Tuesday, December 20, 2011


Despite the (justified) gloom and doom in Europe, Spanish and Italian two-year yields are each 50 basis points lower today. Spanish two-year yields are at the lowest level in seven months and yields have halved since November, according to Peter Boockvar at Miller Tabak.

Moreover, the French two-year yield is the lowest in 13 months.

Importantly, the euro basis swap is down 20 basis points and is now at the lowest level in a week or more.

"In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced President. Yet the Dow rose from 66 to 11,497."

-- Warren Buffett

Yesterday, in a piece in Foreign Policy, Pimco's Mohamed El-Erian discusses the unsettling implications for the global economy of a potential unraveling of the EU.

For now, Europe's debt crisis limits the market's upside -- but in my view, it doesn't preclude a somewhat better market (even while policy, within the backdrop of crisis, slowly coalesces into a more U.S.- like quantitative easing).

Tangible progress in drafting a credible plan for the European debt crisis has just started, and though the recent moves don't provide a permanent solution and the path to stabilization may turn ugly, a flawed plan is better than no plan at all. While stress points remain, crucial details are yet to be worked out and the likelihood of a European recession is high, systemic risk has likely been reduced, and the recent decision to lower interest rates by the ECB further supports intermediate-term stability in the region.

I remain confident that, in the fullness of time, a more permanent solution (through more meaningful monetization and leverage) will follow the current meek and ineffectual policy as European and global leaders and central bankers will all come to their senses. After all, the alternative is unimaginable for the eurozone's economy's longer-term health, which could have an adverse spillover effect around the world.

Stocks are extraordinarily undervalued relative to inflation (and inflationary expectations), interest rates, earnings, sales, free cash flow and tangible book value. Indeed, valuation models using interest rates as a key metric produces an S&P 500 index as undervalued as the market was at the generational bottom of March 2009.