On the Stimulus-Induced Rally and the European Debt Crisis
Last Wednesday, BNN’s Howard Green spoke to Rob Cox of Reuters and me about two issues: the monster rally from March 2009 and the ongoing European debt crisis.
On the markets, yes, I foresaw a rally two years ago because stock prices were depressed. Back in March 2009, I felt we were in an overshoot to the downside. But, it wasn’t clear whether the bear market rally that was sure to come as a result would have legs. It was only when rules on mark-to-market accounting were implemented and Wells Fargo had a breakout quarterly report in April 2009 that I became a true believer. And the upswing since has been longer and better than I thought likely two years ago.
Remember, it was conceivable in March 2009 that we could have a short rally and then overshoot even more to 450 on the S&P for example. Depression with a capital D was at the door. In the end, I felt the stimulus was going to power us higher. Both Rob and I see the rally as very much a stimulus-driven event. In my view the pre-QE2 swoon followed by another sizable rally post-QE2 announcement makes this case best. The question is whether the rally is sustainable without monetary and fiscal stimulus. We will see in the second half of 2011.
On Europe, you have three problems.
- The ECB’s hawkishness is causing problems for the periphery. As usual a one-size-fits-all interest rate policy is challenging since Europe’s economies are not harmonised. An ECB rate rise will be a big problem in Ireland and Spain where they still have mortgage problems.
- Meanwhile Portugal is getting no relief in the market. It has a fairly low average interest rate on outstanding debts. But as it rolls over debts issued at 3 percent for paper at 7 percent, it will not be able to cut its deficits or debt. A bailout is likely as Portugal’s 10-year rate has been above 7 percent for at least four consecutive weeks.
- Spain is the crucial issue because Spain is such a large economy. Many of Spain’s cajas are insolvent. Solving that issue will be paramount for getting the debt crisis behind us. The stress tests will help us get there but right now they are not particularly stressful and I don’t see them being of any value.
Video below. [Click on image for video]