The Thrill of Yet Another European “Plan”

Last week the market started off with a legitimate worry over an extremely slow growing economy and the never ending European issue still percolating. Mid week, the market was totally rescued by comments from the European Central Bank Chief Draghi’s comments saying he will do whatever is necessary to preserve the Euro and we should believe him that it will be enough. Well since the SPX closed almost 50 points higher on Friday than it did on Wednesday, the market evidently did believe him. But why?

The Europeans have had several plans and each one has been received with a very significantly positive market reaction on both sides of the pond, and this has been regardless of what the plan entailed or, for that matter, how many plans had come before it. This is a mentality that I cannot understand. I grew up on the south side of Chicago and, although we did not consider ourselves deep thinkers, it was an environment where a minimum level of common sense was a requirement relatively early in ones life. The simple fact of the matter is if someone when to Plan “B” in the old neighborhood, everyone immediately knew two things: 1) that Plan “A” did not work, and 2) that Plan “B” was not as good as Plan “A” or it would have been Plan “A” in the first place. As of last months European Summit they had their 19th meeting and proposed their 11th plan. By my count, that is Plan “K”, and that was almost exactly one month ago, and we have a 50+ SPX rally on the threat of Plan “L”, a threat mind you, not even a real hard plan that we could evaluate, and we are holding there without even a pullback waiting anxiously to be entertained and rewarded with the actual details. 

Yes, this has been the way to play the market the past couple of years – just anticipate or pile on when any and all central banks were “expected” to print money as the prices of stocks (at least in dollar terms) were expected to be positively affected. However, the economy is slow to stagnant and the earnings growth is falling and is even expected to be negative year over year for the next quarter. Combine this with the fact that central bankers really are being forced to act on their expectations that the economy is further weakening. However, the SPX is up over 1.5% this month on top of the 2.4% gain the last trading day of last month when the last European rescue plan was priced in (that would have been Plan “K”). The plans are failing quicker so now the need come every four weeks but they are anxiously awaited nonetheless.

The shot term guys, especially the professional real time guys play this big time and in fact actually play right into the hands of the central bankers by accentuating and even accelerating the movement and therefore the importance of the announcement. This could be profitable if there is follow through, which to date there has. The intermediate traders can trade this by not fighting it and will profit if there is an extended follow through, which has been getting shorter and shorter and therefore this is becoming much trickier to play. The longer term guys, meaning the real investors – you know – the reason the stock market exists – to raise capital for investment – find this very disconcerting. These investors find the market being raised on short term liquidity issues (i.e. attempts to raise short term market confidence, reassure the market, devaluing the currency, market manipulation – take your pick) that have nothing to do with longer term fundamentals and result in a significant increase in volatility, both of which cause investors to slowly and surely commit less to the market out of confusion and fear. What happens is that they all run with the cash they are still willing to invest to the one area that they hope the volatility will be less – which is now the dividend paying stocks. Long term these may not be bad places to be but like all crowded trades as money is rushing to these like water to the side of a tilted container, they become short term risky. Is AT&T really worth over 20% more than it was in April – even after it wrote a $4 billion check for a totally avoidable management decision to agree to a break up fee for an aborted merger? Could it give that 22% back and still, in the long term, be a good company to own and collect dividends on? What happens in the mean time if this people that now are buying this stock (risk adverse investor that used to own bonds looking for a higher yield) see a 20% short term loss? Not to mention that even dividend paying stocks will not be immune if Plans “L” “M” or even “N” are not successful. 

So, what do we do with this?  The market is now allowing us the following potential opportunity – volatilities are still relatively cheap even in front of very significant scheduled news events. So, now is an excellent time to implement index or broad based ETF put or put spread protection on even your “safe” dividend paying investments.

The assumed safety of the Federal Reserves commitment, the Bernanke put or the ECB’s new pledge that “it will be enough” coupled with the presumed safety of a dividend are rising many boats. It sounds like the beginning of many good stories, however many nightmares start the same way.

Dan Haugh

PTI Securities & Futures

http://www.ptisecurities.com/