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How Much Can US Stocks Decouple?

Kevin Cook

After Greece's somewhat positive election outcomes, the reality remains that the great eurozone monetary experiment is still in deep trouble. Spanish bond yields soaring to new euro-era highs above 7.25% is proof of that.

Regardless of Greece staying within the fold for another few months are bigger issues of politics, solvency, growth and integration that will determine the fate--indeed the survival--of the single currency regime.

And it should also be clear now to all that the troika is not rushing to the rescue with any grand plans that will make any difference in the next few weeks, or even months. Yes, they are drafting specific blueprints for greater eurozone integration that will likely be unveiled around the time of the next EU Summit June 28-29, including banking and fiscal union that will shield against future crises.

But many of those structural reforms depend on EU treaty and other legal amendments that will take time. German Chancellor Merkel and Finance Minister Schaueble have been telegraphing as much for weeks. They see the path of full integration taking two to five years on the low end.

And this works fine for Germany because they can get a lot of things sorted out during that time; things like who stays and who leaves, and who can get their fiscal house in order and who can't. In this way, they ensure fiscal discipline before they dare step down the slippery slope of "debt sharing" (i.e., eurobonds, quantitative easing, and all other forms of monetizing debt and money printing).

Last fall, I was convinced that Europe would get the Fed's religion of QE if only because they saw how bad the US credit crisis hit our economy and markets in 2008 and 2009. But as I learned more and more about their philosophical and economic views and witnessed their stubborn resolve, I realized that they will let member countries go to the brink of disaster before they give in on the ECB becoming the lender of last resort.

Given this, can you imagine that US markets once again slowly adjust to the snail's pace of eurozone "action" as participants realize this crisis is going to be with us for another few years?

And how likely is it that the S&P lows of 1,266 hold in the face of the euro-mess, China deceleration, and our approaching "fiscal cliff?"

These are various ways of asking "can we decouple?"

Obviously, to answer this line of questioning, you will probably also consider things like the extent of Europe's debt and banking crisis and its impact on their recession.

In this morning's "Profit from the Pros" letter, Reity put together a decent scenario matrix with some probabilities and outcomes that get you thinking. He doesn't believe US stocks are pricing-in all the odds of something going wrong in the near-term.

For those who haven't seen it, I share it below because framing our investing and trading questions this way gives you a good framework for making decisions that suit you, ahead of time. In other words, before you are caught off-guard and thinking emotionally. You don't have to get the probabilities right, you just have to know what you will do under different outcomes.

"So even though I think the European debt situation will be contained in time, there is still a 10-15% chance that their politicians botch it up leading to a Lehman type implosion.

"Even with no implosion, there is about another 20% chance that the European economy slips into such a steep recession that they export their troubles to other economies around the world.

Adding it all up there is a 65-70% chance of things being fine with US stocks free to make normal annual gains. And then there is a 30-35% chance of stocks being decimated over the next year."

And you see how I got through this whole thing so far without even discussing new Federal Reserve QE? It will be interesting to see if we can talk about these problems and disregard the "nearly out of meaningful bullets" Fed. Unless of course you think markets are waiting for a short-term stimulus driven rally soon.

Read the analyst report on SPY

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Read the analyst report on TLT

Read the analyst report on UUP

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