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Second Greek Bailout May Not Stabilize Markets

 September 19, 2011 07:57 PM


Financial markets tend to get fixated on a small number of issues, which often leads to questionable decision making for investors. It is important to look at a scenario where the second Greek bailout package is approved. The immediate question for the markets would become, "Now what?" The odds are fairly low approval of the second bailout will stabilize the bond, currency, and stock markets for an extended period of time. The excerpts below shed light on this concept:

The Economist – September 17:

The latest, inadequate plan for a second Greek bail-out, agreed at a summit in July, should be thrown away and rewritten.

[Related -Dry Powder Doesn't Pay]

National Public Radio (NPR) - September 12:

Juergen Michels, chief eurozone economist at Citigroup, says the size of the European rescue fund will very likely have to be increased. He says talk of eurozone defaults in the next year or so is simply realistic. "We'll probably also have to see defaults," Michels says. "Greece, at the end of the day, is likely to have one, and it's also likely to happen for Portugal and Ireland."

Wall Street Journal (WSJ) – September 19:

But even if Greece gets its money in October, it may only postpone the reckoning: Its budget deficit this year is likely to be 10% compared with a target of 7.5%, says Citigroup. And Athens has barely started on a promised privatization program. The market is convinced the Troika—the name given the team of officials from the International Monetary Fund, European Central Bank and European Commission—will ultimately have to admit that Greece won't meet its targets. That would pave the way for a default and coercive, rather than voluntary, debt restructuring.

[Related -ADP: US Private-Sector Jobs Rise 190k In August]

We will maintain a bearish bias until fundamental (mainly Europe) and technical conditions improve. If the S&P 500 breaks below last Monday's low of 1,136, we would consider adding to our deflationary/bearish stance, which includes bonds (TLT), the dollar (UUP), gold mining stocks (GDX), and a short (SH). As covered in the video below, stock market technicals were raising some yellow flags as of the September 16 close, even before the near waste of time weekend meetings in Europe.

When Bloomberg noted investors have pulled more money from U.S. equity funds since the end of April than in the five months after the collapse of Lehman Brothers, it reinforced our "run for the exits" concerns from September 1:

We believe the psyche of investors is on the verge of reaching a tipping point, which could cause a very rapid decline in asset prices. It is next to impossible to know if and when they will reach for the sell button in unison, but the risk for such an event is elevated and must be considered in all portfolio management decisions. Stocks dropped 34% in twelve trading sessions in 1987. High volatility occurred before that drop, indicating an increased willingness to run for the exits. If you have not noticed, the markets have been volatile recently. An "Oh, my God" type event is difficult to predict, but the conditions are in place to make for an interesting next few months.

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