Relief Rally or Disaster? Let’s Hope Greece Gets It Right. Big Move On Monday

June 15, 2012
Author: Peter Stolcers, Founder of OneOption

Last weekend, Spanish banks secured $125 billion from the EU. The negotiations were not drawn out as they have been in the past (Greece, Ireland and Portugal). This could be a sign that Eurocrats finally understand the gravity of the situation. Global markets rallied on the news, but they instantly reversed Monday morning. One major piece to this puzzle has yet to be determined. Greece will hold elections this Sunday. The New Democracy has a small lead and if it wins, the market will stage a relief rally. Other political parties could form a coalition with the New Democracy and together they will forge new policies. This outcome will remove a great deal of uncertainty and PIIGS yields will decline. Interest rates in Italy are down slightly today and they are a little higher in Spain. In both cases, interest rates are at dangerously high levels. The ECB has pumped $1 trillion into European banks, the EU loaned €100 billion to Spanish Banks and the IMF has $1 trillion in its coffers (it is trying to secure another $400 billion in the next week or two). With a victory by the New Democracy, these backstops should contain credit concerns. If anti-bailout leftists win the election in Greece (unlikely), global markets will tank. This will rattle the entire EU and interest rates in Spain and Italy will jump. Under this scenario, Greece would certainly default and traders will watch to see if central banks can prevent contagion. Sooner or later, Greece will default. Europeans will grow tired of financing its structural debt and Greek citizens will object to entitlement cuts and additional austerity. Tax receipts are decreasing and deficits will grow. Today, Europe's largest retailer announced that they are pulling out of Greece. The situation is dire, but disaster will be avoided this weekend. China lowered interest rates (first time in two years), it reduced bank reserve requirements and it is ramping up fiscal spending (infrastructure build out). These proactive moves will stimulate the economy and they will allow traders to look past current economic releases. Growth in China is starting to slow and next week we will get the flash PMI's. Statements from the FOMC should be "dovish" next week. However, I am not expecting QE3. The other economic releases are relatively minor. All eyes will be focused on Greece and traders will be watching yields in Spain and Italy. If credit concerns ease, the SPY could easily challenge resistance at $136. If Eurocrats stay proactive, the rally could be sustained. On the other hand, if they disappear on vacation, the market will get nervous and this rally will stall quickly. In a recent poll, 80% of the Greek population said that they want to remain in the EU. I believe that will play out in the election and the New Democracy will win. I am long calls and I have 30% of my normal position. If I am right, I will make a decent return. If I am wrong, I will spend the next two months trying to recover. Given the probability, I am willing to take this risk. Realize that risk is elevated and this is a time to be prudent. The market is in a holding pattern and traders have already "squared up". We might see a little choppiness because of option expiration, but the market should stay in a range today. image

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