Headline News – Blain turns Bullish! Inspired or just plain wrong?

Newedge – Blain’s Morning Porridge – November 29 2011

By Bill Blain, senior director, special situations, Newedge (as seen on TV)

T: +44 207 676 8615; Mobile: +44 777 088 1033; E: [email protected]

What's the story with yesterday's rally? It wasn't founded in any facts or new truths - in fact, losts of 'facts' yesterday proved factually unfactual and proved fervid imaginings . Initially we dismissed it as driven by market technicals - short covering and such. But as Jim pointed out mid-day, it was feeling more sustained. Headlines on the blogosphere and papers now say the upside stems from 'hopes for European crisis resolution'. So I've been thinking more about it overnight.

And I surprise myself by concluding I AM BULLISH!

What? On the morning of what's likely to be a dismal Italian auction, with the OECD warning of eurozone recession and contagion, amidst still crashing sentiment across credit markets, S&P rumoured to put France on negative outlook, Moody’s preparing to slash ratings on over 80 European banks, and the dance band on the Titanic nervously eying the Iceberg lurking off the starboard bow, Blain the Bear turns bullish? Why...what have I been smoking/drinking? (That’s a completely other story...)

For months we've been learning to trade politics. That's a difficult ask for simple bond traders who understand the mechanics of CDS, the messages and subtleties of yield curves, the arcane science of ratings and credit, and the technicals of economics. But now the markets are 100% about what happens in Europe, and that's entirely about politics.

My bet this morning is the increased focus and talk around closer fiscal union and the German 'stability pact' plans has the feel of something Europe's political classes can rally around. Looking at the European crisis with a suitably jaundiced political eye, it’s possible to discern a clear upside resolution phase in coming days.

It’s all about compromise – and it’s now so serious this is the time to compromise. So, I'm going to predict a positive news-flow of unity stories over the next 10 days into the Summit, and perhaps even a strong relief rally to finish the year.

It boils down to an acheiveable compromise between Germany's enthusiasm for a rules-driven fiscal union (the 'stability pact') and using the ECB to steady the bond markets. Although Germany is unlikely to get the full powers to veto national budgets and the required oversight that it craves, the conference will likely agree an accelerated programme towards fiscal union. That’s enough for Merkel to look tough on.

In return, Germany will compromise on the role of the ECB - perhaps supporting a changed EBC growth promotion mandate, and disguised ECB bailouts in the form of QE to 'promote growth'. Such a compromise leaves all Europe's political leaders with something gained - Germany showing clear strength to its electorate by getting concessions from other eurozone members, and Sarkozy no-doubt declaring himself a euro-messiah.

Of course, it may not happen. We might get the usual EU crisis conference disappointment. But ahead of the EU council meeting on Dec 8, there is clearly room for upside. That’s what we’ve seen coming into other 'critical' dates...only for the market’s hopes to be subsequently dashed when expected concessions and agreements haven’t been delivered.

Will it be different this time? Perhaps this time politicians may stop the posturing and compromise effectively. If it happens, the relief rally will be strong and genuine, and well timed to stimulate a strong re-opening of credit markets, (critically including bank bonds) into the early new year.

However, no one expects a December compromise will be anything more than just effective first aid. Long-term it won’t solve the European debt crisis. Growth remains the problem: Satyajit Das on FT Insight this morning points out that with borrowing costs at 7% Italy has to grow an improbable 8.4% just to keep its debt level from escalating.

Meanwhile lots of other things look equally messy: the EFSF remains a sticking plaster that isn't actually sticky, and the doubts about the ongoing sustainability debt overload in Spain and Italy could yet tip markets. Whatever happens in December, Europe remains in intensive care.

Meanwhile, it may take markets a few days to catch up. While it makes sense to still be scenario planning potential euro break-up, default effects and exits, it’s also worth taking some short-term views.

On the other hand, I may be 180 degrees wrong and any uptick is a sell opportunity. As one smart investor told me yesterday: 'why pay 2 points higher for what I could have bought cheaper last Friday and will get even cheaper next week?'

Out of time…

NB - Before you bet the shop on a stronger market on the basis of my political auguries/guesswork, I should admit my qualifications for becoming a political investment guru are as marginal as anyone else - perhaps less. In my youth I dallied in student politics with the dubious distinction of becoming student president at Scotland's only List D university - giving me a permanent distaste for the backstabbing sociopathic drones that tend to inhabit the corridors of power. They are lying unpredictable fatherless children.