When Will the Know-Nothing Rally End?
06/06/2012 4:07 pm EST
For those hoping today’s bounce will be the beginning of a new long run, MoneyShow’s Jim Jubak, also of Jubak’s Picks, reminds us of the impressive list of political and economic challenges to follow in the next couple of months.
So far, this is a bounce on speculation that somebody is going to do something.
That wouldn’t be enough to move global stock markets except that after Friday’s plunge they were as oversold as they’ve been since last November. How high markets will bounce depends on whether or not we start to see something more concrete than speculation as the June 17 Greek election approaches.
Here’s a brief rundown of today’s speculation:
- Optimism that the European Central Bank’s decision today not to cut interest rates makes an interest rate cut in July more likely. The logic here is that the vote today showed a sizable minority of the bank’s board in favor of a reduction in rates now. And that shows that the momentum has shifted toward an actual cut to 0.75% (from 1%) in July.
- European Central Bank President Mario Draghi’s post-meeting press conference was so negative—increased downside risk, more uncertainty, flat GDP, a lack of any economic momentum—that it is being seen as a set up for a rate cut in July.
- Key allies of German Chancellor Angela Merkel are signaling that they would be open to a debt-sharing deal to save the euro under the right rules.
The fact that the discussion is now about the exact nature of those rules has convinced some investors that Merkel will agree to a deal at the summit of European leaders on June 28-29.
The plan might be modeled on plans for a European Redemption Fund that would be backed by the $2.9 trillion in gold held by Eurozone members. Countries would be able to transfer sovereign debt above 60% of GDP to the fund and the fund would be “joint and severally liable” for the debt.
That might be acceptable to the German government, a Merkel spokesperson has said, if “joint and several liability” were changed to “several liability,” which would limit the potential liability of individual Eurozone members. I think here the logic behind the market’s optimism is that if EuroZone leaders are talking about this degree of detail, it raises the odds of a deal.
- Comments by Federal Reserve Bank of Atlanta President Dennis Lockhart after a speech in Florida today that extending Operation Twist “is an option” are being seen by some traders as a set up for Congressional testimony by Federal Reserve Chairman Ben Bernanke tomorrow, in which he might indicate that the Fed will move soon on a new round of quantitative easing.
I think that’s a lot to read into remarks that weren’t significantly different from what Lockhart has said in the past, but Wall Street wants to believe. The Federal Reserve’s Open Market Committee meets on June 19 and 20.
I think the best way to think of today’s bounce is in the context of the kind of event risk calendar that I sketched out in my June 4 post.
After the big sell-off in May and with a very full schedule of events in June that might bring good news, short sellers and bears would think about taking profits on the slightest provocation, I argued. I think speculation like today’s amounts to “slightest provocation.”
The more the markets bounce, of course, the more that full calendar of events starts to become a list of reasons for investors who have made profits on the bounce to sell.
The big unknown for anyone long stocks is, of course, the Greek election on June 17. A victory by the Syriza coalition could lead to a rapid exit by Greece from the euro. Syriza leader Alexis Tsipras said on Friday that he would rip up the austerity deal with the European Central Bank and International Monetary Fund, and restore cuts to the minimum wage, unemployment benefits, and pensions.
Today ahead of a meeting with leaders from the G20 countries, Syriza has been taking a more moderate position. Yiannis Dragazakis, the member of parliament credited with drawing up Syriza’s economic program, said that the coalition was “flexible” and would take into account “daily reality.”
I think that the Greek election on June 17 carries enough event risk that in the short-term it is likely to act as a limit to any bounce. What happens after that date—a bounce or a return to the correction—depends on the result of the Greek vote and the Eurozone’s reaction to that vote.
(And don’t forget the June 11 International Monetary Fund audit of Spanish banks, or the end of June report on the financial condition of Spanish banks from the independent auditors brought in by the Spanish government. Or that the Greek government looks like it will run out of money in July.)