Spanish Banks, Miami Heat, Lindsay Lohan and Greek Elections

The Greek elections were so exciting this weekend that I didn’t even notice that the Miami Heat won Game 3 or that Ms. Lohan fell unconscious after “working 85 hours over 4 days and being up all night.” (Note to the starlet – go cry to the Marine Sergeant leading patrols in Afghanistan for $35k a year).

While I have more on the elections below, it was a good week in the equity markets.  No, it wasn’t the bailout of the Spanish banks last Monday that set off an equity market rally, but rather speculation that the Fed will announce some new measures aimed at improving the economy when they meet this week. The news that global policy makers reassured that they would step in with liquidity, should the Greek vote end up poorly, was welcomed as well.  It turns out that the Greek vote went well and the U.S. is set to open to the downside this morning.

Go figure.

But this is why we say over and over that individual investors shouldn’t trade on daily news and speculation.  Think about it – was anyone in the main stream media predicting we would see a 2 week winning streak in the equity markets 14 days ago?

Here’s how the market ended up for the week.

As mentioned above, the conservative, pro-austerity, New Democracy party appeared to win a small victory against the radical leftist SYRIZA bloc increasing the likelihood that a Greek exit from the 17-nation euro currency has been averted.

For now.

But it’s not all about Europe right now.  Here in the US, the Fed will conclude its two-day meeting on Wednesday after which Fed Chief Ben Bernanke will hold a press conference.

So while the Fed is closely examining events in Europe, it also needs to address the market’s concern over a third slowdown in the U.S. recovery in as many years.

Contrary to what a lot of people seem to think, the Fed is not out of options. It’s just debatable whether or not the options will provide the required ‘oomph’.

To set the stage, let’s review a little history.  First, the Fed conducted $2.3 trillion in bond purchases (popularly called QE1 and QE2).  From there, the Fed purchased another $400 billion of longer-term Treasury bonds.  The purchases were made with money they got from selling the same amount of short-term bonds.  This is commonly referred to as “Operation Twist”.

Options available include:

1. Extending its low rate pledge beyond late 2014. This won’t really do anything.

2. Cutting the 25 basis point rate on excess reserves that the Fed pays to banks in order to encourage lending. Given that part of our problem is that banks are not really lending much these days, a tiny cut might not stimulate anything.

3. Extending Operation Twist, which concludes at the end of the month.  This would push rates even lower.  However, rates are already at record lows.

4. A full-blown QE3. The Fed could announce a third round of bond purchases. Equity markets would probably do well, but commodity prices would soar again too.

5. I read over the weekend that the Fed could also buy European bonds, including those of Spain and Italy.  That would probably send stocks soaring for the short term but it’s politically impossible – elected officials would go NUTS!

Number 5 could be more entertaining than a good summer book, but don’t count on it.

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