The Stock Market’s Next 1,000-Point Move
Oct 25, 2011
Stuart Varney, host of the aptly named and very highly rated “Varney & Co.” program on Fox Business, put the following question to me in his usual direct style: “Will we have an agreement on Wednesday out of Europe and what will that mean for the markets?”
Yes, I began, we probably will – but for all the wrong reasons, and it will never last.
There are three reasons why:
1. You have 27 nations that now have to agree to review what, in effect, is the treaty that holds the European Union (EU) together. That’s not conducive to anything even remotely resembling quick decision-making.
2. What’s happening in Europe is much the same thing happening here, in that the debt situation has become government at the people rather than for the people or even by the people. That means politicians are still smoking in bed while the house is burning.
3. They have to say something to avoid contagion but that’s already baked into the cake if you examine the cost of credit-default swaps (CDS). The data suggests traders are now turning their crosshairs on Italy, Portugal and Spain even as leaders work towards a solution. So recapitalizing the banks to the tune of a few hundred million euros is but a one-shot deal; the continued thing to focus on is the near-complete lack of fiscal discipline at the government level.
The bottom line: This is not over by a long shot. In fact, I expect it to drag on well into next year.
Still, in the short-term, the next 1,000 points the market moves in either direction are going to be the direct result of whatever “solution” comes out of Europe tomorrow (Wednesday).
The better we understand this situation as a nation and as investors, the better off we’ll be.
A Misguided Mission
At issue is the very nature of the “recapitalization.” The fact is Europe’s debt has gotten to the point that it can no longer be sustained.
Much like our own debt situation here in the United States, there are many causes, including completely incompetent government, irresponsible decision-making, feckless leadership and paltry economic growth.
Citizens on both sides of the Atlantic understandably have had enough.
But the problem is that the policies that led Europe to this point were decades in the making. So it’s unreasonable to expect them to go away any time soon even if the EU announces a solution on Wednesday.
Furthermore, the use of comparatively healthy public balance sheets to shore up irresponsible banks and speculative trading houses is a big mistake that removes the free hand of risk that is a required element of capitalism.
Now, this could come to a quick resolution – if the politicians would stop their meddling. Yes, companies would fail, banks would fail, and the markets would take the brunt of it on the chin.
But – like Iceland, which fabulously ignored international advice and undertook a complete reboot – the sooner we take our medicine, the sooner we can begin healing.
It’s not too late, but whether it becomes too late is a question for the world’s central bankers and policymakers who have yet to become serious enough about what’s needed.
The Downward Spiral
Barring any sort of massive economic growth, neither the EU nor the U.S. can make a dent in the debt cycle and the stuff eventually will hit the fan.
When it does, there are four ways out:
1) Default. This lets the markets take care of the deleveraging process for politicians and by far would be the messiest alternative. Yet, in a way it would be the cleanest, since it would wipe out decades of ineffective policies while also cleaning the financial zombies up once and for all.
2) Austerity. I put this in the “yeah right” category. If tiny Greece, which accounts for about 2% of the EU, cannot do this without riots, imagine what will happen when the reality of sinking pensions, diminished benefits and higher taxes hits home in the world’s primary economies. Nobody will be singing peacefully around the Occupy Wall Street campfires. Not in Paris, not in London, not in Berlin, and not in New York.
3) Repression. Mohammed el-Arian of PIMCO notes that America is intensifying repression by keeping interest rates low for an exceptionally long period of time. He speculates, as do I, that the U.S. Federal Reserve will attempt to engender unanticipated inflation. Call me skeptical, but this won’t work. It has never worked throughout history and will not work now.
4) Growth through redistribution. Government stimulus is really an involuntary redistribution of wealth from the private sector to the public sector. New taxes, lower budgets and more failed government investments like Solyndra are all part of the terribly misguided policies we will have to endure. But until politicians are completely backed into a corner by unruly mobs, they will continue to order up.
Which course we end up taking is yet to be seen. But I do know this: Whatever comes out of Europe tomorrow will directly affect the markets to the tune of 1,000 points in either direction.
As investors, our most prudent course of action is to shield ourselves from the fallout.