Farrell: Prepare For A Counter-Trend Rally
Chief Investment Officer, Soleil Securities
German voters are up in arms at the bailout devised by the heads of state, including their own Angela Merkel.
A majority of German voters (60% as of the latest poll) have lost confidence in her leadership.
The idea that she could continue on the path of closer European integration is far-fetched.
She does not have the political capital to push integration that, by definition, would force Germany to give up more of its sovereignty over budgetary and economic policies. Economists argue that euro zone members need to more closely coordinate fiscal policy to prevent future crises.
German voters have clearly indicated their opposition to such a tilt.
Ms. Merkel's government is now advocating its own rules that pander to the electorate— the ill-advised short-sale bans of last week—and others that would provide for oversight and sanctions for countries that violate spending and deficit rules.
This approach is solely German-centric.
The political reality in Germany makes it nearly impossible for Chancellor Merkel to endorse pan-European reforms that would impinge on German financial/economic superiority.
The Club Med members of the European community allowed wages to rise substantially under cover of low interest rates that were really Germany's to claim. Asset price bubbles and financial excesses flourished and drove the southern economies (and Ireland). Germany kept wages in check to foster their competitiveness. When the bubble burst, Germany was left standing and having fostered an industrial edge the last ten years, they are not going to/should not sacrifice their hard earned advantage to bail others out.
Germany is contributing some $40 billion to the bailout effort.
In a short time, the Merkel government will propose domestic budgetary cutbacks of some $10 billion. If the voters haven't focused on this yet, they soon will. $40 billion to bail out profligate nations and cut $10 billion at home is not going to go down well. The voters are right to say, "We're paying what?"
But they aren't the only ones.
The International Monetary Fund is kicking in some $250 billion to the effort. The US "owns" 17% of the fund but for some reason foots a little over 20% of the tab. So the US, over time, will be kicking in $50 billion to the rescue. That's more than Germany, and, the last I checked, we were running a trillion dollar (plus) deficit. Someone is crazy here.
Jean-Claude Trichet was quoted the other day as saying the euro was not in danger. I beg to differ.
The Euro is in big danger. German patience, if it can be called that, will reach the limit.
The US voter should realize we are bailing out the euro zone, and who signed up for that?
Bond issuance has collapsed the last few weeks in Europe and risk aversion trumps all.
The uncoordinated political response, highlighted by Germany's unilateral move to regulate short sales, has unnerved the markets.
It appears there is dissension in the ranks and no coordinated policy for dealing with the issues. The bond market essentially shut down, says the Financial Times, after the German move. Simon Ballard, of RBC Capital, said, "The primary bond markets in Europe are paralyzed. There was no issuance at the end of last week after the German decision confused the market." Not only was the German move a surprise, it received no support after the fact, and is widely derided as being ineffective at best, if not harmful. If the bond market is closed, how do you finance the bailout? Way to panic, Angela.
Greece is eventually going to have to restructure its debt since the riots in the street indicate there is no resolve to accept the austerity plan. That would not be the worst outcome. It would be far better than dragging the rest of the euro zone down with it with constant infusions of cash. Sooner or later the others will be fed up. Better to accept that now and deal with it.
Probably best for us to stay out of the way for a while.
We have riots in Greece and Thailand, financial reform uncertainty in the US, rising LIBOR in Europe which indicates an unwillingness to lend, a government-induced slowdown in China, Iranian intransigence, and a whiff of deflation in the US.
1045 on the S&P was the low last February and that is also roughly equal to a 1/3 retrenchment of the rally we have had starting March 2009 (the S&P is trading at 1080 at this writing.) A one-third setback of an advance is fairly common. Earnings estimates have come down for next year and probably will continue to trend down a bit. Markets struggle when estimates are falling. Keep the buy tickets close at hand -- just not quite yet. Don't be shocked by a counter-trend rally soon.
Just don't buy into it.
Vincent Farrell, Jr. is chief investment officer at Soleil Securities Group and a regular contributor to CNBC.