Last week’s market action saw the major world averages soar on the rumor that the European Central Bank will orchestrate yet another bank bailout. With many major European banks teetering on the brink of insolvency due to exposure to Greek, Portuguese, Irish, and now Italian debt, the market had been pricing in a systematic freezing up of the overseas financial services sector. There is a strong underlying belief among market participants that the debt issues facing the global economy just won’t go away without significant help from the world’s largest institutions. Namely, a coordinated effort by the Federal Reserve, the Bank of England, the European Central Bank and others (including China). Without this effort, the market is clearly firing warning shots signaling that the game of unlimited growth and development and consumption is in deep trouble. But as I wrote in On the Right Side of the Market back in 2009, there are powerful forces who have a vested interest in the continuation of the current credit-fueled expansion. This is reality.
Let there be no doubt that the U.S. Treasury and the Fed continue to wield a very big stick. That stick was put into full force last week when U.S. Treasury Secretary Tim Geithner stated in his congressional testimony that there is no way that he will let any of our systematically important financial institutions fail. In essence, Geithner has now stated what was before only rumored to be true: there are indeed 12 or 13 banks that are “too big to fail” and they now have the green light to run roughshod over taxpayers, the stock market, their competitors and each other – with no risk to their own survival. Geithner also has been instrumental in convincing european finance ministers that they should offer the same taxpayer-backed bank bailouts as we did back in 2008-09. The results here have been positive (if not politically controversial); EU ministers apparently have agreed.
This is unprecedented, but is born out of the experience with Lehman Brothers back in 2008. Without taxpayer support, these mega financial institutions ARE unsustainable, and now worse, have a tacit blank check from both the U.S. and EU taxpayers.
But back to the markets, I get the feeling that we’re sitting on a powder keg ready to rocket higher due to the continuation of the global bailouts. With continued efforts to keep interests rates artificially low, there really are no alternatives for investors except to increase exposure to the markets. The strong market advance last week is clear evidence of that: once the rumor of the EU intervention got started on Monday afternoon, the markets advanced in 45 minutes what normally would take the better part of a year to accomplish. If the markets can show the ability to hold last week’s gains (which they have not shown over the past two months), several of our short-term trends would improve to the point that we would allocate a segment of our cash horde to equities. ANY bit of good news (or even a hint of inflation) could serve as a catalyst for a sustained advance as the trillions of dollars in cash would be forced to be put to work in the areas that we normally target (equities, real estate, commodities, etc.). We’re eager to participate, but with full knowledge that the game’s afoot and that to win you have to understand the rules, even if they change while you’re playing. The recent market advance is certainly welcome as it is a sign that maybe our economic issues are solvable, or at least manageable for now.