Can Europe's Debt Problem be Fixed?Dec 09, 2011
For over two years financial leaders have been trying to “fix” Europe. However, every Band-Aid has fallen off and the situation is only getting worse. Is Europe fixable or should we get use to an ever-worsening investment environment?
There is no reason to be concerned about Europe’s financial crisis anymore.
In a phone call on Wednesday, President Obama and German Chancellor Merkel agreed on the importance of a “lasting and credible solution to” the European debt crisis (according to the White House).
With over two full years of the Greek/European debt spectacle in the rear-view mirror, I think it’s safe to say that the chance of reaching a “credible” solution has passed.
Bury Denial Before Looking at Quick Fixes
The recent years have only proven two facts, simple but far-reaching:
1) Politicians and government/financial officials always under estimate the full scope of financial problems (domestically and abroad) and are unqualified to render accurate assessments.
To illustrate, here’s what Greek Finance Minister Yannis Papathanassiou said in June 2009: “Our goals are specific and clear: to reduce the deficit below 3.7% of GDP and to ensure the credibility of our country in the international market.”
Here’s another one from Greek Prime Minister George Papandreou spoken on October 27, 2011: “The debt is absolutely sustainable now. Greece can settle its accounts from the past now, once and for all.”
2) Politicians and government/financial officials can’t tame the equity markets.
The chart below, courtesy of the Wall Street Journal, plots the 10-year government bond rates of different euro-zone countries against various efforts to keep the damage contained. In short, it hasn’t worked.
Stay Away from Euro-Kool-Aid
The ETF Profit Strategy Newsletter refused to participate in the financial yo-yo European governments subjected investors to. Here are a few excerpts from past issues:
December 17, 2010: “Europe's bourgeoisie has been trying to one up each other on assertions that the worst is behind us. Eventually a chain reaction will get the dominos falling.”
January 14, 2011: “The front page of the Financial Times declared: "Rally points to 2011 cheer." Over-confidence rarely bodes well for stock prices, especially against a backdrop of serious fundamental problems. It appears that around current prices would be a good opportunity to scale down exposure to Europe and add some short positions.”
May 20, 2011: “Things in Europe are much worse than anyone will admit. Thus far they've held their house of cards together but the vultures are circling. The debt problem of sovereign European countries has, or is, about to turn into a dept problem of super- sovereign entities. The IMF and EU swallowing up massive amounts of debt has not eliminated debt, it has merely re-shuffled and concentrated it."
July 15, 2011: “The high reward, low risk trade would be to go short EFA (NYSEArca: EFA) or EEM (NYSEArca: EEM) with a stop loss just above the 200-day. Corresponding ETFs are Short MSCI EAFE ProShares (NYSEArca: EFZ) and Short MSCI Emerging Markets ProShares (NYSEArca: EUM).”
What Are Europe’s Options?
Europe’s problems are too vast to explain in a few paragraphs. The single biggest hope was that the European Central Bank (ECB) would print money used to buy bonds of Greece, Italy, Spain and the like.
This hope was squashed by ECB’s decision not to increase its bond-buying efforts. Not only that, Mr. Draghi, the ECB’s president, also ruled out using the International Monetary Fund (IMF) as a conduit for bond purchases.
The eurozone did get help from the Federal Reserve’s re-authorization of foreign currency swaps on November 30. This doesn’t increase the amount of Euros in circulation, but it adds liquidity to the eurozone.
The ECB also threw something else into the liquidity pool, lower interest rates. While we know that there will be ripples anytime something’s thrown into the liquidity pool, I doubt that the ECB and Fed’s current efforts amount to the cannonball proportions seen during QE2.
Forget About Europe!
Forget about Europe! That seems like a drastic idea but it’s not that impractical. In fact, take a moment and think about the effect of Euro news on your investment decisions.
On October 27, Euro leaders announced a comprehensive fix to the Euro crisis. Here’s the media’s advice from that day:
Breakout: “Don’t fight the rally; stocks soar after Europe deal
Forbes: “Europe’s three-point debt salvation plan sets bulls free”
Reuters: “Wall Street soars on hopes EU finally has a fix”
Over the next month the major indexes a la Dow (DJI: ^DJI), S&P (SNP: ^GSPC), and Nasdaq (Nasdaq: ^IXIC) lost about 10%.
The right time to buy was at the beginning of October, not at the end. On October 2, the ETF Profit Strategy updated stated that: “Even though October has hosted some ugly bear markets, it has also killed its fair share of bear markets. I don’t think October will 'kill' this bear market, but it should spur a powerful counter trend rally. From a technical point of view this counter trend rally should end somewhere around 1,275 – 1,300. The ideal market bottom would see the S&P dip below 1,088 intraday followed by a strong recovery and a close above 1,088.”
On October 4, the S&P briefly dipped to 1,075, closed well above 1,088 and went on to rally more than 200 points in less than a month. The Vanguard Europe ETF (NYSEArca: VKG) soared as much as 26% in 18 trading days.
The upside target has been reached and the S&P looks tired. This doesn’t preclude another spike; in fact seasonality would support higher prices next week.
However, regardless of what happens in Europe, the risk remains to the down side. If the S&P falls through support, prices are likely to slice to new lows like a hot knife through butter. If support holds, the S&P is likely to team up with positive seasonality and push to the revised upper target range.
Focusing on the information that counts (and tuning out misleading noise) is the key to successful investing. Important support/resistance levels outlined by the ETF Profit Strategy Newsletter earlier this year included 1,369 (in May) and 1,088 in October.
Being aware of such key support/resistance levels is almost like “insider trading” because it provides a sneak peek into the market’s inner workings. Due to the fast rally from the October and November lows, there's little structural support beneath current prices.
Today's ETF Profit Strategy Newsletter identifies the one support that must hold to prevent another waterfall decline along with a short, mid and long-term outlook for stocks, gold (NYSEArca: GLD) and silver (NYSEArca: SLV).