Sell Risk into the Know-Nothing Rally

10/12/2011 10:30 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Investors betting heavily on expressions of political support are likely to end up disappointed, writes senior editor Igor Greenwald.

The fix is in, so the risk trade is back on. Across the planet, plunge-protection teams are making sure next year’s elections bring the desired continuity in government.

In this script, the losses of August and September were merely a pricey alarm clock that woke policymakers to the dangers of inaction. Properly motivated, they’ll give the markets what they want if only because the alternative is more protesters in the streets, and that lot is oh so hard to satisfy.

So, the best plan for saving Europe turns out to be to have the leaders of Germany and France swear bilingually that this chore will get done, and soon, while hoarding the details that might let critics pick apart the how.

If you simply must know how the $400 billion-euro rescue fund not yet approved will stretch to cover big-bank shortfalls and sovereign debt markets many times its size…well, OK. The German insurer Allianz is said to be developing a plan to turn it into a bond-insurance scheme, with the protection terms jiggered as need be to keep selling the debt of the overly indebted countries.

Feel better? I thought not. A lack of specifics is a feature, not a bug, in these treacherous times. Better to just take Angela Merkel and Nicolas Sarkozy at their word that they’ll figure it out over the next month. If European Union Commissioner Olli Rehn says the debt crisis can be resolved, that’s good enough.

The same dynamic is in play in China, which closed down for a week-long holiday amid talk that its property bubble was about to burst, talk backed up by signs of financial strain and a plunge in copper prices.

When markets reopened, Shanghai stocks promptly sank to a two-year low. But then a government investment fund started buying shares of the big Chinese banks, fueling a turnaround that pushed Shanghai 3% higher overnight.

The Chinese leadership is due for a cosmetic makeover next year, just like its counterparts in the US and France, and doesn’t fancy playing musical chairs amid popular unrest. Beijing’s market intervention has stoked hopes that the credit crackdown—implemented to keep prices in check—will now be relaxed.

Even in the US, cursed with a divided and dysfunctional government, there are reasons to hope for official help. The Senate’s rejection of President Obama’s jobs bill last night was a necessary pantomime setting the stage for piecemeal consideration of the elements that enjoy bipartisan support, such as tax cuts.

The congressional supercommittee charged with forging a long-term fiscal compromise by Thanksgiving has every incentive to avoid the alternative of sharp defense cuts and the expiration of temporary payroll tax breaks come January.

Better still, the gloomy sentiment that has stoked recession fears is being challenged by more recent signs of stability in other indicators of economic health.

Unfortunately, time might not be on investors’ side. A few more “better-than-expected” jobs reports like the one last week will mean a few hundred thousand more among the millions of the unemployed will become unemployable and discouraged.

Jan Hatzius, the chief economist at Goldman Sachs (GS), warned recently that stagnation in personal income, like the one we’re currently seeing, is a bad sign for the economy’s prospects in the fourth quarter and beyond.

It takes time for growing pessimism to worm its way into the production chain and spending habits. The National Federation of Independent Business reported a minor uptick in its monthly sentiment survey of small-business owners Tuesday, from suicidal to merely deeply depressed. But that was still an “ugly” number consistent with a recession, the poll noted.

It’s worth remembering that it will take a heroic amount of political horse trading merely to avert federal cuts that would impose ill-advised austerity by default if no deal gets done. And, of course, state and municipal governments will continue to swell the ranks of the unemployed regardless.

Markets like to climb walls of worry, but this one seems to be counting pretty heavily on competent support from the same governments that had it down 20% and in freefall as of a week ago. It’s also written off recession as a realistic danger. That seems premature.

A week ago, no one wanted to own risk. I’d sell some here now that there are buyers chasing it.

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