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:
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?