on the table, regardless of what the market wants to believe (or sell you). In Germany's political calculus, there is no reason at all for Chancellor Angela Merkel to come out in favor of them. The German people are against them, by a margin of something like 70% of the population. Merkel's party and finance ministry are against them. Merkel is against them.
The markets rallied on the story yesterday that Italian Prime Minister Mario Monti may have joined newly-elected French President François Hollande in favor of eurobonds. No doubt that must have deeply cowed Madame Merkel. Unfortunately, neither Monti nor Hollande can vote in the German elections, nor can their respective party members, and the average German doesn't care very much what either of them think. For that matter, we don't think Texas is about to solicit the advice of Massachusetts Governor Deval Patrick on how the former should manage its budget. We could be wrong, but we're going to stick with that belief.
Merkel would gain nothing but her own expulsion from the leadership by coming out in favor of eurobonds; she wouldn't even last long enough as chancellor for Germany to ratify it. What is in Merkel's interest is to hope the Greeks can be bluffed, frightened or otherwise brought back into the fold by the next round of elections in mid-June. In the meantime, the falling euro is a boon for German exports, as evidenced by the unexpected strength in German GDP in the first quarter. The Bundesbank can get free money by selling bonds at rates of interest that don't even cover the postage.
For now, only a market meltdown could get the Germans to budge. Keep in mind that Europe has a different relationship with its markets than we do: Here in the capital of capitalism, the prevailing view in the last few decades has been the supremacy of markets over the bumbling thieves in government. In Europe, it's the equity markets that are viewed as populated by bumbling thieves, while the more clever thieves are in bond markets. The fact that equity prices are now slightly in the red on the year in Europe means nothing at all to the ruling elites.
But a meltdown would matter. Merkel was quoted as saying that fiscal union is "a long way off," to which Zero Hedge cleverly riposted that it was about "500-600 S&P points off." Quite right, and such an event would be accompanied by bond market havoc and a plunging euro. That would discomfit the Germans, we agree. However, as put options go, it's a very expensive one.
What about the global economy? In Europe, Germany did manage that surprise GDP flash print, although industrial production took an unexpected drop in April. But the rest of the Union's larger members, the UK, France, and Italy are all slipping and we don't have to tell you how rotten Spain, Greece and Portugal are doing.
Despite the Chinese remark about pro-growth policies, you would think that here of all places, markets would know that growth can't simply be flipped on, especially in a country as tightly controlled as China. "Official" government statistics notwithstanding, last night's flash PMI from HSBC showed a decline to 48.7 (50 is neutral). The country has a deflating property bubble to deal with, and no such bubble anywhere has gone unpunished.
Here in the U.S., the economy continues at a modest pace. For the 363rd time in the last four years, the financial press was moved to start blathering about the housing "recovery" this week. New home sales, after all, beat estimates and how exciting is that?
The totals of actual new homes sold in the first four months of 2009-2012, in thousands, beginning with 2009 are 116, 128, 109, 117. Those are the four lowest such four-month totals (first four months of the year) since records began being kept in 1963. Some trend. Some recovery.
Existing home sales prices rose in April, the National Realtor's Association trumpeted, but that was due to the drop in distressed sales as a percentage of the total. All that said, we will agree that there are some tailwinds for housing: inventories are low, especially in new homes; affordability is high, the cost of renting has overtaken the cost of ownership in some places, and there is even a little demographic bulge from birth rates in the early 1990s.
But credit remains miserably tight and overly concentrated in the Gang of Four banks, with all but Wells Fargo (WFC) finding new holes in their balance sheets of late. That isn't going to help them loosen the purse strings, especially with a potential financial meltdown sitting overseas. That demographic bulge in the circa-1990 birth rate can't find jobs, and housing has lost its cachet as a store of value. It will recover in time, yes, we are in the bottomlands, yes, but as an engine of growth, housing isn't there yet.
Disappointment is lurking for the May U.S. data next month. Both the Richmond and Philadelphia business surveys from the last week showed significant slowdowns, in the latter case an outright decline. Mortgage-purchase applications have been falling this month, implying a decline in sales rates, and Redbook is currently predicting a decline in retail sales for May. Did we mention that Brazil is easing monetary policy in order to try to head off a recession?
The third and final element consists of the markets, and their ever-ready ability to stampede. Now we begin to enter the world of the metaphysical, if not outright hope and smoke. We are admittedly still quite vulnerable to a drop to the 200-day average on the S&P 500 (around 1275), but markets remain somewhat oversold and some of the bolder types may try for an upside squeeze. While there is no law against it, May rarely sees major declines and the end of the month - a very important bullish fundamental, you know - is approaching.
We can think of a number of rumors that could get some hooves thundering again, if for no other reason than to try make some quick trading profits: Another round of LTRO by the ECB. Hints of QE-3 by the Fed. Employment data that somehow ensures that the Fed "has to act." There was a story floating last night that Merkel stands ready to guarantee all bank deposits. Sure she will. Maybe today there'll be a story that she will personally lend her debit card for an entire day to any Greek that needs it.
The global economy is still slowing, and won't turn on a dime - but hopes of more monetary easing could suffice to make a little money in the meantime. The EU will decide nothing before its mid-June meeting, absent a crash - but the Greeks can't vote themselves into the ditch until then either. The markets should be wise to all of this, but trader's markets look for the easiest way to make money first, and worry about the logic later. If you do decide to go along for the ride, keep one hand on the ripcord.