[dropcap]T[/dropcap]he single biggest thing investors have been waiting for to commit more fully to stocks is strong ECB action on the European debt crisis. This week, they got some of what they wished for. On Thursday, the ECB approved a plan to purchase unlimited quantities of shorter duration bonds from struggling countries in the Eurozone, albeit with many conditions. Stocks rallied accordingly. Treasuries declined on the ECB announcement and continued lower on Friday despite a disappointing jobs report. Gold rose.
S&P 500: 1,438 (+2.3%)
MSCI EAFE: (+3.2%)
US 10 Year Treasury Yield: 1.67% (+0.13%)
Gold: $1,735 (+2.5%)
USD/EUR: $1.282 (+1.9%)
- Tuesday – The ISM manufacturing index fell for a third straight month, coming in below most expectations.
- Tuesday – August US auto sales rose 20% from a year ago, providing a bright spot for the economy.
- Wednesday – Former President Clinton delivered a speech supporting Obama at the Democratic National Convention, stating that America is better off than it was four years ago.
- Thursday – The ECB approved a plan paving the way to make unlimited purchases of sovereign debt, while leaving its benchmark lending rate unchanged at 0.75%. Stocks rallied.
- Thursday – Mr. Obama gave his speech at the Convention, acknowledging challenges but saying that America is on the right path.
- Friday – The Labor Department showed the US economy added 96,000 jobs in August, fewer than most expectations. Unemployment fell to 8.1% as more workers exited the labor force.
Up to now, Europe has taken several baby steps which did little to solve its debt crisis. Thursday’s announcement that the ECB will be able to buy unlimited debt from troubled countries has the potential for a significant lasting impact.
Debt problems are straightforward. They reflect directly on the balance sheet and income statement and are an issue of wealth. A person, country, or region with too much debt cannot live a wealthy lifestyle forever. But the ability to use debt is based only on perception. An entity can continue to borrow at attractive rates as long as investors believe they will get paid back. During this time, the entity has two options: fall deeper into debt or shore up its balance sheet. The ECB may have just presented Italy, Spain, and (maybe) Greece with this window. These nations now have a lot more time to tidy up. Whether they actually clean house remains unclear.
These types of actions do little to solve structural problem and are, in fact, just another way of kicking the can down the road. But there is a big difference between kicking the can a few months down the road and several years down the road. Stock markets won’t sit around waiting for a crisis that may only resurface many years in the future. We saw the start of this on Thursday as global equities rose about 2%. If the ECB action is effective, this could be a small fraction of the gains to come in the next 12-18 months. But this is a big if. There were a lot of conditions in the ECB announcement and it is yet unclear what the real impact will be. Several previous policy announcements from the past few years have failed to deliver the expected benefits. The next few weeks should be telling.