For those who feel relieved about Spain's $125 billion bailout, you may want to re-think the matter. If this were a sign of progress we would not be seeing Spanish 10-year yields blowing out like they are this morning, currently up to 6.52%. Within spitting distance of their May 6th highs of 6.56%, Spain's 10-year yields now appear poised to spiral to the upside. We could see yields quickly spike to 7%-7.5%. Such a move could usher in a concomitant move higher in Italian yields, ultimately leading to a new level of chaos requiring a forceful response from the ECB, possibly even ahead of the European summit.
If markets have taught us anything over the past five years, it is that politicians and central bankers of all stripes move too slowly in arresting market crises. While the market clamors for an immediate long-term fix to Europe's debt crisis, Germany's Angela Merkel continues to move at her own pace. This could haunt her in the coming days and weeks. Bond vigilantes in Europe seem to be making a statement to Ms. Merkel and ECB Chief, Draghi on Monday. To us, their message is loud and clear: devise a credible long-term fix for Europe and quickly implement it - the longer you take to act, the bigger the ultimate response will need to be.
Recently George Soros gave Europe until early September to get its house in order. With all due respect to Mr. Soros, are markets really going to let these politicians move so slowly? We think not. Decisive action is needed and one gets the feeling that Draghi does not have the authority from the Bundesbank or from Merkel to act as the omnipotent firewall that most market participants have been clamoring to see for some time.
This seems to leave it up to Ms. Merkel. Having seen fellow politicians in such countries as France, The Netherlands, Italy, and Spain recently booted out of office, Ms. Merkel has to finally understand the need to arrive at a comprehensive fix for the debt crisis. To that end, we expect to see progress made at the upcoming European summit. It seems obvious to us that Europe needs to move to a central authority, like our Treasury, that could oversee and coordinate fiscal policy in the eurozone. With an ability to impose central taxation, such an entity would allow Europe to issue bonds and borrow effectively again. While this plan would take time to implement and not be easy to get all nations to agree to, it seems to be one of the only remaining options for Merkel to pursue at this point.
Should such a plan be espoused by Merkel, we question how quickly she would follow through in implementing it, however. Without quick action, we expect to see the bond vigilantes increase the pressure on the Spanish, Italian, and even the French bond markets. Eventually, if Germany were ever threatened, this could serve as one potential catalyst for a decisive long-term fix.
Or, things just quickly unravel. The ball is in Europe's court.
With Greek elections looming next weekend, Spanish yields surging, and no long-term fix for Europe in sight, the gap opening this morning in equities seems to have been a major trap to buy into. Moving past Europe, we expect the strength in the dollar and the weakness in worldwide economies to serve as major catalysts for a disappointing earnings season and for another down-leg in equities. Earnings will miss in a big way. Just look at what happened to Tempur Pedic (NYSE:TPX) last week after it pre-announced a disastrous quarter.
In conclusion, the best trade right now seems to be no trade. There are still so many things that could go really wrong all over the globe in the short-to-intermediate term. Against this backdrop, we are happy to not be trading this month. Instead, we are hard at work trying to discover the next inflection point stories to emerge later this year like we have recently seen in both Calamp (NASDAQ:CAMP) and Neonode (NASDAQ:NEON). They are out there and will emerge in due time. How quickly they emerge ultimately depends on what type of climax we see out of Europe and how aggressive China becomes in re-stimulating its economy. This is a time for caution - these next few months in Europe will be historical.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.