Stock World Weekly: Fear and Loathing in the Eurozone
(Excerpt from the week ahead section)
Late Thursday afternoon, Jon Hilsenrath of the Wall Street Journal, a well-known sounding board for Bernanke when he wants to give signals to the markets, reported “Federal Reserve officials are starting to build a case for a new program of buying mortgage-backed securities to boost the ailing economy, though they appear unlikely to move swiftly.” (Fed Is Poised for More Easing)
This report builds on sentiments that Federal Reserve Governor Daniel Tarullo expressed in a speech on Thursday evening. Bloomberg reported “Federal Reserve Governor Daniel Tarullo’s call for resuming large-scale purchases of mortgage bonds may boost chances the central bank will start a third round of asset buying aimed at reviving U.S. growth.
“Policy makers should move the tool ‘back up toward the top of the list’ because it would help the economy through lower mortgage costs that would boost home purchases and spending by people who refinance their home loans, Tarullo said late yesterday in a speech in New York.”
Tarullo’s speech and Hilsenrath’s article both came out on Thursday, suggesting the Fed is making an effort to broadcast its seriousness about using its tools to jump-start the moribund U.S. economy. Any large-scale program of buying bonds will essentially be another round of quantitative easing (QE3), predictably leading to increases in stock and commodity prices.
However, regarding commodity prices, one event last week may put a damper on increases in commodity prices. On Tuesday, the Commodity Futures Trading Commission (CFTC) voted to put position limits on commodity markets, as it attempts to deal with problems created by runaway speculation. Phil has repeatedly reported on the manipulation in the oil markets, with articles such as last June’s “Which Way Wedne$day - Let’s Break the $peculator$.” Tuesday’s action, while welcome, is long overdue.
The six month chart of the Dollar shows the 73 to 76 range that the Dollar traded in for five months, before it broke out in early September. Now, however, the Dollar’s impressive breakout is failing. It looks like the Dollar may return to its previous trading range. Moreover, with Bernanke and Tarullo banging the drums for more QE, market participants know that QE3 is likely to weaken the Dollar. If the inverse relationship between the Dollar and the stock market persists, the depressed Dollar is bullish for equities. This is no secret and is why hints of QE3 drive the Dollar down and prop equities up.
Europe will be the focus of the financial news again next week. German Chancellor Merkel and French President Sarkozy will try to work out a deal to give additional funding and more discretionary power to the EFSF, while simultaneously strengthening “economic integration” and capitalization of European banks, all under the auspices of implementing “economic governance of the euro area.” Achieving their goals would be historic by any measure.
A primary issue at the heart of the struggle is whether the theoretically unlimited funding of the European Central Bank (ECB) can be used to ‘backstop’ the EFSF, thereby guaranteeing sufficient capital to recapitalize banks and buy distressed bonds. While Sarkozy is a strong proponent of backstopping the EFSF with ECB funding, going so far as to abandon his wife during childbirth to travel to Frankfurt to make his case to Chancellor Merkel, his efforts were in vain. Merkel, backed by ECB President Jean-Claude Trichet, adamantly refused to consider Sarkozy’s proposal.
As the UK Telegraph noted “Europe's central bank could not be used to boost the EFSF because of a 20-year EU treaty clause forbidding the union from using its cash to save European governments. Unlike the EFSF, an ad hoc inter-governmental ‘special purpose vehicle’ based in Luxembourg, the ECB is governed by the detailed chapter and verse of European law.” According to a senior EU diplomat, “If the ECB could act like a national central bank that would make life a hell of lot easier, problem solved, but that runs up against the treaties and Germany's cult of the Bundesbank. Sarkozy was told 'game over’” (France and Germany: an unstoppable force meets an immovable object)
Indeed, the mood at this weekend’s summit in Brussels was somber. The impasse over the EFSF was overshadowed by a surprise announcement from Christine Lagarde, former French finance minister who is now chief of the International Monetary Fund (NYSE:IMF). Lagarde warned that, without a default, the Greek debt crisis by itself could deplete the entire €440Bn EFSF fund. Her announcement further stated that the IMF was no longer willing to pick up a third of the total bill for rescuing Greece, estimated at €73Bn, unless European banks were prepared to write off at least 50% of Greek debt. One eurozone finance minister was quoted on Saturday as saying that the situation in Brussels was “Grim, the worst mood I have ever seen, a complete mess.” (Eurozone summit - despair and backbiting in the corridors of power)
Stock World Weekly writing and editing team, Elliott and Ilene, recently interviewed Russ Winter of Winter Watch at Wall Street Examiner. In part 1, Chaos in the Land of Oz, we established that the Fed is the Wizard, and we are living in an economic Land of Oz. This week, in part 2, we discussed the debt crisis in Europe, the too-big-to-fail (TBTF) banks, and whether there is a pathway back to Kansas:
Elliott: By not allowing TBTF banks to fail, the federal government is continuing its environment of corruption and moral hazard. Case in point - the scheme to force taxpayers to insure Bank of America's worthless debt via the FDIC. So, Russ, the situation will get worse, until TBTF banks get decapitalized?
