All Eyes on Euroland

What a wild ride.  After jumping up about 4.5% in the first three days of the week, the S&P500 closed DOWN 0.24% by the end of trading on Friday.  Volatility, while higher than normal, dipped for the week.  And volume was light, but that probably had more to do with the upcoming Labor Day holiday weekend as investors and traders simply postponed major decisions until everyone returns from vacation in about a week.

The doom and gloom in economic data continued to build.  Pending home sales fell more than expected. Personal incomes were stagnant. While personal spending rose more than expected, much of the rise has to do with unsustainable transfer payments (think unemployment insurance) from the government. Consumer confidence plunged….to the lowest level since April 2009.  Chicago PMI fell month-over-month, but not quite as much as expected.  Initial jobless claims were higher than estimated.  ISM manufacturing fell, but also not quite as much as economists had predicted.  The shocker of the week was the big number, the jobs report for August, which literally collapsed.  Instead of the 70 thousand new jobs that were predicted, the economy generated ZERO jobs.  What’s worse, average hourly earnings fell; they were expected to rise slightly.  The average workweek shrank; it was supposed to hold steady.  This was the worst jobs report in almost a year, and this stunningly bad result sent the US and global markets into the big sell-off on Friday.

Technically, the bounce that began a couple of weeks ago—while not officially over—is showing signs of weakening.  If stock markets shake off Friday’s drubbing and immediately rally at the beginning of next week, then the bounce could continue for a while longer.  The problem is that the weekly charts are still badly broken.  In fact, almost every major indicator is suggesting that the late July and early August crash was the beginning of what could be the next cyclical bear market, almost two and a half years after the last one ended in late March of 2009.  If so, then the psychology of the markets will change.  Instead of buying the dips, traders and investors will learn to sell the rallies. That means that this bounce which began several weeks ago may not have much more room to go.  If selling resumes early next week, then another strong leg down, perhaps to the mid 1,000 range, could begin.

Now that the August jobs report is out of the way, equity investors will not have any game-changing events—in the US—to react to, for several weeks. Sure, they’ll listen to the Obama speech on jobs, but nobody really expects much from it.  And yes, the Fed meets toward the end of the month, but much of the anticipated Fed stimulus (Operation Twist, or otherwise) is already being priced in by the markets; it was the primary catalyst behind the late August bounce.

That leaves Europe.  All eyes will be on the German court ruling (next week) on the legality of the bailout fund.  Others will be looking at the Greek negotiations over their second bailout, negotiations that seem to be breaking down.  Still others will be watching Italy and their rising bond yields as the ECB steps away from buying the bonds and suppressing the yields.  And everyone will be fixated on European inter-bank credit markets to see if one, or more, key bank is on the verge of falling into a funding crisis.  And there’s more.

But the bottom line is that Europe is now a powder-keg with multiple fuses……all of them lit.  Unless the troika—the ECB, the IMF, the EC—can kill each and every one of these fuses, there will very likely be an explosion, a financial explosion that will rock the world and its markets.

The US jobs report was bad. The risk of a new global recession is scary.  The fears of a hard landing in China are real.  But nothing will lop off 30% of the value of global stocks faster than a Euroland contagion.

Yet the odds of such an explosion have never been higher.  It could happen as early as next week, or as soon as next month.  Either way, Euroland does not have, it seems, another six months to live.

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