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Sunday, 30 October 2011

Hope versus Economic Reality

How can a Greek DEFAULT  be a success?
Right now, we're seeing much the same global reaction we saw after many of the EU's previous 13 crisis summits: officials are congratulating themselves for doing next to nothing. The media is proclaiming the meetings "successful." So are all stock markets and currencies except for the dollar.

So where's the beef behind Europe's latest news? THERE IS NONE!

Over the next few days, the reality of the EU's hopeless situation will set in with investors. The euro will continue its collapse.

They've had one heck of a party on Wall Street in the past few weeks. The Dow Jones Industrial Average shot up from 10,404 on October 4 through 11,891 yesterday — a gain of 1,487 points in just 22 calendar days.

The reasons I hear most often cited?

HOPE for the mega-bailout in Europe.
HOPE for a mega-refinance plan that will help every beleaguered homeowner in the U.S.
HOPE for a mega-compromise from the deficit "Super Committee."
HOPE that fund managers — who are hopelessly falling behind their benchmarks — will just throw money at any piece of you-know-what stock to try to make up their performance gaps so they don't get fired come January 1.

That's a big heaping of hope, as far as I'm concerned. And unfortunately for the bulls, hope is now colliding with reality — and not in a good way! That tells me we're due for more losses ... possibly very soon!

Let's start with the bailout talk from Europe. The latest market hopes, based on the European Union summit we had this week, are that European banks are going to take 50 percent haircuts on their Greek debt ... that the 440-billion euro European Financial Stability Fund will be leveraged up to 1 trillion in a couple of different ways ... and that banks will be backstopped with around 100 billion euros in additional capital.

That all sounds good on the surface. But when you look at the action in the European BOND market, you see that real-money investors just aren't buying the happy talk! They apparently don't believe European politicians can afford to do what they say they can do!

Do you want a brutal dose of reality? Do you want to know why European officials have met 20 times this year alone — and STILL failed to come up with a bailout that actually works? Italian 10-year yields have surged up toward 6 percent again, closing in on the highs they set several weeks back. Spanish and Portuguese yields are also climbing. And the difference between yields on French and German debt just exploded to an all-time high. This is all happening AFTER the European Central Bank started buying PIIGS bonds in a futile attempt to prop up their prices and AFTER the outlines of the latest bailout schemes were leaked to the market.

Then here is the reality:

The peripheral European countries are virtually broke. The only way they can survive over the long term is if their debt burdens are slashed dramatically. At the same time, countries like Germany and France can't afford to spend hundreds of billions of euros bailing out their neighbors without destroying their own balance sheets!

Plus, the circular nature of this bailout fund is downright ludicrous! You literally have countries like Italy and Spain borrowing money and putting those funds into the bailout fund ... so it can turn around and spend that money buying up those countries' bonds.

Does that make sense to you? Does that sound like a plan that can actually work over the long term? Bond investors sure don't think so, because the yield on the EFSF's OWN outstanding bonds are climbing, a sign that the fund's AAA status is slowly coming into question.

My take is simple: Please don't rely on hope when it comes to investing. Look at the cold, hard facts and reality on the ground. They suggest we haven't seen the worst for stocks, despite the recent rally, and that caution remains your best investment bet!