What to buy when investors lose faith in the latest bail-out
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David Stevenson Sep 16, 2011
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The eurozone has been saved again. Or so it seems.
Yesterday, central banks rode to the rescue. A 'co-ordinated intervention' will be now be plying the markets with huge quantities of dollars.
Since share prices love to see extra cash turn up, stocks went bananas on the news. The FTSE 100 index jumped by 2.1%, the Dax flipped up 3.15%, and the S&P 500 climbed 1.7%.
So what does this really mean? And why do we feel uneasy about it?
Central bankers launch yet another bail-out
Here's the gist of what was announced yesterday.
The US Federal Reserve, along with the European Central Bank, the Bank of England, the Bank of Japan and the Swiss National Bank are – all together now – going to supply banks in the eurozone with extra dollar loans until the end of the year.
What's behind this? The immediate concern was that we might have been heading for a repeat of the Lehman Brothers collapse. As we wrote about earlier this week (How a Greek default could hammer global markets), a number of European banks – French ones in particular – have big short-term funding needs. That means they have to borrow dollars in the money markets.
The problem is that these markets have been freezing up. Counterparty risk has been kicking in. In other words, lenders have been becoming more fearful that they won't get their money back when they need it. So they've been more reluctant to make loans. That's pushed up the price – ie the interest rate – of the loans that they do make.
That's been nasty for French banks short of cash. It's one reason why the likes of Société Générale has seen its shares drop by more than 50% in the last ten weeks. So to try to relieve these money market strains, the central bankers are handing out more cash. In effect, it's another form of bail-out.
"The central bank co-ordinated action is rather significant", Brian Jacobsen at Wells Fargo Funds Management tells Bloomberg. "We can take a little confidence in knowing that when money market funds or banks are unwilling to expand liquidity to each other, central bankers are willing to step in and fill that void."
And the way equity markets responded yesterday, you'd have thought the eurozone's problems were behind it.
Lead indicators for Britain's economy
This is another sticking plaster
The trouble is, this looks like a classic example of 'extend and pretend'. In other words, the authorities are simply trying to plaster over the cracks in Europe's financial system.
It doesn't tackle the real problem in the eurozone. Which is that Greece is bust, full stop. So is Portugal. Ireland may not be in quite such bad shape, and has more reason for hope about the future, but all three have already needed bail-outs. Without these, they'd have had the bailiffs on the doorstep months ago. Meanwhile, the finances of both Italy and Spain are looking increasingly iffy.
In turn, big trouble is storing up for the banks that have lent money to all these countries. As fears of the latter defaulting have grown, the value of their sovereign debt has slumped. (Which has caused the yields on these bonds to soar – you can check out the daily details here).
This means the banks holding this debt will have to make massive write-offs on it, sooner or later. That will leave some huge holes in their balance sheets. Estimates vary as to how big these will be. But as we've already noted, Deutsche Bank chief Josef Ackermann warned last week that many European banks wouldn't survive if they had to write down all their sovereign bond holdings to current market values.
The US dollar comeback looks set to continue
What does this add up to for investors? To sort out the bad balance sheets of all the eurozone's banks would mean bail-outs on a scale never seen before. It's impossible to predict how it will all play out. But despite what happened yesterday, there's still a good chance it could all end in tears when a euro-area country finally defaults.
Certainly, as my colleague Merryn Somerset Webb has suggested, there's a high likelihood the ECB will start printing lots of euros to try to fund the ultimate bail-outs.
At the very least, then, this is set to be a very tricky – and confusing – time for investors. Stock markets are likely to remain ultra-volatile. And currency markets are likely to be very jumpy indeed.
But there could be one saving grace here. A bigger supply of euros around would be good news for one currency - the US dollar. And that points to one potentially good investment area.
In this week's magazine cover story, we examine what's going on in the global currency markets. We also look at a number of stocks that would get a boost from a stronger buck. (If you're not already a subscriber, get your first three copies free here.)
Our recommended article for today
Investing has changed radically over the last few years. Electronic trading and instant communication mean shares can be bought and sold in a matter of seconds. But rather than being a good thing, all this could make a serious dent in your profits, says Tom Bulford.
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