Will Europe Step Back From The Abyss?

Includes: DIA, EFA, FXE, QQQ, SPY, UUP
by: Wall Street Sector Selector

by John Nyaradi

Will Europe step back from the abyss and save its currency, economy, and even the world?

As European leaders race to find a solution to their two year old crisis, investors watch to see if France and Germany can finally get in front of this fast moving crisis. If market participants find credible solutions emerging from the coming week’s events, the stage could be perfectly set for a year-end rally extending into the “January Effect” in 2012.

On My Wall Street Radar

S&P 500 (NYSEARCA:<a href='https://seekingalpha.com/symbol/SPY' title='SPDR S&P 500 Trust ETF'>SPY</a>) chart courtesy of stockcharts.com

In the chart of the S&P 500 above (NYSEARCA: SPY), , we can see that the index bounced off strong support levels and last week’s rally created a near vertical move back to significant resistance at the 1250 level and the 200 day moving average. A break through above the 200 day average will be required for this rally to continue with any significant upside.

The Economic View From 35,000 Feet

Last week’s big news, of course, was the global central bank intervention to pump liquidity into the European banking system and buy time for policy makers to finally get a handle on this festering situation.

This week will put Chancellor Merkel, French President Sarkozy and their colleagues to the test to see if they can deliver a credible solution to the ongoing crisis. If they’re successful and market participants buy into their plans, it will be very bullish for the euro (NYSEARCA: FXE) and for the European equities markets (NYSEARCA: EFA) in general. In this event, we could expect further declines in the U.S. Dollar (NYSEARCA: UUP) and a strong rally in U.S. stocks as represented by the S&P 500.

Action is taking place on many fronts as dollar financing was made easier this week with the euro zone’s finance ministers floating ideas to bolster their European Financial Stability Facility.

More radical proposals could come from the European leadership summit next week and from Treasury Secretary Tim Geithner’s arm twisting visits with financial officials from Germany, France, Spain and Italy.

Fiscal integration of the European Union could be on the table, along with the European Central Bank buying debt via the International Monetary Fund as the fund apparently doesn’t have the assets to prop up a country the size of Italy. A likely alternative is for the IMF to provide some stop gap financing or the ECB lending money to the IMF which would then go to the troubled countries to contain borrowing costs that have reached unsustainable levels.

Some of the options appear to be more likely than others. One is a plan to have euro zone central banks lend money to the I.M.F. The fund could then provide lines of credit to countries struggling to finance their debts, and could participate in fiscal monitoring.

Any new money from the IMF would have to be approved by the United States since it is the major supporter of the IMF and so new money seems unlikely given the current mood in the United States about deficits and our own case of gridlock.

Finally, German Finance Minister Wolfgang Schaeuble has a plan that would allow member states to spin off debt and place it in a new, special fund that they could then pay off over the next twenty years which is truly bringing ”kicking the can” to a new level, or to use an American term, “restucturing debt” over the long term which will turn this into yet another problem for our children to solve long after many of us have left the scene.

All of this will come to a head at the December 9th summit and so investors need to keep a close eye on Europe as the week wears on.

Bottom line for stock market and ETF investors: A credible outcome from yet another European summit, or even a long term deferral of the problem, could be the catalyst for a powerful, global “Santa Rally,” while another failure or band aid fix could have devastating outcomes. Technical indicators point to higher prices ahead and human nature being what it is, European leadership will likely do whatever it takes to avoid a plunge over the abyss on their watch.

Disclaimer: Wall Street Sector Selector actively trades a wide range of exchange traded funds (ETFs) and positions can change at any time.