The monster stock rally was kicked off yesterday when the major central banks cut the rate on dollar swaps to ease the funding crisis at European banks. Today, Mario Draghi spoke to the European Parliament and dropped a hint of more to come from the ECB (via AP):
European Central Bank chief Mario Draghi said the 17 countries that use the euro must unify more closely to avoid a repeat of the debt crisis that’s rocked the common euro currency and is threatening the global financial system.
He also hinted that the European Central Bank may play a more pivotal role in the resolution of the crisis, but he insisted that the governments must first back proposals to align their budgetary policies.
“Other elements might follow, but the sequencing matters,” Draghi told the European Parliament Thursday. “And it is first and foremost important to get a commonly shared fiscal compact right.
The world’s major central banks are embarking on another round of money printing and this time its coordinated. China even joined the party by cutting reserve requirements for their banks a mere 8 hours after saying no such thing was required. It appears this is being coordinated by the US as the first hint was a meeting at the Treasury Monday between EC President Herman Van Rompuy and Tim Geithner. Later the meeting moved to the White House where they all met with the President. No doubt, with his re-election prospects hanging in the balance, Obama made a strong case that Europe needed to get moving.
Now today, Draghi is dropping hints that the ECB may be willing to do more if a deal for fiscal union is worked out. If there is an announcement December 9th that a deal on fiscal union has been struck (not a done deal by any stretch), I would expect the ECB to be buying peripheral debt in large quantities by December 10th. So, the question for us as investors is a simple one: assuming all this happens as I’ve laid out, how do we take advantage of it? What do we buy before December 9th?
My first thought is the obvious one – buy gold. But that presents some problems. If the ECB engages in massive QE – and I think it would have to be massive to be effective – what will the Euro do? US adventures in QE have pushed the dollar lower but the Euro rallied yesterday on the cut in the swap rate. Tighter fiscal policy and easier monetary policy might be viewed as a positive for Europe. Even if we knew the Euro was going to fall how would gold priced in dollars react? Gold might rise in Euro terms and fall in dollar terms.
Second thought is to buy European stocks and European bank stocks specifically. The banks would theoretically have the opportunity to offload a lot of their peripheral bonds onto the ECB balance sheet at better prices. That is an obvious positive. But European banks face other headwinds. The new capital requirements might still mean more capital raises for some of them which would probably be dilutive for current shareholders. I think the former would outweigh the latter though.
Another thought is to buy a general commodity index ETF such as GSG. It is already setting up an interesting chart pattern and with easing in the emerging markets + easing in Europe, there might be considerable upside to oil and other commodity prices. Here’s the chart:
That’s about as well defined an inverted head and shoulders pattern as I’ve seen in a long time. A break above 35 would complete the pattern and be pretty bullish.
Another idea would be to buy emerging market stocks since China’s largest trading partner is Europe. Better economic conditions in Europe should be positive for China and therefore emerging markets in general.
Finally, of course, one could just buy US stocks which have been tethered to the whims of European politicians since late August.
So, what, if anything, should we do in advance of the December 9th announcement? There is the possibility – some would say probability – that no fiscal union deal is done by then. The aggressive move is to position ahead of the announcement. The conservative move is to wait and see. What say you Alhambra followers?
Joseph A. Gomez
December 1, 2011 at 5:07 pmWe are facing slowdowns in Europe, China and the U.S. is not necessarily roaring, yet oil is stubbornly holding $100/barrel. If calamity is averted in Europe, I think oil is poised to go higher, a lot higher.
Another attractive option, long-term is gold. It acted very well during QE and QEII. The weekly chart for gold looks strong.
I
Douglas R Terry
December 1, 2011 at 5:12 pmFor me, the probabilities lie with no fiscal union on Dec 9. The issue is extremely complicated and not likely to be entered into lightly. More likely are fiscal budgeting constraints. This seems to be a minimum requirement for additional ECB involvement in the form of bond buying.
Second, I feel the US market is quite comfortable in the short run here around 1250 in the S&P.
