Friday, May 18, 2012

"I'm So Bearish That I'm Bullish"

The title of my post today comes from a comment made yesterday by Michael Hartnett, Chief Global Equity Strategist at Merrill Lynch, who I heard speak at a luncheon meeting.

Most of the discussion, as you might imagine, revolved around Europe.  All agreed that the euro situation is fairly dire, and solutions will not be easy - no surprise there. The overwhelming consensus is that Greece will be leaving the euro block soon, and that European markets and economies are in for a very difficult time.

Michael does not necessarily disagree with the dour assessment of the precarious state of the European community.  However, he does believe that it is the fragile economic conditions are  setting up for a very nice trade in European stocks.

It seems unlikely, in Michael's view, that the leaders of the major European countries are going to simply sit idly by and watch their countries disintegrate into an even deeper economic morass.

The more conditions worsen, and the more civil unrest occurs, the greater the pressure will be on the leaders to inject massive amounts of monetary and fiscal stimulus into the euro block to try to at least ameliorate the situation.

If this occurs, markets should rebound massively.  One only has to consider the large equity rallies that occurred in this country when the Fed intervened twice in the credit markets to see the potential.

The selling in European markets has been broad-based, and markets are priced at historically low valuations.  In Spain and France, for example, bank stocks have actually outperformed traditionally stodgy utility stocks, even though most would probably agree that the financial sector should be more at risk.  Investors just want out.

So here's how it could work out:  faced with a very unhappy populace, European leaders huddle and agree to try stop the economic hemorrhaging through a program of bank recapitalization, fiscal stimulus, and aggressive intervention in the credit markets.  Stock markets soar across Europe, and bond yields plummet, as bearish investors scramble to undo their bearish trades.

At this point, however, Michael Hartnett would suggest taking profits, and heading to the sidelines.  He too believes that the ultimate solution to Europe's problems will take years, so that European stocks should be "rented not owned".

Seems like a reasonable strategy.