EU Bailout Plan Takes Shape

There’s a rumor making the rounds that EU will forgive 50% of Greek debt and increase the ESFS bailout fund to 2 trillion euros.

Now, "forgive" is a nice way to say allow a default. And the reason the stock market likes this news is that Greek default is at least somewhat priced into the market. Of course, the question of Portugal and Ireland, and maybe Spain and Italy, will eventually rise. And likely sooner than later. But for now, a little clarity on Greece is a good thing.

How would a 50% Greek default affect the market? Well, the fact that the ESFS would also be increased tells us that the banks will need cash, and get it. The report that the ECB will re-introduce 12-month loans to banks tells us the same thing.

I would expect there to be some tense moments in the market following the actual writing down of 50% of Greek debt. That write-down would have to be booked as a loss, and even though we know pretty close what the loss would be, it would still have an effect.

Of course, the EU wants to have a plan in place in 5 or 6 weeks, which is a long time for the market. We’ll be nearly through 3Q earnings and into the holiday shopping season by then. Still it would be nice to get through this Greek saga…

I should also note that this "rumor" of a settlement for Greece is one of those "rumors" that gets "leaked" to gauge the markets’ reaction. Like the when we started to hear about the Fed’s Operation Twist before the official announcement.

Recall that while the market liked the idea in theory, it sold off hard after the announcement.

JP Morgan (NYSE:JPM) reported yesterday that Apple (Nasdaq:AAPL) is cutting its orders from its iPad suppliers by 25%. And while JP Morgan’s analysts covering Apple isn’t cutting his sales estimates for iPads, but this is still a sign of weakness in the global economy. Anytime a company cuts orders, it will bring up the weakness question.

Now, Apple has been exceeding all expectations by a wide margin for quite some time. The company has to come back to earth at some point. And the stock didn’t exactly get crushed. Apple trades at 12 times forward earnings estimates. It’s cheap, and can probably handle a small bit of weakness.

Warren Buffett thinks Berskshire Hathaway (NYSE:BRK) shares are as much as 17% undervalued, so he’s putting some of his company’s $48 billion to work in a share buyback.  

Berkshire has never done a stock buyback. Its cash has gone to build a war-chest and do acquisitions.

Right now, Berkshire is reportedly throwing off an amazing $1 billion a month in cash. And Berkshire’s commitment to generating cash allows Buffett to make very beneficial deals when the market is crushed, like he did in the aftermath of the Lehman bankruptcy.

Having the cash on hand to take advantage of panic lows for stock prices is a key to successful investing. And with the uncertainty of Greek default ahead, emulating Buffett and having cash on hand is a good strategy.

Just a reminder: Alcoa (NYSE:AA) reports on October 11. That means we are currently in earnings warnings season for third quarter earnings. 3Q estimates have already been lowered by 5% or so. And in the absence of any warnings, we could have some more upside for prices.

Write me anytime: [email protected].

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