The first week of November the markets had a feast of Greek dolmas (stuffed grape leaves). Greece appeared to be in a meltdown only to be revived at the end of the week. Last week the markets dined on cannoli as the collapse of the Italian bond market moved the crisis from Greece to Italy. In both cases, a change in leadership temporarily caused the markets to surge and recover the big losses that started each week. We now have two new leaders in Greece and Italy who will ultimately prove just as ineffective as the two ouster premiers. When debt problems are so overwhelming and the structural flaws of the political and financial systems are so deeply embedded it’s just a matter of time before the endgame must be played regardless of the quarterback. Once again it appears the endgame has been delayed until 2012. But with the rapidly moving scenarios playing out across Europe, the opening whistle to the endgame could blow at any time.
What’s ahead? It’s clear that no one knows. While the markets celebrated the end of the Berlusconi reign, there is no guarantee that the bond market in Italy will cooperate. The plunge in prices in Italian bonds was arrested by the change, but the debt of Italy remains in a very fragile state. The conditions that caused the bond debacle are still present; only the name on the Premier’s office changed. Unfortunately, even if Italy and Greece manage to avoid further disruptions for a few weeks, Spain could be next in line in the unlimited buffet of debt problems in Europe. The debt of Spain has been trading better than that of Italy, but the Spanish bond market is following the same pattern as Italy’s. In fact, some of the concerns about the true nature of Spain’s banking system (with potential losses unaccounted for) are more troubling than those in Italy. Tapas might be next on the menu.
The perplexing aspect of all of this is that the stock market in the U.S. is virtually unchanged on the year. While it’s always possible that the European debt crisis will be solved in an orderly fashion, it’s also not realistic. At best, the various components of the European Union bailout plan will result in a recession in Europe that will have be a drag on the global economy. At worst, the debt fiasco will end badly and result in a few weeks of market chaos and then a global slowdown.
As I’ve mentioned in the prior weeks, Wall Street traders, et al, just want to end the year in rally mode in order to bank some more bonus checks. To most of us, logic would dictate a cautious approach with some many unresolved issues ahead, but that’s just crazy talk on Wall Street. The 3rd quarter was a terrible quarter for Wall Street and especially hedge funds (big accounts that take big risks with borrowed money). Most of us would be reluctant to take on more risk after that experience. But these guys play a different game – big risk for big reward. There is no middle ground. What some recent numbers and anecdotal information have revealed is that hedge funds actually ramped up risk after that the 3rd quarter debacle. Wall Street mavens are saying that the market has taken on all the bad news and remains unshaken, and this means the market is a “buy.” Perhaps. But, it could also mean that the market is an illusion if not delusional and not at all reflecting any future outcome other than the optimal.
While Europe has been and will continue to be the dominant force, our own economy continues to chug along at a sluggish pace. We should get more evidence of that this coming week. You will be reading about Housing Starts, Retail Sales, Industrial Production, and the Consumer Price Index. All of these should reflect an economy that is cautiously moving ahead. As mentioned in last week’s column, businesses are being cautious in these uncertain times. The pace of economy and level of business and consumer confidence reflect more an appropriate response to the events this year and the risk ahead. Wall Street’s throw-caution-to-the-wind attitude is fine for the big, short-term risk takers, but that attitude doesn’t work for those in it for the long haul.
For some of you the last few weeks (months) of volatile trading has led to several bouts of indigestion. As I’ve said before, the real test of whether or not you have the right investment mix is whether you can sleep at night. It’s really hard to get a good night’s sleep if you have indigestion. Delusional or not, the market continues to give you opportunities to think long-term about your needs and whether or not your current investment profile is really right for you. Eating at an all-you-can-eat buffet when your system can’t handle it is bad for your health.