Traders are looking at the likely stream of headlines in the week ahead and buying the market. Some of the details of the G20 Summit have been leaked, and apparently, European project bonds may be proposed, as well as substantially increasing funding for the European Investment Bank. In the US, Federal Reserve officials have indicated that more quantitative easing was data-dependent, and lately, data has been disappointing. Most likely there are traders buying the market based on speculation of more quantitative easing, even though they know perfectly well that data hasn't been bad enough to justify it yet. Furthermore, the QE might take the form of mortgage backed securities buybacks rather than Treasury buybacks, since the existing Operation Twist has had a detrimental impact on Treasury market liquidity.
Bill Gross of PIMCO, who manages one of the largest bond funds in the world, proclaimed that the global war on deflation had begun. That is not a positive for equities, yet they still went up last week. There is both fear, on the part of shorts, and hope, on the part of investors, that G20 leaders will propose some massive measures at boosting global liquidity, but it is not likely that these short-term solutions will solve anything and most traders know that. In the recent past, the market has typically gone down once an attempt at providing details of proposed solutions is announced and the public debate amongst politicians becomes louder.
Spain's 10 year bonds are yielding around 6.8%, close to the highs of 7.08% reached last fall before the LTROs bailed them out, and they have another bond auction coming next week. Italy has a huge amount of debt to issue and is behind schedule for this year. Their fiscal deficit, as we think we know it, is within the EU guidelines but may not stay that way in the future and once that slips markets will react negatively. Italy's not elected, technocratic Prime Minister Mario Monti has imposed austerity measures and tax hikes, that if passed, will slow the economy further and make balancing the budget more challenging, but if the people reject the austerity, that would be equally bad; there is no easy answer.
Concerns about Greece appear to have subsided as people seem to perceive the situation as a case of MAD (mutual assured destruction), whereby Greek and European leaders must compromise, because the alternative is too gruesome to imagine, but that seems to me overly-optimistic. Besides, the headlines are likely to be stomach turning in the weeks ahead, as leaders use the media to push their agenda.
That leaves the S&P 500 ETF (SPY), PowerShares QQQ (QQQ), Vanguard MSCI Emerging Markets ETF (VWO), SPDR Barclays Capital High Yield Bond ETF (JNK), Select Sector SPDR-Energy (XLE), bank stocks like Bank of America (BAC), JP Morgan (JPM), Goldman Sachs (GS) and Morgan Stanley (MS) as well as cyclical stocks like Caterpillar (CAT) and tech stocks, like International Business Machines (IBM), that rely on overseas sales, all vulnerable to disappointment. I am not necessarily suggesting that long-term investors sell these holdings, but suggest that investors looking to spend some excess cash wait for a better entry point.
Markets will likely anticipate and price in slower global economic growth and the hype over what monetary authorities will do will dissipate. Historically, there is very little leaders can do to affect the economic cycle anyway, but the situation is especially challenging now at a time when most countries have such bloated debt levels that leave limited capacity to stimulate demand through government spending.