One of These Things Doesn’t Go With the Others

As I write this note at midday on Veterans Day, the US stock markets are experiencing a bit of a relief rally (bond markets are closed). We think this small bounce is a good opportunity to lighten-up on positions you may not love, particularly in companies that are overly exposed to European demand for their earnings. While Greece and Italy have both found temporary caretaker PMs ahead of elections early next year (a change that I don't think was a good idea – see our last note "The Devils We Know"), they still have some significant issues facing them. Greece is definitely insolvent. (Spain and Portugal likely are as well, but in a global game of kick the can down the road, those issues have been booted forward a few years.) Italy is the focus not because it's debt and deficits are worse than Greece's (they aren't) or that their economy isn't able to produce growth in the future (it is – Italy is still one of Europe's strongest industrial nations, and its products are known for their quality and workmanship). It is the focus precisely because of its size and importance in the global economy. Italy is different. It doesn't go in the same bucket as the others. This article in the FT by Nouriel Roubini reads a lot like our recent posts, and captures the issue concisely – Italy is a problem because the Euro structure prohibits Italy from printing money with which to pay its debts. The US doesn't have this issue because when debt comes due, we can simply "print" (although an electronic debit to the account of the bondholder is the reality) more money to pay it back. Hence, no default. Could the purchasing power of the dollars the bondholder receive be lower? Of course – but that's not a default, that's a devaluation of purchasing power. They have different results near term (longer term, they tend to have the same effect).

So while the markets today like the new caretakers and the possibility of more austerity budgets in Greece and Italy, what these deals are really doing is delaying the inevitable. The austerity programs will actually exacerbate the problem long term, as the economies will shrink from less government spending and higher taxes. There are only 2 solutions (and I apologize for repeating myself lately here, but this is the main issue for the markets): either the ECB becomes the buyer of last resort in unlimited amounts, or the Euro breaks up. Since Germany seems unlikely to support unlimited ECB buying, the Euro breakup becomes more likely, which will roil markets globally when it happens. If Germany changes its tune on ECB buying, then the stock markets will go screaming higher, as the real resolution will be at hand. So monitoring the German mood regarding the ECB will be the key to making the right call on the markets going forward. Until then, enjoy the bounce, raise some cash, and play defense. Have a great weekend.

SPX Levels for today:

Support at 1245/1247, then 1235 followed by 1218/1220.

Resistance at 1265, then 1285 has a lot of resistance overhead.