What are people thinking?

Over the past couple of months, I've been thinking to myself, "what are people thinking?"  I've got my retirement money invested in the FTSE 250 index to practise what I preach to small investors, that they should keep things simple by investing into the small/mid-cap indices when the economy is growing and investing into government bonds when they see a recession coming.  So you only need to make two decisions over an economic cycle of a few years...relatively straightforward...and should beat 90% of the "professional" financial advice out there.  As you can see, the strategy's done fairly well...I missed all losses from the entire financial crisis...though I didn't catch the bottom of the market and bought in much later, it didn't matter as I didn't lose money in the first place.

But what's caught my eye over the past couple of months is how the market is going up in a straight line.  Are things that rosy that people are willing to buy into equities with almost no volatility?  Evidently they are as money has been pouring into equities since the beginning of the year.  Amusingly, institutions such as pension funds are still discussing cutting equity exposure as they don't want the volatility.  Hopefully that haven't done that yet!  But does this mean that market perception about macroeconomic risks has changed?  I don't remember this smooth a ride since the financial crisis, and an eyeball look at past data shows that volatility was only this low back in spring of 2010, right before the Greek debt crisis started.

It's obvious where the risk to financial markets should come from, the Eurozone countries which are not reforming fast enough.  The European Central Bank buying the sovereign debt of Spain and Italy only gives them more time...not solve the problem.  I've been watching UniCredit (UCG), the weakest of the major banks in those two countries, and it's stock has come off about 20% from the high.

It's clear that the momentum behind the latest market rally is petering out, so is it going to come crashing down again and require another bailout or is something going to save it?  Spain looks pretty dire...PM Mariano Rajoy hasn't been able to implement many reforms, though to be fair, labour reforms are always the toughest.  Italy I think is the wild card.  Currently, Pier Luigi Bersani's centre-left coalition should win based on polls, but their lead has been decreasing.  If they win by a small margin and has to work with Mario Monti's coalition, I think the markets will be happy.  But how do you tell a centre-left coalition still with a lot of unreformed communists that they have to let go of their social and employment protections? I'm really sceptical that they are going to make things happen without having their arms twisted.  Perhaps we will see the market start to trade sideways more.  The central bankers have made hints that they may do more quantitative easing, but little of this seems to be channeling into the real economy, so the money goes where it is easiest to do so, the financial markets.  So the richest part of the population (who own the most amount of securities in the financial markets) benefits the most in the name of macroeconomic stability.  This isn't the way things are supposed to work, is it?