Wouldn't it be nice if we could make a mistake and not have any consequences?  While once in a while some people are able to get away with some mistakes, most of the time if they don't pay for it, somebody else has to.  As hard as the Central Planners Bankers and Politicians around the world try to make mistakes disappear, the consequences keep coming back.

America is not far behind.  The Professional Can Kickers in Congress are learning that the can keeps getting bigger each time they kick it, which means they cannot kick it as far as they used to.  There is a reason America was downgraded, no matter how hard everyone tries to run from the truth.

By focusing on the short-term the Central Planners Bankers do not realize they are using the wrong model.

This morning is another reminder that you cannot magically make your problems disappear.  European markets are down 2-3% so far today, with bank stocks leading the way down.  Funny, last week France, Belgium, Italy, and Spain blamed the massive decline in banking stocks on short-sellers.  They thought that even though it did not work in 2008 that banning short-selling in financial stocks would stop the carnage.

Somebody should have asked the bank that had to borrow 500 Million Euros yesterday from the European Central Bank if the problem was short-selling or the fact that they have so many bad loans on their books that they are running out of money? 

The chart above is the closest European equivalent to the Federal Reserve's overnight discount window.  It allows banks to borrow for short-term periods to provide liquidity when necessary.  For those of us that remember the summer and fall of 2008 this news, along with an article in today's Wall St. Journal discussing how closely the Fed is monitoring the liquidity at the European banks brings back haunting memories.

The Fed is worried that the troubled European banks will pull their assets out of their US units in order to provide liquidity for their European units.  Adding to the liquidity worries is the fact that Bank of America has been holding fire sales for many of their "non-core" divisions in order to raise capital on their balance sheet.

Many people are calling for both the creation of Euro Bonds to provide funds to bailout the failed European countries and banks as well as the Fed to launch another round of Quantitative Easing.  Either solution would be another attempt to make problems magically disappear.  As we are hopefully learning, we cannot get past the problems until we address the real problems.

There is a reason people are calling for Quantitative Easing.  It's the only thing that has driven the market higher the past two years.

For those people hoping for QE3 to save their portfolio I have two reminders:  1.) the inflation numbers out this week make the Fed's ability to print more money without serious consequences much smaller, and 2.) the Fed's mandate is not to juice stocks -- it's to help the economy and QE has done nothing to help the actual economy.

The stock market is not exactly an efficient pricing mechanism as it tends to get ahead of itself both to the upside and the downside.  However, I've always believed that eventually stock prices correctly reflect the reality of the underlying economy.

The fact that the stock market is now back to the point it was at just before Lehman failed and the point it was at just before the 2010 Greek crisis is testament to the market's ability to eventually get the price right.

In both 2008 & 2010 policy makers tried to do things that solved the short-term liquidity problems, but did nothing to actually fix the REASON behind the liquidity problems.  Now because they did not address it, here we are, right back where we started.

Why do I spend so much time focusing on these big picture fundamental topics?  Because I know eventually the market will price it in.  If you are in a buy & hold strategy you have to understand that problems do not magically disappear.  Eventually they have to be dealt with and when they finally are it will not be fun to ride it out.

As for the short-term, I'm sure that once again solutions will be floated around that try to make the problems disappear.  If so, the market could easily jump higher once again.  However, I would point out that after a sharp sell off like we had last week, the market will move in fits and starts.  Last year we thought the "flash crash" was bad, when in fact it was only the beginning.  I've circled the day of the flash crash on the chart below along with the days following it to highlight the volatility that was created.

We are in another period of extreme volatility as the market attempts to find a new consensus.  The old consensus was that the banking problems were behind us, Europe was going to be ok for a few more years, and that the slowdown in our economy was "transitory".  Be careful to not read too much into the day to day moves of the market and instead use this period to assess whether or not you or your clients have too much exposure to assets that need the economy to be strong in order to make money.

Our portfolios remain in a "bearish" position, with only 12% equity exposure in both EPA and EGA (both programs are benefiting from some government bond exposure that will offset some of the equity exposure).  INA has a small amount of bond exposure, although all new INA accounts since July 25 remain invested in money market.