The hot start in risk assets continues as stocks in the U.S., developed international and emerging markets are all up between 9%-18% this year. Greasing the move has been the input of liquidity from central banks around the globe, most notably the European Central Bank's Long Term Refinancing Operations (LTRO).  In late December and then in February these operations issued $1.3 trillion in three year, low interest loans to European banks. This helps solidify the funding of the banks directly as a significant amount of those funds effectively lengthened the terms of existing ECB loans to those banks. LTRO is also a backdoor approach to addressing the soaring yields in some European sovereign debts as the banks can earn a significant carry by using the cheap ECB money to buy those debts. This has helped calm the market for Spanish and Italian sovereign debt.

LTRO sounds familiar because it's comparable to the Fed's quantitative easing (QEI and QEII) programs. In those the Federal Reserve bought U.S. treasuries and mortgage backed debt from banks, driving down interest rates and fueling a rally both times in equities and commodities. The ECB is restricted from acting as directly as the Fed due to lack of fiscal or political union in the Eurozone, but by flooding banks in the area with cheap funding they can expect banks to search for higher yielding instruments to invest that money. Euro sovereign debts are an obvious destination and local governments will undoubtedly be applying discrete, and not so discrete, pressure on the banks to buy their bonds. The comparison to the Fed's QE programs also brings to mind that they both ended poorly for the U.S. stock market. The first program ended March 31st, 2010. The S&P lost over 11% the next three months:

QEII ended June 30th, 2011, quickly followed by a 14% loss:

So for now the European sovereign debt issues are off the emergency screen and have survived the official declaration of a Greek default by the ISDA. However, it remains to be seen if the recovery in Italian and Spanish bonds is the real deal or an artifact of the increased liquidity provided by the ECB. And the recovery seen in those larger nations has not been sustained in Portuguese bonds which have faltered leading up to the Greek bond restructuring.

Portuguese 10 Year Government Bond Yield Source: www.bloomberg.com

Our opinion is that the Euro zone has stretched out the whole Greek crisis to such a point that the market has completely priced in the effects its default would have across the rest of the zone. We do not feel markets have been similarly prepared for a default in any of the other member nations. While the LTRO's have helped buy some time, the Euro currency members will still have to come to terms with the structural chasm between their Teutonic north and Latin south. 

The ECB has been joined by central banks from many of the largest developing nations in recent weeks; Brazil continues to cut rates, China has made cuts in its banks reserve requirement even as the yuan depreciates against the dollar. The result has been a strong start of the year for emerging markets as shown by this year-to-date performance chart for the BRIC countries.

This is a welcome departure from 2011 when these countries significantly underperformed the U.S. market.

In the U.S., we have seen a firming of some economic data, particularly on the labor front with the February jobs report indicating a gain if over 200,000 jobs and upward adjustments to previous reports. Obviously, sustained job growth would be a huge boost to consumer spending, housing and the economy in general so we hope to see that continue. The gains in commodity prices that accompany this data is less welcome, particularly oil prices which are approaching all time records for sustained high prices. Poor macro trends such as this and poor trade data have caused a few Wall Street banks to lower their projections for first quarter GDP even as employment seems to be firming. We think it is unrealistic to expect more than short periods of outsized economic (or job) growth as we still see structural headwinds such as household and, coming soon, public deleveraging limit the upside.

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