So, my opinion is that the December 9th outcome will be positive but not offer the final solution. A combination of a fiscal union and European asset purchases by perhaps China next year will be an all clear signal. Unfortunately, by this time, equity purchases will not be at compelling levels.
From this perspective, I would be a buyer of global equities on weakness leading up to Dec 9. My preference is for US and EM stocks as the European economy will likely face stronger headwinds from fiscal tightness than the rest of the globe.
Douglas R Terry
December 2, 2011 at 10:00 amThe commodities are definitely an interesting sector. There is a good amount of money supply that can spill into the economy, bullish case. There is an argument for a stronger dollar, bearish case.
Also remember that gold is elevated on a relative basis, the flavor of the day for a few years running. Compare Gold versus Platinum, compare Gold to any metal to see this. For bulls I would advocate for platinum and copper.
Oil might be high on a relative basis because of recent Iranian news.
John L. Chapman
December 2, 2011 at 1:38 pmJoe this is a great post and adequately captures the dilemmas facing global investors. I agree with the post above that no fiscal union is likely by December 9, or if one is drawn up it will be akin to the phony Greece rescue packages that have on a few occasions excited markets only to be seen as naked-emperors a few days later after examination.
I think Draghi will conduct a QE type operation regardless of backing from EU governments; the ECB “constitution” and its strictures have already long been violated and are irrelevant. I do not know the details of how he gets around the supposed ironclad operating rules for asset purchases, but the same did not stop the Fed in recent years. The propping up will continue until an inflection point inevitably occurs.
With major world central banks inflating pari passu, commodities as a general matter seem poised for a run. I would think ECB-led inflation of the quantity of money and credit, even if somewhat mild, would be positive for the US dollar and US equities, however temproary this proves to be.
The Federal Reserve’s minutes for its Sept. 20-21 set a record for the extraordinarily pessimistic tone it set in its outlook across 2012. Perhaps it was a case of under-promise in order to over-deliver, but it intimated knowledge of troubles inside EU banks that are slowly being made manifest in the weeks since. Ratifying this, we learn that central bank purchases of gold exploded in 3Q 2011:
http://www.theglobeandmail.com/globe-investor/central-banks-go-on-a-gold-rush/article2239253/. More than double all of 2010 purchases! That is ominous as it can only mean loss of faith in sovereign debt. Gold is a great play right now, given this news — they cannot all be wrong since they are more in the know than anyone else in the global investment community.
.
Perilous times, alas, until the music stops playing, losses are realized, asset prices fall to real relative values, and recapitalization begins. Relatively speaking the US looks fantastic in the years ahead compared to Europe.
Joseph Y. Calhoun
December 2, 2011 at 2:00 pmJohn,
I actually think they will come up with something by December 9th but it won’t be full fiscal union. I doubt that will ever be on the table but they’ll find a way to get something done. Even if they don’t, as you say, I expect Draghi to do something. He can easily justify it as deflation expectations are rising in Europe. Money supply is falling in the periphery so it makes perfect sense from his standpoint to buy those bonds. He’ll justify it as being true to his mandate for 2% inflation.
I have to chuckle a bit on your gold comment though. Central banks can’t be all wrong since they are more in the know??!!! Were they out of the know when they were selling at $250?
John L. Chapman
December 2, 2011 at 6:15 pmYou missed my point. I was not asserting central banks are omniscient; I wrote a piece a month ago quoting Bernanke saying things were just fine in the summer of 2008 and so forth. And I would be interested in seeing a link to the data from 2001 if you have it.
Even so, sales at $250 do not negate what I am saying. For the last few decades, during the Great Moderation circa 1980s-2007, central banks were gradual but consistent sellers of their gold holdings on net. It made sense as long as there was no fear the world was going to blow up; better to hold interest bearing sovereign debt. As we have discussed gold is a lousy investment in an economy exhibiting real growth and a large degree of monetary stability.
