A European Hope Rally

The big catalyst helping stocks enjoy a huge surge last Friday was the deal reached by European Union (EU) leaders to effectively bailout troubled banks. That day, the market woke up to news that EU officials had agreed to allow the European Stability Mechanism (ESM) to directly recapitalize banks, rather than having money flow through the sovereigns. The EU also declared that funds received from the ESM would not be senior to existing debt, removing a major concern for bondholders. Yields on Spanish and Italian debt fell on the news.

 

 

The deal does provide some relief for the strained system, at least in the short term. In the long run, I have serious doubts about this latest “save” for Europe. You don’t cure a debt problem with more borrowing, and there is little hope that bailing out European banks will stave off recession in the region. The fact is the slowdown in the Old World has already reverberated throughout the rest of the world, particularly China. That nation’s economy continues to slow, and that slowdown continues to put pressure on international and emerging market equities.

 

Until the European issue is off of the table for good, any rally in Europe is more hope-based than reality-based. I am looking for more euro-induced selling throughout global equity markets in the months ahead. So, whatever you do, be very careful out there.