The S&P500 was unchanged for the week, and would have finished lower if not for a surge in the final 30 minutes of trading on Friday. Volume for the week was light. The VIX index dropped. Complacency grew as the Fed’s now explicit put option is being factored into stock buying analysis–why buy put options when the Fed will do it for you?
The macro data continue to paint a picture of a struggling economy, despite the fact that the recession has been officially declared to be over. Producer prices were lower than expected–both headline and core. The same thing happened with Consumer prices. But a major question remains: how accurate are these figures when the government has a strong interest in keeping them suppressed. Housing starts were much weaker than expected. Initial jobless claims are still stuck in the mid-400 thousand range; not where they need to be for a true recovery. The Empire State survey was much worse than expected; the Philly Fed survey was much better.
Technically, the S&P is struggling to bounce back from its prior week drop. Momentum is still weakening and pointing to more downside risk. The bullish percentage is slipping. And several indicators of the market’s breadth (eg. advance/decline ratio) are also weakening. Just as in late April and early May of this year, the equity markets are not standing on firm ground; it wouldn’t take much to cause a stampede out the door.
And the crisis in Ireland could possible lead to that stampede. But not in a direct way.
Like Greece, Ireland is about to be “saved” by the EU and the IMF. The problem with being saved this way can be described by comparing the Eurozone nations to a group of mountain climbers who are all tethered together for mutual protection. If one climber, out of say ten, falls off the edge of a cliff, the remaining nine climbers can confidently prevent the fallen climber from plunging to his death, even if the climber is only suspended by the tether and dangling in mid-air. That first climber was Greece, and he fell in May. Ireland will be the second hiker to fall. But now only eight climbers will remain to keep the two fallen climbers alive.
Soon after Ireland falls, Portugal looks like it will also fall off. Then only seven climbers will be expected to “save” the fallen three.
Soon a tipping point will approach. If Spain falls after Portugal, then the remaining climbers may not be able to keep the fallen nations suspended without getting dragged off the cliff’s edge themselves. Spain has far more debt to be refinanced than the first three nations, and there will be fewer strong nations left to do so.
Finally, even if by some miracle Spain’s fall does not cause the remaining climbers to collapse, then the odds are high that Italy (which has even more public debt than Spain) will certainly do the trick.
If or when Spain (and Italy) falls, one of two things will happen. Either the Eurozone will blow up, right then and there, or the remaining strong states (led by Germany) will cut the tether and causing the fallen nations to fend for themselves while the remaining states circle the wagons and defend their own banking systems from the tsunami of credit losses that they’ll incur as the PIIGS implode.
Either way, the Eurozone is doomed. The bottom line is that there is way too much debt in the PIIGS nations (relative to their GDP’s) and there isn’t enough money in the system to bail everyone out.
So there will be pain, severe pain, and the question will be: how does this pain get distributed between the creditors and the taxpayers, and when does this start?
And this isn’t even the bad news. What truly scary is that the same debt problem is building in the US, the UK, Japan and even China. In fact, much of the developed world (far more than 50% of global GDP) will face this very same nightmare.