What I am saying is, there has been a hockey stick inflection in gold PURCHASES recently, after many years going the other way on net.. Whether that is interpreted as fear of sovereign credit-worthiness or fear of fiat inflation of the set of tradable hard currencies is a separate topic, and may in any case more or less devolve to the same thing. It cannot be interpreted as a good thing in any case.
Ask yourself this question: do the bankers making those purchases think gold will see $1250 first, or $2250?? If your case for optimism is borne out surely the former is true and I hope you’re right. Personally I am afraid I fear the latter is more likely as I have no faith in policymakers to get it right.
Joseph Y. Calhoun
December 2, 2011 at 8:10 pmNo, John. I didn’t miss your point but I think you missed mine. Central bankers should not be acting like investors or speculators but they are now just as they were when they were selling. If the only asset they could hold was gold and the price was falling – indicating deflation – what should they do as central bankers? The answer, of course, is that they should be buying gold to increase the money supply and raise the price of gold. With a balance sheet of nothing but gold, if the price is rising – as it is now – what should they be doing? They should be selling gold and absorbing the excess money. Of course, having allowed the inflation in the first place, one could argue that in the interest of economic stability they should only sell enough to stabilize the price at current levels.
Of course, in a world of fairly free flowing capital, monetary policy is more complicated than that but a rising gold price should be signal to central bankers about monetary policy. To a speculator it might mean something else entirely, but to a central banker rising gold prices now should be just as much a signal as the falling price should have been in the 90s. They ignored the monetary signal gold was sending then and they are ignoring it now. My point is that central bankers are human too and if they act like investors or speculators they will make the same mistakes. I think they’re buying like so many others in the gold market right now because the price is rising. Hockey stick purchases of any asset smack of desperation and rarely end well. What will the central bankers do when the price starts to fall (whenever that is)?
Sorry I didn’t make myself clear.
Joseph Y. Calhoun
December 3, 2011 at 12:27 pmIs it fair to say the consensus is that something will happen on December 9th but it won’t be enough? And that the ECB is likely to do something anyway? If that is what happens, it will be interesting to see if the ECB does something immediately or waits until circumstances force their hand. There might be another down leg to risk assets coming before we get full blown European QE. We’ll find out soon.
Joseph Y. Calhoun
December 3, 2011 at 12:51 pmJust saw this in Mauldin’s weekly letter, quoting from Dennis Gartman:
“Turning to the ECB, the new President, Mr. Draghi, has obviously taken on the most difficult of jobs and we’ve no choice but to admire him for the audacity necessary to take on a role such as his… especially at a time such as this. Yesterday, Mr. Draghi made a statement that we find tectonic-plating-shifting-like in nature when he said firstly that the ‘Downside risks to the economic outlook have increased.’
“They have indeed, and we’ve no problem with what he said for that is indeed the truth. Then, however, the plates shifted when he said, noting that the ECB’s mandate, that price stability is to be maintained ‘in both directions.’ In other words, the ECB’s mandate forces the authorities to be concerned about deflationary risks as well as those inflationary.
“Did you hear the plates shifting? You should have for they have indeed shifted. Draghi’s warning was that the authorities are just as concerned about deflation as inflation and that monetary expansion is to be considered just as has monetary contraction.
“So we are now… or shall soon be… faced with a monetary and political union that is manifestly different than that which the original united nations had signed up for AND we have a central bank intent upon fighting deflation as strongly as it has fought inflation. These are the attributes of a regime intent upon weakening, not strengthening, its currency in order to strengthen the economy and to save the union… if at all possible.”
Like I said in an earlier comment, the ECB will justify further easing over concern about deflation. I think that is fairly significant. The question is whether they will do it quickly enough and whether it will work.
I think this reinforces something John said recently. The Euro is probably going down. That might be the easiest and most direct way by far to take advantage of what is coming.
Joseph Y. Calhoun
December 3, 2011 at 12:55 pmIn that last paragraph, I’m referring to John Chapman by the way, not John Mauldin. Mauldin was a complete flop at managing money so I wouldn’t pay much attention to any recommendation coming from him. Most of the value of his weekly letter is in what he quotes from others.