The markets have been rallying since June 26th when Mario Draghi, the ECB President, announced that the ECB would do “ whatever it takes” (or as Wall Street terms it “will bring out the bazooka”), to save the Euro. Add in the fact that August has been the number one month for the NASDAQ and Russell 2000 indices in election years, and this month’s rally has come as no surprise.
But remember in investing, it is not what you make but what you keep that matters. The following is from Megan Greene, of Roubini Global Economics, and reprinted in John Mauldin’s “Outside the Box” Newsletter.
As usual, this has been a lazy August, but we do not expect the quiet to last. Indeed, for the second September in a row, developments in the eurozone (EZ) have the potential to be highly dramatic.
Greece: The troika is due to return to Athens in September and make a ruling on whether to release additional tranches of funding to Greece. If the troika decides to cut the taps off—and we don’t think it will—then Greece would default and exit the EZ. The Greek government aims to renegotiate the second bailout program when the troika returns to town in September. If the troika plays hardball and does not grant the Greek government any concessions, then the governing coalition would likely collapse. Also in September, the Greek parliament will have to pass a number of measures to generate €11.5 billion in savings for 2013-14. With a high degree of austerity fatigue in Greece, we can expect social unrest.
Portugal: With Portugal starting to slip on its fiscal targets, we expect Portugal to begin negotiations on a second bailout package. Currently, Portugal is meant to return to the markets in 2013 but, with bond yields well above sustainable levels, we regard this as highly unlikely.
Spain: The auditors Deloitte, KPMG, PwC and Ernst & Young are due to present their full reports on the capital needs of Spain’s financial sector in September. The findings of this report will be used to determine the exact amount the Spanish banking sector will need to borrow from the EZ’s bailout fund, the European Financial Stability Facility (EFSF).
Italy: The Italian general election campaign will begin in earnest in September. Although polls point toward a center-left-led coalition, Italian politics is at its most fluid state since the early 1990s and, with so many voters still undecided, it is impossible to call the election.
Germany: The German constitutional court is due to vote on the legality of the ESM (the successor to the EFSF) and the fiscal compact on September 12. We expect the court will deem the ESM legal but, if this does not occur, it would serve a major blow to EZ policy makers, who have committed the ESM to potentially purchasing sovereign debt in the primary markets.
France: The French government is scheduled to unveil its 2013 budget in September. Markets will be disappointed if it does not include large spending cuts, but the announcement of further austerity risks riling trade unions and stoking civil unrest.
Netherlands: A general election is scheduled for September 12. Recent opinion polls suggest the ruling right-of-center VVD will be unable to form a right-of-center majority
government. Consequently, coalition negotiations are likely to be protracted. The left-wing, euro-skeptic SP may win enough votes to be the second-biggest party. This would make it more difficult for the new Dutch coalition to secure parliamentary support for additional support measures for peripheral EZ countries.
Eurozone: There is a progress report on establishing the ECB as a single banking supervisor due out in September. Given that many details have not been hammered out yet, there is a chance that the progress made on this first step toward a banking union will disappoint.
In terms of the broader EZ developments, we expect the Greek government to collapse by the end of the year, and a Greek exit in early 2013, followed by an exit by Portugal by end-2014. Moreover, we expect Spain to receive official support from the EFSF/ESM in late 2012 after the ESM has been fully ratified (the second half of September at the earliest), while Italy will hang on longer but will eventually need support as well.
Add in that seasonally September is one of the worst months for U.S. markets and September could bring back a level of volatility that we have not seen for awhile. While I have been in the camp that just can’t comprehend how Europe holds the Euro together – the amount of money involved is truly staggering, even by U. S. debt and bailout standards, I do think German Chancellor Merkle acquiesces and gets out of the ECB’s way. In other words after a month of haggling, name calling, bluffs, and counter bluffs, the ECB turns on the printing presses before year end. Greece may or may not be invited to the party. But not sure it matters in the medium term.
I have done a 180 and think that even Greece will stay in the Euro. Consider down the road five years if Greece leaves, devalues their currency and now “competes” with the rest of Europe. Shipping costs, one of Greece’s actually industries, plummet due to the devalued Drachma, which revives the glory days of Greek shipping. Tourism is flourishing as it costs have as much to vacation in Greece as anywhere else in the Euro controlled Europe. Wouldn’t Spain, Portugal, Italy, and Ireland all be looking on and reconsider their own Euro status? Just sayin’.
Back to matters at hand. For lots of reasons, including those already mentioned, I think this rally is getting a little long in the tooth. I wouldn’t be jumping in now. Let’s get into September, see if we can find a better entry point, but be ready to invest aggressively in October.
October, November and December are traditionally strong months, especially in election years. If Draghi gets the green light to bring out the bazooka, i.e. print endless amounts of money, the big worry over the market will be lifted. Fiscal cliff will be put off, and China will be priming their pump over the winter. Forget politics, focus on the markets and we could have a strong fourth quarter, but expect things to get worse in order to make them better.
