My hunch paid off. Investors continued to buy stocks this week hoping that Europe will be able to sort out its financial crisis within the next few weeks. Right now, the markets are in need of a few days of consolidation before breaking higher.
Granted, much of this rally is based on a hope and a prayer. Investors are hoping that the U.S. can avoid a recession. September’s macroeconomic data was surprisingly upbeat. Auto, retail and chain-stores sales were all positive and higher than expectations. The unemployment numbers, although still largely in neutral gear, have seen some marginal gains in jobs over the last month. So far so, good.
Investors are also praying that the latest version of a plan to save Europe (announced last weekend), will actually result in more than just empty promises. The new, new plan will be reveled by November 3rd, according to its authors, French President Sarkozy and Prime Minister Merkel of Germany. Obviously, the German and French leaders are now working to “sell” their plan to the other members of the European Community.
They know, as do investors, that without the entire EU membership behind the plan, it stands little chance of passing. A TARP-like program to recapitalize European banks would be the bare minimum that investors should expect. This week’s drama around Slovakia, the last remaining member of the EU to ratify the European Financial Stability Facility (EFSF), illustrates the still-tenuous nature of Europe’s financial relief efforts.
It took a week and a change of government before the plan was ratified while the financial fate of much of the Western world hung in the balance. With their approval, the new bailout fund will now be able to lend up to 440 billion Euros (up from 250 billion Euros) and also buy government bonds in the secondary market. Investors fear that the EFSF will need much more money (as much as two trillion Euros) to really contain the crisis. There are also questions on just how the bond buying process should be structured.
As part of the “Group of 20” finance ministers meeting in Paris Friday and Saturday, the crisis in Europe will be center stage. A few more tidbits of the upcoming plan of a plan have been leaked including higher bank capital levels, deeper losses for investors holding underwater Greek bonds and additional bailout money. All of this sounds encouraging, but the devil is in the detailed implementation of this package, which must be fully backed by all 17 member countries.
“The hard part is still ahead,” admitted U.S. Treasury Secretary Tim Geithner, who is attending the event.
However, markets have been rallying for eight days on anticipation that a deal will be struck, Europe saved, and the correction that has plagued us all summer will finally be over. So far, the prognosis is good. The internals of the market are encouraging, although we are overbought in the short-term and could use a pullback. Positive breadth, a key variable of most technical analysts, is confirming the recent gains in the market.
A key area of resistance for the S&P 500 Index is 1,220. It is a level where five such rallies in the recent past have met their Waterloo. This week we have attempted to vault that barrier several times only to be thrown back by the bears. I’m hoping that we consolidate around this level, or a little lower, for a couple of days before charging once more into the breach.
If we succeed, the next level will be 1,250. If not, let’s all pray that Europe will get its act together over the next two weeks. Otherwise, I am afraid we head lower and no one wants that.