14th APRIL 2008

The Euro: a soft currency with a (temporarily) hard image
Longer-term negatives could soon become short-term issues

The main reason we think the tipping point is close to being reached is that Spain and Italy are facing big economic problems, and we don't think the governments of these countries will be content to accept the ECB's relatively tight monetary stance for much longer.

On a longer-term basis, the unfunded government liabilities issue that confronts Italy today will confront both Germany and France within the next several years. It's an issue that governments will almost certainly want to 'solve' via inflation, because any genuine (viable long-term) solution would entail considerable short-term pain. It therefore looks like some current EMU members will opt out of the euro in the not-too-distant future. Either that, or the ECB will jettison its inflation-fighting image and begin operating in a way that makes the Bernanke Fed appear tight-fisted.


The stock market's 'prescience'

GE is probably the most widely followed stock in the world, yet the market and the many analysts that follow the stock weren't able to anticipate the CURRENT quarter's earnings (let alone future quarters' earnings!). It seemed to come as a complete surprise that GE, the largest financial services company in the US, was being hurt by the credit crisis.

- There will be more negative surprises as first quarter earnings are reported over the coming fortnight, but because sentiment is already at such a depressed level the market will handle these negatives rather well

- The market will begin to rally based on the belief that the bad news is already factored into stock prices and that things will improve during the second half of this year - Some time over the next couple of months the market will reach the point where it is discounting a rosy future, but then it will begin dawning on investors that Q1-2008's earnings were nowhere near the bottom of the cycle

- A 6-12 month downward trend (the next bear-market leg) will commenceThe stock market is likely to hit bottom many months before the economy hits bottom. This is because the extrapolation of bad news will eventually cause stock prices to fall to where they have discounted the worst. However, it would be very unusual, perhaps even unprecedented, for the market to bottom before a recession is widely acknowledged (at the present time there is still a lot of discussion about whether the US can AVOID a recession).


Further to the above, there's a good chance of the current rebound continuing until sentiment has become bullish/complacent enough to push TIBS up to at least 25.
posted by Dil at 1:25 PM