A lot of the commentary suggested that investors on Thursday were applauding the perceived victory by presidential candidate Mitt Romney over President Obama. But that wasn’t likely the case because most veteran investors know by now that stock markets have tended to fare better under Democratic administrations in the past hundred years, probably due to higher spending.
In reality, the stimulus came from Europe, as the equities around the world have largely been flat in the past two months, except on days in which central banks have either made new announcements of monetary easing or offered help to troubled banks. Because of that, one of the most highly anticipated events this week was a meeting of the European Central Bank. Led by President Mario Draghi, the ECB left rates unchanged as expected.
While there was no discussion of further easing, Draghi presented another strong defense of his new program, called outright monetary transactions (OMT), which is aimed at purchasing the bonds of troubled countries that request help. Spain is expected to be the first to make such a request, and what markets want to know is exactly how forceful the OMT program will be once it launches.
In his statement, Draghi continued to stress that troubled governments will have to take the first step, which means the ECB won’t act on its own. Governments like Spain are reluctant to ask for help — even though their short-term funding has risen dramatically due to the lack of demand for their credit, which has the effect of pushing down prices and pushing up yields.
Think of yields as similar to the interest rate you pay on your credit cards. The higher they are, the more governments must divert money from social programs just to pay for the right to borrow from creditors.
Draghi did not provide any additional insight into what conditions the ECB is seeking, though he did note that he would act to protect the central bank’s credibility. That was taken as a stern point of view, which was a positive from investors’ perspective.
The reason that we care about all this is that U.S. and European banks are among the creditors to Spain. So, to the extent that the ECB will buy its bonds and push down yields, there’s a higher likelihood of all creditors receiving what they expect.
It’s kind of convoluted, but that’s the reasoning investors are mulling over. And every time the pendulum of sentiment swings in favor of believing that the ECB has the region’s sovereign debt woes under control, risk appetites swell on Wall Street.
Since the situation really hasn’t changed after Draghi’s announcement, for now I’m not recommending exposure to that area.