We imagine that a significant phone call occurred 11/29/11 between the central bankers from the U.S., Switzerland, U.K., Japan, Canada, and Europe. The first five are going to provide needed liquidity to help the sixth, and send a message to the world. The short-term financing market that banks rely on had dried up for European banks. The first five of these central banks agreed as a group to provide low cost liquidity; sending a message that it is safe to fund European banks. These five national central banks are the same ones who have been supportive of Quantitative Easing (QE) as a tool to spur economic growth worldwide.
This coordinated effort to strengthen the banking system of Europe when it runs into a funding problem is essential for markets to regain confidence. Is it hard to imagine that they will do the same thing should Quantitative Easing be needed in the future? No. It is obvious to us that this will be the choice of the world’s central bankers should the banking system run into trouble again.
Remember that the U.S. Federal Reserve alone provided over $7trillion of liquidity during the U.S. banking crisis of 2008. It has been reported that on one day alone the Fed provided $1.7 trillion. Clearly, the entire Euro zone needs less than $7 trillion in support, so there is little doubt that all these central banks in coordination can do similar things if needed.
China Also Sends A Message To The Markets
Earlier today, China lowered its reserve requirements for the first time in three years, signaling their renewed focus on strong economic growth. We view this as a clear sign that China wants to provide liquidity to its economy, and is satisfied that the real estate bubble that was forming has been stopped or substantially delayed.
Growth will continue in China and that it will soon return to the strong levels that the world has been used to. We have always believed in a soft landing for China, and this action shows that the governmental economic powers want to continue to see annual growth of 8% plus.
More Is Needed For A Final Resolution To Europe’s Banking System Problems
The following three things will have to happen before we can call the problems ‘solved’:
1. Banks must have sufficient liquidity to fund their day to day needs.
2. Banks need to write down bad paper on their balance sheets so investors will trust the balance sheets to be accurate representations of the banks’ condition. They must have sufficient capital to fulfill their purpose, which is to lend new money to companies who need financing to operate, to employ people, and to expand. This is what creates economic activity and economic growth. Note: The clean-up of bad bonds on bank balance sheets during the U.S. crisis took place through the Troubled Asset Relief Program [TARP] and other similar programs. Eventually, European governments will work together to create a program similar to TARP for Europe.
3. Banks need to raise capital from investors to improve the quality of their capital base. This is necessary to create confidence in the long term viability of any banking organization. This will happen after the European banking system gets initial capital infusions from the European nations themselves. Once European nations have shown a commitment to the banks, the banks will be better able to convince investors to buy their stock offerings.
Additionally, We Saw Some Things In Europe Late Last Week That Changed Our View On The U.S. Market To Positive
After the ECB announced late last week that they had bought bonds to create demand for the bond auctions of this week, they further stated that they had not sterilized all of those purchases. Some viewed this as a bearish event, but it made us become more bullish and we began to buy stocks on Monday 11/28. Europe’s bond buying without sterilization is QE, or money creation.
New data came out yesterday saying that ECB and Euro zone’s 17 national central bank’s balance sheets have grown to an all-time high of 2.4 trillion Euros [about 3.3 trillion dollars]. Some see this as a bad thing…we disagree…we see this as proof that central banks have provided and will provide liquidity when necessary.
Readers will recall that we have been arguing that this would happen in Europe and now it has begun to happen. It was not a lot, but it is a start. As a result of this signal we bought some stocks on Monday and yesterday. It is now Wednesday, and the markets are up a lot these past three days, so we might take some profits: the tone of the markets has improved.
Investors should buy partial position in U.S. stocks to benefit from a trading opportunity during the current short squeeze, and add to these positions when the inevitable periodic stock market declines take place. As we have continually said, QE will be the last resort, and when major European QE takes place world markets will rally vigorously.
1 Year Chart of the S&P 500
1 Year Chart of the Shanghai Composite