For about two years now we have had a strong pattern repeated several times in which the stock markets in the US and Europe go down on worries over Europe, go up on hopeful announcements of measures to deal with the crisis only to see European leaders under-deliver. Then the markets sell off again.
So far this month, the first two parts of the cycle have pretty played according to script. Will the announcements from the summit late this week be disappointing once again and stock markets around the globe sell off again? I have a couple thoughts on that.
(1) I hate that political announcements from Europe are what largely drive the markets the last two years – it can hardly instill confidence for individual investors looking to earn more than money market accounts that are at basically paying zero interest or even less in the case of annuities.
(2) I think the answer to the question above is yes – the cycle will indeed play out again. The substance of what Germany and France are trying to lead Europe to do is already known and the execution, if successful will take months at least. Even then, the outcome would seem to be “automatic” penalties for member countries having annual deficits larger than 3% of their economic output (GDP). The problem is that these penalties can be overridden by a super-majority vote, presumably weighted so that larger or more stable countries have more votes. The particulars have not yet been announced more specifically.
Since the original Eurozone treaties already had a 3% cap on deficits and I think every country broke them in 2009-10, including Germany and since all were excused, this whole scenario is hardly the long-term reform for which the market is looking. That will come not from political announcements but from the problem nations going through years of austerity and a recession.
Having said that, it is extremely encouraging that yields on Italian and Spanish sovereign bonds have dropped sharply the last few days. Since the ECB has bought few bonds during that time, it may be that political pressure on the banks and a fresh source of funds from the coordinated promises made by several central banks around the world last week are working, at least for now.
On the other hand, high bond yields in Europe have been the primary danger and they are jumping and falling extremely quickly without a lot of visibility as to what is behind the moves. That just adds to investors’ frustrations and inability once again to time any moves.
I have clients slightly under-weight in stocks currently and our income holdings tend to be risk-averse.