Wishful Thinking on Economy and Europe Driving Markets

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


U.S. stocks had a major rally on Columbus Day based on the French and German leaders' mystery plan to recapitalize EU banks and on raised forecasts for U.S. economic growth in the second half of 2011. While both news items seemed to contain nothing but wishful thinking, that's often enough for short-term traders.

The Dow Industrials closed up 3.0% and Nasdaq 3.5% on low trading volume. Big moves in the market are more likely when many traders are away and the people who want to move the market know this. Huge rallies under such circumstances are common in severe bear markets. Nasdaq  for instance went up 4.9% on Friday July 5th in 2002 when almost everyone was off on a four day weekend. The market then had an ugly selloff later in the month and an even bigger drop in September and October.

It shouldn't be surprising that "good" news on the economy appeared on Columbus Day. The timing had probably been carefully planned. Goldman Sachs and Macroeconomic Advisers raised their growth forecasts for third quarter U.S. growth to 2.5 percent from about 2 percent and this created the predictable cheerleading coverage from the mainstream media that the U.S. was avoiding a recession. While it is certainly possible that the government will report GDP growth of 2.5% in the 3rd quarter, this does not mean that the U.S. is avoiding a recession, or even that the U.S. isn't currently in a recession. The original GDP numbers at the beginning of the Great Recession weren't that bad either, but they have since been revised down.... again ... and again ... and again. This is how GDP reporting works in the United States. Good numbers are released when everyone is watching and the downward revisions, which can go on for years, are reported when no one is paying attention.

Adding juice to the rally was the news that the German and French had a plan to recapitalize the EU's crumbling banking system. No details of the plan were available however. The lack of information can mean only one of three things. The first possibility is that there is no plan at all or the details are so sketchy that releasing them would make it clear that nothing significant had occurred. Alternatively, there might be a plan that could work, but the chances of getting it approved by everyone involved are close to nil. Or there could be a plan that has a good chance of being approved, but wouldn't be very effective. Regardless, there was no good reason for a market rally from this "recapitalization you can believe in" piece of news.

The EU banking/debt crisis has no easy solutions and will have an ugly ending of some sort despite the mainstream media's constant stream of upbeat "things are getting better" articles. ECB president Trichet admitted today that the EU's debt crisis has become systemic and has moved from the smaller countries to the larger ones.  The rumors of a possible 60% haircut on Greek debt (reported by the Helicopter Economics Investing Guide on Monday and in the financial pages throughout the EU on Tuesday) may even be optimistic. When Luxembourg's Prime Minister Juncker was interviewed on Austrian TV late yesterday about the rumors of a 50% to 60% reduction in Greek debt having to be taken, he replied "we're talking about even more."

A credit crisis can have a devastating impact on the global economy as was made quite evident in 2008. While a case can be made that the monetary authorities have learned how to handle a credit crisis from their recent experience, they have less to work with than they did three years ago. Fed funds rates have already been close to zero for almost three years in the U.S. Quantitative easing has already been done twice in the U.S. and is on its second round in the UK, although it's already run into a glitch there. The BOE refused to buy gilts for the first time ever on Monday because they were too expensive. Maybe money printing isn't the panacea it's supposed to be after all. If not, the global financial system is in a lot of trouble.

Disclosure: None.

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.