Mon, 10/24/11 3:03 PM – Waiting on the Wednesday Euro Summit

U.S. stock markets were only up 1% last week as a 2% Friday rescued what had been a down week. Friday’s rally has carried into today with another 1.2% gain.

It’s a sign of how long things have been volatile when a 1% week is ho-hum. That’s a 52% annual pace.

Last week we waited on the Sunday European Summit but that only produced rumors of progress and the date was set back to another European meeting set for Wednesday.

Rumors have it that rather than go through a messy default, European banks will be forced to take a 40%-60% writedown on the value of their Greek bonds. Some banks can do that without raising extra capital from stock and/or bond offerings and some can’t. The next question logically, is how much is needed to support banks outside of Greece and figures of anywhere between €100 billion – €440 billion have been offered.

Then there is the issue of the Italian and Spanish bond markets, mostly the former. Italy has not put in place the austerity measures they have been asked to and the rest of Europe, notably France and Germany are really sore about that because actually, Italy is a much bigger problem than Greece though it has had a small fraction of the media exposure.

Different versions of getting more mileage out of the European Financial Stabilization Fund (EFSF) are being discussed and one or two will likely be decided on shortly.

These are big problems with big costs, probably €1.2 trillion and parties have very different strongly held positions on how to solve it.

The market wants to hear an announcement Wednesday that (1) addresses all three areas, (2) forces a writedown of 50% on Greek bonds and (3) leverages in some way the EFSF from €440 billion to a minimum of €1 trillion but preferably €2 trillion with some sort of guarantees on Greek and Italian bonds at least. If the market gets its way, you should see a jump of several percent on European and U.S. markets the same day with more to follow.

To the extent the announcement falls short we should see a sharply lower market. I really doubt it will trade sideways for a few days after.

So, place your bets now because the move in stock prices will likely start a few minutes before the actual announcement and much of the movement will likely occur in a matter of minutes.

I’m sticking with pretty normal allocations to stocks, low allocations to bonds and looking for a spot to buy more gold.

Of course, Europe is not the only issue on the table, the recent unexpected pickup in economic data weighs in and so does the slowdown in China which some fear could get out of hand. Lots of problems there are being masked. But for now, the focus is on Europe, especially since investors feel a little better about the U.S. economy lately.