Yesterday's reactions across an array of markets, from equities to globally traded credits, reminded me of a postgame locker room celebration after little Timmy tossed the game-winning touchdown under the Friday night lights. "That-a-boy" back-slapping was seen by those brave market goers who had been net long, and had worried each time their Bloomberg terminal is fired up.
More revelry came among those finance wonks who collect checks from any of the six governments that agreed to agree on a united response to the ongoing European Union crisis.
Unfortunately, amidst the "rah-rah," an important realization went absent. That is, making dollars cheaper for still-over-leveraged EU financial institutions -- that got too over-leveraged to begin with due to cheap funding -- addresses zero of the fundamental issues plaguing the eurozone. In fact, I wonder if it only makes things worse. Cheaper funding alongside weak growth doesn't exactly scream fertile grounds for risk-takers to swoop in. It sounds like grounds for stagflation.
The fundamental problems that remain unanswered (because nobody wants to drink the hard medicine upfront, in similar fashion to the U.S. on entitlement reform) include the following.
- What is the ultimate role of the International Monetary Fund?
- What is the ultimate role of the European Central Bank? ($274 billion in bond purchases since May 11 is a drop in a bucket that badly needs to be sterilized.)
- What, precisely, are the growth-killing austerity measures that will kick into gear in countries other than Greece? (Italy's are around the bend.)
- What is Germany's ultimate role?
- Do the laws governing the eurozone need to be officially redrawn once and for all? If so, what would a new eurozone resemble?
Many, many questions obviously remain to be answered. The market was akin to a diabetic after last week's malaise -- it badly needed its latest bit of sugar to reenergize itself. It received the sugar, but pardon me if I am a bit skeptical of the sustainability of these feel good pre-holiday tidings. Call it lessons learned from Lehman Brothers. Call it lessons learned from more than a year of this eurozone drip-and-drab news flow. Call it natural analytical skepticism when one talking head after another calls Wednesday's announcement a "game changer." (I'm not a fan of that term, as what we deal with daily in these markets is far from a game.) I will continue to respect the scars gained from the summer of 2007 to the present.
That said, it's important to be creative in how one approaches the market as we head into the end of 2011. Keep one eye focused on near-term trades that are able to ride the positive eurozone news, and the groundswell of favorable U.S. macro data, until each of these waves comes crashing onto the shore. I was asked by a subscriber about banks earlier in the week. If you haven't been nibbling amid increasingly oversold conditions, now would be an appropriate time to stay best in breed with a JPMorgan Chase (JPM). Investment thesis: The eurozone news should have short-term staying power, and the domestic economy is showing more signs of life.
Another focus should be on having short exposure to inferior companies. A quick starting point would be running a screen on which firms have underperformed the market this week and have the fundamentals to support the lagging nature of their stock. Finally, you should also be looking forward into the first half of 2012 -- for a name that could take the market by surprise on reduced earnings expectations and some form of macro catalyst (for example, HanesBrands (HBI)).
I'll end on this philosophical note. When the market closed for the session and the back-slappers left the locker room, I couldn't help but to think of this passage by Burton Malkiel in A Random Walk Down Wall Street:
"Researchers in cognitive psychology have documented that people deviate in systematic ways from rationality in making judgments amid uncertainty. One of the most pervasive of these biases is the tendency to be overconfident about beliefs and abilities and overoptimistic about assessments of the future."