Once the EU bailout wears off, markets will once again struggle

Global stock markets soared yesterday, with the Dow rocketing almost 340 points, as investors decided to put a jolly spin on the EU’s latest bailout package.

No doubt, the market’s first reaction is partly correct. There are, in fact, some helpful things in the deal.

At long last, European leaders are admitting that Greek government debt isn’t worth anything near face value. Institutional investors, under pressure from the authorities, have agreed to accept a 50% haircut in the value of their Greek bonds.

In effect, Greece will undergo an informal bankruptcy (without saying so). This is an essential first step toward reducing the country’s debt burden to a sustainable level.

The EU is also taking two additional measures, boosting its bailout fund to 1 trillion euros to provide for emergency purchases of sovereign debt and imposing a recapitalization plan on the continent’s banks. However, these tactics may not prove quite as effective as the markets, in their enthusiasm, seem to have believed today.

For one thing, the emergency fund isn’t immediately receiving any fresh cash from EU member states. Instead, it will borrow money, as needed, to buy troubled bonds. In a real crisis, the emergency fund itself might have trouble borrowing at reasonable rates, compounding the panic.

In addition, the recapitalization plan calls for the banks to raise 106 billion euros — about half the amount thought necessary by private-sector experts.

Bottom line: Europe has bought itself some time. By early 2012, though, if not before, I suspect that the euphoria will wear off — and global equity markets, including our own, will struggle again.

For now, the surge is on. My best guess is that it will continue into the first half of December, taking the S&P 500 comfortably above 1300 and possibly within striking distance of last April’s highs.

How to p! lay it? With the market now severely overbought on a short-term view, this is an excellent time to shed stocks and mutual funds that offer dubious prospects for 2012.

For Example:

I recommend that you sell Cisco Systems (NASDAQ:CSCO) and?Eli Lilly (NYSE:LLY). Both companies will face strong earnings headwinds in 2012, even if by some stroke of luck the U.S. economy manages to stay above the flat line. In general, some big tech names and Big Pharma players will have trouble keeping up their recent gains in the short-term.

I’m also throwing in the towel on E.ON (PINK:EONGY), the German utility. The stock has enjoyed a 50% bounce off its September low, but the increasingly tough regulatory climate in Germany will hinder E.ON’s results for the next couple of years at least. The utility sector in general is a crowded trade, so consider trimming back in the short-term.

Anything to buy?

With most stocks substantially above near-term support, I would direct the lion’s share of any new money into bonds.

DoubleLine Total Return Bond Fund (MUTF:DLTNX) has held up remarkably well amid the shellacking the Treasury sector has taken over the past three weeks.

Current yield: 7.7%, based on actual year-to-date distributions.