(Ed Note: "Recapitalize" banks is code for pulling it out of the hide of German (and other) taxpayers and future generations. "Decapitalize" means: do the crime, do the time - i.e., take the losses.)
Russ: Right. Take the investors out, the bondholders, and shrink the sector. Banking globally should be cut in half. That means the capital backing these institutions needs to go to money heaven. The word for it is "losses." Right now we have "too big to let lose" because of fear of a bad hair day.
I was very disappointed last week when they started shilling for more bailouts. The bankers resist the restructuring, and the market rallies on that news. The market is hooked on bailouts and socializing losses. That was the basis of the 2009-2011 bull market. That can't go on forever. All these money managers are chasing stocks because they expect another bailout. It's nonsense!
Elliott: As an investor, I like to look for value. But it's so hard to find real value when so much has been gimmicked by the Fed.
Russ: That's my view entirely.
Ilene: What outcome do you expect?
Russ: I'm highly cynical. We're like deer in the headlights, but we have to protect ourselves from the pump-and-dumps and avoid the herd mentality of jumping on these bailout rumors. I'd be ready to jump in [to the stock market] if the right outcome occurs - big haircuts for bond holders and decapitalizing the financial sector.
Ilene: But then after Greece, there are other Eurozone countries. Are we going to go through all this again with Italy, and Spain?
Russ: Most likely. All of these countries may have some kind of debt restructuring. They can't pile the debt on the remaining few healthy countries. Look at the debt-to-GDP of Germany, for example. (Is Germany the Savior of Europe?) So who is the next patsy for the banksters? Answer: not many are left.
Russ: Well, it's worse than that (and that's just the sovereigns). I wrote an article called "The EFSF plan in Europe is no free ride." The gross debt to GDP of the United States has reached 100%, the U.S. doesn't have any bullets left for this kind of policy. Politicians are talking about cutting Medicare and Medicaid and safety nets, so that they can bail out the banksters...
Ilene: Are you long or short any particular stocks?
Russ: Right now, I’m shorting the "Palace of Versailles" stocks, stocks like Tiffany’s, Ambercrombie-Fitch, Coach, Starbucks, that sell at rich multiples, because supposedly wealthy people are doing well. Well, rich people were losing their asses in the market in the last couple of months. If you look at the polls, rich people are just as negative as poor people now. The Palace of Versailles trade makes little sense when protesters are in front of your houses, and the stores you shop at. I try to run counter to the conventional wisdom. (Click on this link to read the full interview, Chaos in the Land of Oz, part 2)
Late Friday afternoon Phil took a “cashy and cautious” stance. He wrote, “Well that was a totally fun week. Congrats to all the bullish faithful and, of course, the $25KP players – CASH IS GOOD – enjoy the weekend!”
In contrast to Russ and Phil's more cautious positioning, Lee Adler of the Wall Street Examiner is on the cusp of potentially turning more bullish, BUT he wants to see some proof first. He wrote to subscribers of the WSE’s Professional Edition, "The market has broken a key resistance level. Unless this move whipsaws, the market could reach projections of 1280-1300 quickly. Such a breakout would in turn suggest that the 18 month 2 year cycle had entered an up phase. Unless bears mount a ferocious countermove on Monday, the likelihood is that they could be in hibernation at least through the winter months."
We have a trade idea this week from Pharmboy, who writes, “Bristol Myers Squibb (BMY, $32.56) is losing its patent protection on Plavix next year, but has a blockbuster replacement in Xarelto. The company has other interesting pipeline candidates, and a hefty 4.1% dividend yield.
I like starting a position by selling the January 2012 $31 puts for $1.10 or better.”
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