I had Jim Fix in mind in December when I did my 2012 forecast, seeing great danger in the first half of the year. While the U.S. economy is definitely improving, it doesn’t matter how good the economy is — if the financial system has a heart attack, like we did in 2008 when Lehman collapsed. Likewise, there is a real possibility of a sovereign collapse in the European financial crisis.
Fortunately, the European financial system has received some imaginative “stints” in the last few weeks. First, the ECB introduced a new three-year loan program, that effectively bought time to hopefully resolve the fiscal policy issues. Second, we learned that 90% of the credit default swaps on Greek debt are already collateralized, meaning minimal shock to the system if Greece has a sovereign heart attack. Third, the widely-hyped “troika” talks over Greek debt collapsed over the weekend, and the stock markets remained calm nonetheless. Finally, the Fed on Wednesday announced they were also extending the period of artificially low interest rates another 18 months, until the end of 2014. More importantly, they indicated a readiness to deploy the third round of quantitative easing if necessary.
All of this has considerably reduced the risk of financial collapse in the near term. At the same time, the U.S. stock market has been enjoying a minor bull run so far this year. That introduces a new risk, i.e., the risk of NOT having a caridac event in Europe and missing a major bull market in the U.S. As is customary, as one risk has been decreased, another has increased. To hedge this new risk, I suspect it is time to begin the incremental deployment of cash.