The European Central Bank indicated on Thursday (2nd. August) it may again start buying government bonds to reduce crippling Spanish and Italian borrowing costs but the conditions it set and the dissenting voice of its key German member disappointed markets.
In the latest move to contain the eurozone crisis, ECB President Mario Draghi indicated that any intervention would not come before September - and only if governments activated the euro zone's bail-out funds to join the ECB in buying bonds.
"The Governing Council ... may undertake outright open market operations of a size adequate to reach its objective," Draghi told a news conference after the central bank's monthly meeting, using the central bank's code for bond-buying.
The ECB kept euro zone interest rates at a record low 0.75 percent but Draghi said the council did consider a further rate cut on Thursday amid signs that an economic recession in peripheral European countries is spreading across the continent.
A Reuters poll of nearly 50 economists after Draghi spoke found that most expect the ECB to start buying Italian and Spanish bonds in September and to cut rates t o 0.50 percent.
Draghi was under intense pressure from investors, European leaders and the United States to deliver on a pledge he made last week to do whatever it takes to preserve the euro by bringing high borrowing costs down.
But shares and the euro fell after the ECB chief's remarks, and Spanish and Italian bond yields jumped, with Spain's 10-year paper vaulting over the 7 percent danger level.
"It is quite disappointing ... There is a lack of any action so he has basically passed the buck back on to politicians," said Ian Smith, strategist at Knight Capital.
So reported Reuters in Frankfurt yesterday. Since last Monday the ECB had hinted that on Thursday Mario Draghi would announce a "game changing" initiative. However his presentation to the press turned out to be a "non-press" conference. No new initiatives were propounded.
On the contrary Draghi intimated that Italy would probably need to avail of a bailout in addition to Spain. Thus the European Stability Fund (ESF) which is supposed to be the great savior of Euro sovereign debt will be 40% "secured" by countries availing of bailouts. Four Euros out of every ten are the ESF contributions to be made by Greece, Portugal, Ireland Cyprus, Spain and Italy. Thus the "Bailout Fund" is in large part being bailed into by those countries actually bankrupt. Talk about the blind leading the blind.
When will this farce end my American colleagues ask? Things have got so bad that two weeks ago the IMF reported that they would no longer contribute to any more ECB bailouts unless radical measures are taken to address the structural problems in the Eurozone. Draghi's presentation on Thursday was in part as a result of this American pressure however, his response was far less than what was expected and accordingly the Euro "crisis" is back on centre stage once again.
Today, Friday, Ireland's most influential newspaper; the Irish Times, had its main economics editor Dan O'Brien reporting that he has raised his probability of a breakup of the Euro from 15% to over 50%. This is mainstream media not some off-world blog. Such articles would not be appearing in premier publications unless the Irish establishment was actually preparing for the possible demise of the Euro.
Across the Irish airwaves other economists were picking up on Mr. O'Brien's comments. They too reckoned the Euro would fall and soon. Jim Power, one of the top economists with an Irish bank, pointed out that the European "model" had failed. He believed like the Irish Times journalist that Germany was walking away from Europe and was deciding to tie in its lot with Poland, Russia and the East rather than the West. Strange times indeed.
Dow Theory Schizophrenia
I have been teaching stock market investment now for over two decades. One of the first modules I present in my course is called "understanding the markets". The main conceptual paradigm I use in this exercise is Dow Theory coupled with Advance/Decline Line (ADL) analysis. In all my time monitoring and teaching Dow Theory I have never experienced such "schizophrenic" technical signals as those charted over the last 4 months.
I am not alone. At the end of April most Dow Theory commentators read a classic Dow bear market sell signal in the technical picture. The Dow 20 Transports had failed to break new highs set by the Dow Industrial 30 and then both indices broke below previous lows. This Dow bear trend had been forewarned by the ADL on the 16th April when the Dow Transports daily moving average (DMA) broke below the 50 DMA. However despite this "sell" signal, markets rallied and the 20 DMA on the ADL broke above the 50 DMA on July 5th. Thus in summary the bulls were killed in April and the bears were slaughtered June/July Thus Dow Theory is not giving the reliable technical signals it is historically renowned for.
In my view the main catalyst behind these confusing gyrations is the Euro crisis. In April the markets were reacting to the confusion surrounding the dire situation in Spain. By June as soon as the crisis appeared to have been solved the markets reacted accordingly. Thus I think it is fair to say that until the Euro crisis is finally resolved, either way, the markets can be expected to give very mixed signals. Markets do not like uncertainty and it is probably only once every 50 years or so that a "doomsday" event like the potential breakup of the Euro Zone appears on mister market's radar.
Major crises spawn major confusion.
The political classes on both sides of the Atlantic should take this fact on board. The last thing the markets want is the current status quo to persist. We do not want 20 years of a stagnating Europe, al la Japan. Germany must decide if it wants to remain benefiting from a 100 billion a year trading surplus with its Euro partners and cough up to Euro bonds accordingly or it should revert back to the Deutschmark. Yes there will be fallout but as with Mexico in the 1989, Argentina in 1990 and Russia post 1991 there is life after default and devaluation.
Such devaluation is exactly what Greece, Ireland, Portugal, Spain and Italy require to recalibrate its sovereign debt balance sheet and make their exports more competitive. History shows that the pain will be hard but it will short and sweet.
America on the cusp of a boom; if only?
The metrics of the American indicate to me that she is on the cusp of a boom once the Euro Zone issue is finally resolved. American companies are the most profitable, competitive and resourceful in the world. In valuation terms they and the stock market had gone nowhere since 2000, particularly when you allow for inflation. In a field of instability the American dollar is by far the most favored currency on the globe and its democratic/political system the envy of the world.
So what's holding America back? What is the catalyst that will trigger this long awaited boom? In my humble opinion the fuse will be lit when, following a Euro Zone resolution (either way), the over 30 year bond bull market finally gasps its last breath. Then and only then will the stage be set for a boom in equities. We are nearly there but not quite. Yes this scenario will involve the raising of interest rates but rates cannot remain at zero forever. When FED policy changes it will be timed perfectly be under no mistake about it. All its ducks will be in a row and when it moves the effect of the American stock market will be substantial.
This demise in the bond bull market will have the potential to create a wealth effect to match the Millenium tech boom. This in turn will influence the American real estate market, making a new secondary wealth strata. This real estate recovery will in turn recalibrate the value of American banks. This recalibration will place these financial corporations in pole position to take advantage of their less favorably placed European and Asian cousins.
In other words I can see American banking institutions "buying up" bankrupt European banks, corporations and state assets. How long will this scenario take to play out? I am not sure but I do perceive the American establishment putting the pieces in place. I believe the City of London has been forced into a political cul-de-sac as a result of the horrendous LIBOR scandal. This will leave Wall Street the pre-eminent financial power house in the world and the dollar the undisputed reserve currency. All this augers well for Uncle Sam. I reckon for America the best has yet to come.
Keep your powder dry and await the technical buy signals which will be breakout high on Industrials, Transports, Real Estate and American Financials. I repeat we are not there yet. I reckon following the September 2012 earnings season the imminent balloting in the American presidential elections will be an interesting time followed by what I reckon will be a watershed year - 2013.
(C) 3rd. August 2012 Christopher
Raise a glass to Robert Emmet, the Irish rebel leader executed on this day in 1803