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On the lookout for good news

12 July 2012,

Investors always respond to news that appears good. Economists react in the days following the news, when their criticism gets most attention. This means that positive investor sentiment can head back in the opposite direction as quickly as it improved. Investors would do well to take into account that the big gains in equity markets after the EU Summit at the end of June could evaporate just as quickly in the following week.

At first sight, the outcome of the EU summit seems positive, at least if we are to believe the politicians. They managed to give that impression on 17 previous occasions too, if we consider the outcomes of all EU summits since 2007. The decision that a banking union is required has probably been taken, but the details remain to be fully worked out. Experience shows that the 27 Member States of the EU will not reach agreement quickly, even under enormous pressure from the euro crisis. Political agendas and lobbying by the banking sector will play an (even) greater role over the coming months, so it is unlikely that a banking union will come into being by the end of this year.

The agreed support to (the banks in) Italy and Spain is positive but seems nowhere near enough to meet the refinancing requirement in 2012/2013. There is a strong probability that banks will call on the emergency funds to unload their bad loans, which is actually shifting the problem back again onto the authorities who agreed to provide support for the emergency funds. If the banking union comes about, then there will be more and direct support to the banking sector, but as stated earlier, that union does not exist yet. Meanwhile, the real estate market weakened further in Spain and demand for support from the Spanish banking sector is rising.

So why the euphoria among investors? Merely because a decision was taken at the EU summit. This was apparently something so extraordinary that investors reacted extremely positively to it. The underlying details, most of which have not yet been decided, and the effect of which is completely unpredictable, are regarded as a secondary matter. They just want good news!

But the fundamentals of investing are what matters most to us: economic development in the world. Growth is slowing in all continents and the economic signals currently appear to be showing no signs of improvement. Despite the current low interest rates, which would normally be a catalyst for growth, the economies of Western countries remain extremely weak. And when all the euphoria has subsided once more, investors will start looking at the fundamentals again.

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