The market cheered this morning. Italian prime minister, Silvio “bunga-bunga” Berlusconi will resign.
A statement from Italian president, Giorgio Napolitano read, “Once this commitment [to pass a new budget] has been carried out, the prime minister will submit his resignation to the head of state.”
The U.S. market gained more than 1% on the news. And the Aussie market has moved higher this morning too. So, where will it go next? And how can you make a buck from it? We’ll get to that later.
First, you need to know the reason why this market rally is no stronger or longer-lasting than the one before…
Things move quickly in Italian politics. Just yesterday Berlusconi had posted the following message on his Facebook page, “Le voci di mie dimissioni sono destituite di fondamento.”
According to Google Translate, in English it reads, “The rumours of my resignation are groundless.”
By the way, it’s good to see the PM has a nice photo of him on his Facebook page holding hands at a 2009 G-8 conference with… the late Muammar Gaddafi!
They make a lovely couple.
Quite what difference a change of PM will have on Italy’s public finances is beyond your editor’s understanding. Even so, the markets love it – for now.
But one thing we know: you’ve got to be kidding if you think the Italians will actually cut public spending. They can’t… it’s impossible. Just as it’s impossible for any other welfare dominated state to cut spending.
The reason is simple. Once a nation embarks on the path of becoming a welfare state it’s a slow but certain economic death.
You see, governments are obsessed by economic growth. In their view an economy must never stop or take a breath. It must grow forever. That’s why governments love credit growth and banks. Credit growth means pumping more money into the economy.
The actual investments don’t matter. As long as the new credit pays off the old credit. (That’s why infrastructure projects are so popular with governments. Build a road and people will use it. Build a real business and there’s not the same guarantee. But it’s easier to hide losses in a new road because it’s “for the public good”.)
And as long as the government is prepared to provide a bailout when everything goes wrong… credit can keep growing. Well, for a limited time anyway.
Because as we both know, growth can’t go on forever. At some point it stops.
And because credit provides a leveraged boost as the market expands, it provides a leveraged knock when the economy busts. Firms go bust, banks cop the fallout from bad debts, and governments see a big drop in tax revenue.
That’s why all the talk about budget cuts and austerity is a smokescreen. Politicians the world over are making the right noises about cutting spending. But they’re doing the complete opposite. They’re increasing spending.
Western governments now account for 30-50% of all national spending. So, if governments stop spending then the economy will go into recession. That’s when you get firms going bust, banks copping bad debts… and governments raising less tax money.
Now, in our view that would be great. Governments should get out of the way of market forces. But no politician wants to cut spending because they know the consequences.
So they have to keep the spending party going.
The U.K. is a perfect example…
If you keep tabs on the Old Dart, you’ll know the Conservative-Liberal Democrat coalition made a big song-and-dance about cutting spending. They said it was for the good of the country… they couldn’t go on living beyond their means… etc.
As we wrote at the time:
“We’ve taken a look at the so-called savage cuts made by Tory Chancellor of the Exchequer, George Osborne, and we’ve come to the conclusion that it’s nothing more than a not-so-elaborate smokescreen…
“[When] you look at the actual spending review… [you] see that the supposed £81 billion (AUD$130 billion) of savings over the next few years actually results in an increase in government spending of £43 billion (AUD$69 billion).”
And according to UKpublicspending.co.uk, net public debt over the next three years will be 53% higher than in 2010:
So much for savage cuts and austerity.
The same is happening in the U.S. The same will happen in Greece… and in Italy. Whether or not Bunga-Bunga Berlusconi is PM.
You’ve seen what happens when an indebted economy stops growing. Government bond yields rise as investors worry the debt-riddled governments won’t raise enough tax revenue to repay the debts.
But asking governments to stop spending when they control between one-third and one-half of all spending just isn’t going to happen. So they have to make all the right noises about cutting spending while at the same time making sure spending (and therefore debt) keeps going up.
In short, as we’ve warned for the past three years, the problems that led to the near collapse of the global economy in 2008 haven’t been fixed. The problems are still there… and are getting bigger by the day.
All the current crop of politicians is doing is scrambling to patch things up as best they can. To make sure the final collapse doesn’t happen while they’re still in office.
But one day (exactly when, we can’t say) the postponed depression of 2008 will return. Only it’ll be much bigger. As the market not only tries to purge all the bad investments and debts from before 2008, but purges the many more bad investments and debts made since 2008.
As an investor, that puts you in a tough spot. You know the market is living on borrowed time. But you also know fools could push the market higher… and that’s something you don’t want to miss out on.
That’s why we continue to recommend small-cap stocks for explosive growth (the type of stocks that tend to surge the most when the market rallies), and blue-chip stocks for leveraged gains to the upside… and downside (if you’re comfortable short-selling).
In other words, the only way to play this market right now is if you’re prepared to buy and sell. This is neither a buyers nor a sellers’ market. It’s a timers’ market. Because getting the timing right is the most important factor when investing today.
P.S. So, what do you do? The markets love the latest non-event from Italy. But the excitement will soon wear off and the market will fall. Then we’ll get another non-event… which the market will love… until that wears off too.
The trick is figuring out when to buy and sell. That may sound obvious. But trust us, today it’s a lot harder to pick the buy and sell points than it was three years ago.
That’s why each week, for the past few months we’ve religiously tuned into Murray Dawes’ Slipstream Trader YouTube channel. Every Wednesday, Murray lays out his thoughts on the markets. We asked Murray – before he started recording today – where the market is going next. In short, the key level to look for is around 4,400 points on the S&P/ASX 200.
What that means for the markets is revealed in the free weekly video update. Click here to watch later on today.
From the Archives…
Your Retirement Savings – The Day the Government Began to Raid Them
2011-11-04 – Kris Sayce
Fed Up With Inflation…
2011-11-03 – Kris Sayce
All for Gold… But is There Gold For All?
2011-11-02 – Dr. Alex Cowie
Why Australia Needs More Losers
2011-11-01 – Kris Sayce
Qantas – A Grounded Investment?
2011-10-31 – Dan Denning
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