THE BIG TURN AROUND IN EUROPE THAT INVESTORS ARE MISSING / MARKET AUTHORITY

The Big Turnaround in Europe that Investors are Missing

by Ben Rand

Wednesday  April 30, 2014


"90% of the game is half mental."
- Yogi Berra


Keynes coined the term "animal spirits" to describe the instincts and emotions that guide human behavior. These spirits demonstrate how people feel about the economy can be quantified in surveys such as consumer confidence. The goal of monetary policy is make investors believe that the money they give to someone else will be paid back in a timely manner at an agreed-upon rate. Lending is what drives economic growth and this is how the credit (and thus money) is created. It's a purely psychological belief that rests on the credibility of central bankers. All of the levers that central banks are now pulling (quantitative easing, ZIRP, IOER) are just illusions to make you feel better about your economic prospects.

Let's turn back the clock to see how the European Central Bank conjured up animal spirits and saved the Euro.

FLASHBACK: It's December 2011. Europe is facing a sovereign debt crisis. Economists predict an imminent collapse and breakup of the Euro. The PIIGS (Portugal, Ireland, Italy, Greece, Spain) are in complete disarray as governments are forced to cut spending in the face of economic weakness. The punishing austerity is weakening growth and foreign creditors are driving up bond yields to record high levels. As bond yields rocket higher, governments face higher finance costs, leading to more spending cuts.

What happened in 2012 to cause such a dramatic shift in PIIG bond yields? 

In July 2012, ECB President Mario Draghi rode to the rescue while speaking to investors in London by uttering this now-infamous line:

"Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough." 

Immediately, borrowing costs in Italy and Spain dropped as investor sentiment shifted from doom and gloom to, "Hey, the eurozone is cheap!" Animal spirits began to appear and consumer confidence surged through the long-term average, erasing the 2011 sovereign crisis decline: 

In the last year alone, bond yields have improved considerably: 

Greece, once the pariah of the Eurozone, now has yields under 7%! This dramatic shift was precipitated by a few words from Mario Draghi and the resulting optimism among investors. 

But as Yogi once said, "It ain't over til it's over."