Unemployment could decline over the medium term, but another wave toward the highs is expected. What will be decided this week in Brussels?
Employment: Rising or falling?
The U.S. Federal Reserve decided to renew "Operation Twist" last week. It will buy about $270 billion in longer-term treasury securities and will sell its holdings of short-term treasuries for the same amount. Mr. Ben Bernanke opted for this softer approach, and he kept Q3 (quantitative easing three) for the last part of 2012 or the beginning of 2013. The Fed is ready for any action to promote growth and sustain employment. However, it cannot resolve the European sovereign debt crisis. A "wait and see approach" is considered the best choice for now. Housing is bottoming and should support the recovery over the longer term. On the contrary, current employment growth is the weakest since the end of WWII and has gained less than half of the nine million jobs lost during the recession. Growth is not strong enough to sustain momentum.
What could happen next? The history of cycles anticipates a contraction toward 8.0%-7.8% before the markets will resume the long-term uptrend. Let's examine why. Since 1948, the unemployment rate had two bullish cycles (1952-61 and 1969-82). Movement lasted for 9 to 13 years and extended 63%-67% top/bottom. Both cycles climbed in three distinct waves before collapsing. Within these secular bull cycles, the unemployment rate topped and bottomed every four to six years. Corrections have instead continued for one to three years top/bottom. How would this fit in today's scenario? Unemployment began in 2000. It topped in 2003, bottomed in 2007, and completed the second wave in 2009. The movement extended for 60% top/bottom. A third and final wave is still lacking, and it could be expected between 2012-2013, if history repeats itself.
Greece: What could happen next?
Greece is once again in the game. The pro-Europe parties have the capacity to form a government in the coming weeks. An agreement should be found with the IMF, ECB, and EU. Greece will then receive more support loans from the second bailout plan. Will Greece comply with the troika requirements? No, it will not. Greece does not have the resources (moral and financial) to cope with the crisis, considering also the adverse economic cycle. Chances of a default are high, and exit risks are possible. Apart from the country leaving the eurozone, the only solution would be to park the Greek debt for a few decades. Hopefully, the next expansionary cycle will make it easier for the country to pay out its burden with the help of the European Central Bank (ECB).
Europe is solid as a whole. The public deficit should remain below 3.5% of the GDP this year, and the current account could instead show a surplus. This week, Spain will submit an official request to the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM) to recapitalize its banks. However, markets are worried about the lack of political and fiscal cohesion.
This week's European summit is crucial for the eurozone. The heads of state must find solutions for the European political and financial deficiencies and boost confidence. At the top of the agenda will be strengthening European firewalls through the issuing of a banking licence to the ESM or the institution of a redemption fund. Italy and Spain will need 920 billion euros by 2014, far above the EFSF/ESM bailout fund's capacity. Different views are already emerging. On one side, Germany expects the establishment of Eurobonds after public deficits have been reduced. On the other hand, France wants to guarantee cheaper financing for states and boost growth over the short term.
Will Europe succeed? A solution is still in the cards. Restoring confidence will be the toughest task. A selloff of the euro is possible; however, funds are mostly shorting the market. In the past, this has been an indication of important turning points.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.