Insights & Advice

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Promises, Promises

Twice in the last month the stock markets gained well over a percent in less than an hour. Both times the markets had sold off all week only to snap back on any hint of good news. Markets are primed to go higher. All they need is a promise or two fulfilled.

This week the focus was back on Europe, specifically Spain. Investors were once again selling Spanish sovereign debt with yields breaking 7.5%.  Interest rates over 7% in the Spanish government debt market paniced investors, who believe government debt repayments are unsustainable at that level. Italian debt did not fare much better.

The U.S. market sold off in sympathy with Europe’s problems day after day and then Thursday morning the head of the European Central Bank President Mario Draghi spoke. He warned that they “stand ready to do whatever it takes to save the Euro.” He also said that the violent spike in bond yields in recent days was hampering “the functioning of the monetary policy transmission channels.” It was the identical choice of words Draghi had used to justify each of the ECB’s previous market interventions.

Investors are so attuned to central bank speak at this point that the European markets were climbing even before the ECB President was finished speaking. Yields on Spanish and Italian two-year debt dropped 72 basis points in an hour. The stock market in Milan surged 5.6% and the rest of Europe followed suite.

All of this happened before our markets opened. So if you were not invested already (or sold out the day before) by the time you could put a buy order in our markets were already up over one percent. Unfortunately, this is the nature of markets today. The reaction to news is so instantaneous that in order to capture the upside swings, you must stay invested.  Of course, the downside to that strategy is there is little hope of escaping losses if the news is negative on any given day or week.

I warned readers that the markets would remain volatile in the short-term. That has proven to be an accurate prediction. Over the longer term, I believe the trend is up, so stay invested. Try and ignore the short-term fluctuations. Otherwise all you will do is increase your stress level and produce an overabundance of angst which could force you to sell five minutes before the turn. By no means try and trade this market. You will lose your shirt, pants and possibly your underwear.

As for Draghi, his implied promise to intervene in order to reduce government bond yields of the weakest European countries could box him in. On the one hand, he has to deliver or face another sell-off in the markets. But in doing so he could anger Germany, which thinks getting Spain and Italy’s fiscal house in order should be the first priority. Germany’s Angela Merkel is not happy with the ECB’s continued interventions nor are most Germans. They believe that if the EU keeps providing bail-outs that fiscal austerity will never happen.

Once again, bad news is good news back home. U.S. GDP came in as expected—a gain of 1.5% for the second quarter—in line with consensus estimates, but slower than the 2% gain we experienced in the first quarter. When you annualize this economic performance, it amounts to a 1.5% growth rate–far lower than necessary if we want to put a dent in our 8.2% unemployment rate.

That number highlights another promise investors expect will be fulfilled, possibly as early as next week. The U.S. central bank has also promised to intervene “if necessary” if economic growth slowed and unemployment remained at high levels. Friday’s GDP data simply put another nail in the coffin of America’s recovery. The markets rallied in expectation that the Fed’s promise will be delivered. So far it is a market of promises unfulfilled but patience could be rewarded for those who wait.

Posted in A Few Dollars More, At the Market