Why I keep hammering on the “hope vs. reality” theme!

We’ve had one heck of a party on Wall Street in the past few weeks. The Dow Jones Industrial Average shot up from 10,404 on October 4 through 11,891 yesterday — a gain of 1,487 points in just 22 calendar days.

The reasons I hear most often cited?

Hope for the mega-bailout in Europe.

Hope for a mega-refinance plan that will help every beleaguered homeowner in the U.S.

Hope for a mega-compromise from the deficit “Super Committee.”

And hope that fund managers — who are hopelessly falling behind their benchmarks — will just throw money at any piece of you-know-what stock to try to make up their performance gaps so they don’t get fired come January 1.

That’s a big heaping of hope, as far as I’m concerned. And unfortunately for the bulls, hope is now colliding with reality — and not in a good way! That tells me we’re due for more losses … possibly very soon!

Hope vs. Reality, European Edition

Let’s start with the bailout talk from Europe. The latest market hopes, based on the European Union summit we had this week, are that European banks are going to take 50 percent haircuts on their Greek debt … that the 440-billion euro European Financial Stability Fund will be leveraged up to 1 trillion in a couple of different ways … and that banks will be backstopped with around 100 billion euros in additional capital.

That all sounds good on the surface. But when you look at the action in the European BOND market, you see that real-money investors just aren’t buying the happy talk! They apparently don’t believe European politicians can afford to do what they say they can do!

Italian 10-year yields have surged up toward 6 percent again, closing in on the highs they set several weeks back. Spanish and Portuguese yields are also climbing. And the difference between yields on French and German debt just exploded to an all-time high. This is all happening AFTER the European Central Bank started buying PIIGS bonds in a futile attempt to prop up their prices and AFTER the outlines of the latest bailout schemes were leaked to the market.

Do you want a brutal dose of reality? Do you want to know why European officials have met 20 times this year alone — and STILL failed to come up with a bailout that actually works?

Then here it is:

The peripheral European countries are virtually broke. The only way they can survive over the long term is if their debt burdens are slashed dramatically. At the same time, countries like Germany and France can’t afford to spend hundreds of billions of euros bailing out their neighbors without destroying their own balance sheets!

Plus, the circular nature of this bailout fund is downright ludicrous! You literally have countries like Italy and Spain borrowing money and putting those funds into the bailout fund … so it can turn around and spend that money buying up those countries’ bonds.

Does that make sense to you? Does that sound like a plan that can actually work over the long term? Bond investors sure don’t think so, because the yield on the EFSF’s OWN outstanding bonds are climbing, a sign that the fund’s AAA status is slowly coming into question.

Hope vs. Reality, Housing Edition

Here in the U.S., housing stocks and banks rallied sharply heading into this week amid rumors of a mass refinance program from the Obama administration. Many borrowers are upside down on their mortgages, owing more than their homes are worth. There was hope that essentially all of them would be permitted to refinance into new, cheaper mortgages as part of the new plan.

But the program rolled out on Monday looks like yet another “nothing sandwich” in a long line of them! The original Home Affordable Refinance Program (HARP) was supposed to help as many as 5 million borrowers. Only 900,000 have participated.

The HARP changes we just learned about will ease appraisal requirements and reduce fees associated with refinancing. But because of the nature of the changes, and restrictions and fees that still apply to home loans, the new, improved HARP will likely only allow a couple hundred thousand more borrowers to refinance over the next few years.

That’s nowhere near enough to make a dent in the broad economy or housing market, considering some 11 million homeowners are underwater, according to CoreLogic estimates. In fact, Royal Bank of Scotland estimated that only 17 percent of the outstanding, 30-year Fannie Mae and Freddie Mac mortgages will qualify for a refi under the new plan.

Home prices just took another big drop, pushing even more owners underwater.

Meanwhile, the housing news isn’t getting any better. Existing homes lost almost 4 percent of their value versus a year ago in August, according to S&P/Case-Shiller. New home prices plunged 10.4 percent in September, the biggest decline in more than two years.

Applications for home purchase mortgages remain mired in the muck. And confidence is completely lacking — with American consumers more negative about their circumstances than at any time since March 2009!

Hope vs. Reality, Super Committee Edition

Finally, there’s the deadline Wall Street investors haven’t been talking about much recently because of all the European shenanigans. That would be the November 23 deadline for deficit-reduction recommendations from the so-called “Super Committee.”

The committee of 12 Republicans and Democrats is supposed to come up with proposals to reduce spending and raise revenue over the next several years. If the committee doesn’t come up with a plan, then $1.2 trillion in automatic spending cuts are supposed to kick in beginning in 2013.

All the reports I’m seeing suggest this will be the nothing sandwich to end all nothing sandwiches! Committee members are hopelessly deadlocked, with Republicans unwilling to raise substantial amounts of revenue and Democrats unwilling to cut spending and entitlement programs in any meaningful way.

Super Committee struggles to make progress as clock ticks.

Why is this so important?

Because Standard & Poor’s has already cut its AAA rating on U.S. sovereign debt. Fitch and Moody’s punted, citing the creation of the Super Committee as a reason for optimism that some kind of deal would be reached to bring the deficit down. When (not if, in my opinion) the Super Committee bombs, they won’t have any more excuses. They’ll have to take action. S&P could even cut the rating further.

This is the next major crisis that Wall Street fund managers are trying to get you to ignore. After all, if they don’t manage to prop up the market through year-end, how can they collect their hefty bonuses and stake out a nice Hamptons homestead next summer?

My take is simple: Please don’t rely on hope when it comes to investing. Look at the cold, hard facts and reality on the ground. They suggest we haven’t seen the worst for stocks, despite the recent rally, and that caution remains your best investment bet!

Until next time,

Mike

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