55 Trillion Reasons Europe is Doomed

October 29, 2011

On the heels of the announcement of Euroland’s “solution”, the S&P500 moved up another 3.8% last week.  This brings the S&P back to where it was, approximately, in July—still over 6% below it’s highs of the year.  Volume was moderate.  And volatility (as measured by the VIX) is still quite elevated…meaning things have not returned to normal.

In macro news, the US economy is still struggling.  Home prices are still falling, per the Case-Shiller index which showed a further 3.6% year-over-year decline. New home sales are scraping bottom, and what’s worse: median prices fell over 10% year over year. Pending home sales plunged almost 5%. Consumer confidence is collapsing.  Durable goods orders slipped. Initial jobless claims are still stuck above 400,000. Growth in personal income ground to a virtual halt, while spending continued–this means that households are draining their savings to make ends meet. Not a good sign, and not something that’s sustainable.

Technically, the S&P500 is extremely overbought on a daily basis.  A pullback, even a modest one, is VERY overdue and very likely. On a weekly basis, the downtrend that began in May is not broken. In fact the possible upside “bounce” targets, that we outlined a few weeks ago, within this overall downtrend, are only approaching:

“..the S&P could continue to bounce for a another 5+% (up to 1,300) before running into stiff resistance.  In other words, there is no good reason why this bounce must come to an end anytime soon.”

A few days ago, Oliver Sarkozy—the brother of the president of France—published a piece in the Financial Times.  In it, laid out a strong argument why Europe’s leaders, together with the ECB, must take huge steps to confront the financial crisis in Euroland.

The essence of the argument was that Europe is SO over-leveraged in its banking system, that the leaders cannot afford not to act boldly….and fix the problem.

But another take on this argument is that Europe is SO over-leveraged, that it’s beyond saving.  The hole that it dug for itself is simply too deep to crawl out of.

How deep is the hole?  Sarkozy points out—horrifically—that the European banking system alone (ignoring sovereigns and households) have $55 trillion of debt, that must be serviced by a $15 trillion GDP. This compares to only $13 trillion of debt in the US, which services this debt with a GDP that’s also $15 trillion.

The European banking system is over FOUR times more leveraged than the US banking system.

But that’s not all.  Whereas in the US only $3 trillion (of the 13) is funded by risky short-term wholesale funding markets, in Europe, $30 trillion (of the 55) is funded by risky short-term sources.

And there’s more. Non-banking (think corporations and households) hold a HUGE amount of debt as well—about 150% of GDP.  That’s another $22 trillion of private debt that must be serviced by the SAME $15 trillion of European GDP.

And there’s even more.  Public, or government, debt in Europe is at least 100% of GDP (on average). So this adds another $15 trillion of debt….once again, debt that must be serviced by the SAME $15 trillion of GDP in Europe.

Add it all up and you’ve got over $90 trillion of explicit, interest-bearing debt…..ALL of which must somehow be serviced by that comparatively TINY $15 trillion of GDP.

Europe is horrifically over-indebted.  It’s far more indebted than the US, which itself is over-indebted.

And as far as “solutions” go, there’s nothing—with any realistic chances—that can happen, whether organically or from top-down “plans”, that can make this massive over-indebtedness go way.

The only way it will go away is through a deflationary collapse, OR through a hyper-inflationary money-printing program….which would also lead to collapse.

Euroland is doomed.  Sooner, or later, Euroland will collapse.

Deathwatch in Euroland

October 22, 2011

The S&P500 inched up about 1% last week, all of that net gain coming on Friday alone.  Volume was moderate, and volatility edged up about 11%.

Economic news mostly negative.  The Empire State Manufacturing Survey was much worse than expected.  Producer prices rose more than predicted.  Consumer prices were in line.  Housing starts rose, but not because single family home starts beat expectations; instead, the entire beat came from apartment starts. Housing permits disappointed.  Initial jobless claims stayed above the critical 400,000 recessionary threshold.  Existing home sales fell more than expected; median home prices fell 3.5% year-over-year. While the Philly Fed beat expectations, Leading Indicators missed.

Technically, the S&P500 is very over bought on the daily charts.  Even a moderate pullback seems very overdue.  On the weekly charts, the S&P’s downtrend is still intact. In fact, as mentioned here several weeks ago, the S&P could rise above 1,300 without violating the downtrend that began in late April.

So what’s going on?

Two of the formerly detailed forces are still in effect:

1. The US and global recession, which seemed like it was about to arrive, could be delayed, slightly at best.  But that delay is enough to offer the Wall Street shills ammunition to argue that perhaps no recession will arrive.  That’s wrong.  But in the meantime, this glimmer of hope helps push stocks higher.

2. The deathwatch in Euroland is not hitting home the way it did a few short weeks ago.  Make no mistake, Euroland is a terminal.  If Greece was the fuse, Spain and Italy will be the actual bombs that blow up the entire currency project. And last week alone, Italian and Spanish government bond yields continued to creep higher and higher. Since together, these two states have about $2 trillion in sovereign debt, a further rise in yields will—-without a doubt—destroy the euro zone, because there simply IS NOT enough money, public or private, available to fund these sums if the credit markets abandon Spain and Italy.  The jump in yields is a sign that the run is already happening, slowly. Meanwhile, silly claims that European leaders are planning to craft plans to “solve” this debt problem were, amazingly, enough for the equity markets to push prices higher.

3. The new twist comes from the Fed.  At the end of the week, two Fed governors made speeches that strongly hinted that the Fed was ready to launch QE3 if conditions required it.  Since the equity markets have already bounced up substantially over the last two weeks, and since inflation is running higher than the Fed’s well-known policy target level, the Fed would likely need to see more “damage” in the markets or in the real economy before launching another round of money creation to buy securities.  But once again, fast traders and algorithms jumped on this message as a sign to buy, buy, buy.

A plausible scenario goes as follows:

Over the next two months, the recessionary forces will reassert themselves, driving estimates of future corporate profits down.  This will begin another wave of stock price sell-offs, perhaps in a reasonably orderly manner.

Then, if Greece does hard default, or a more serious escalation of panic develops in Spain, Italy or even France, a disorderly panic sell-off could add to the existing price erosion, price erosion arising from the developing recession.

Finally, after the markets get hit badly enough, Ben Bernanke will formally announce QE3, perhaps in conjunction with European Central Bank (BoE, BoJ) credit programs.  This will arrest the free fall, and deliver another multi-month rebound in stocks and other risk assets.

Will this be the end of all the risk, all the problems, etc.? Of course not.

But it could kick the can down the road for another six months or so. And then the root problems will rear their ugly heads again, leading the next phase in the ongoing global financial crisis.

What Just Happened with Equities?

October 15, 2011

The S&P500 soared almost 6% last week, as stocks continued to build on the prior week’s gains.  That’s the good news.  But there’s lot’s of bad news and a lot of head scratching to try to explain what just happened.  For starters, volume was VERY light; this means that new buyers did NOT rush in to buy stocks. In fact, all surveys of retail money flows showed that average investors continued to pull money OUT of stocks.

There’s more to this, but first some macro news.  The trade deficit is still horrible; and with China, it’s near record highs.  Initial jobless claims rose to 404,000 from last week’s 401,000.  Retail sales (excluding autos and gas) met expectations.  Consumer sentiment fell badly; instead of rising to 60.0 as expected, it fell to 57.5.  What’s worse, the “expectations” component fell to 47.0 which is the lowest reading since 1980!

Technically, the S&P on a weekly basis is still in a cyclical bear market, the two week rally notwithstanding. On the daily charts, the S&P is severely over bought.  It is very ripe for a pullback.

What could spark such a pullback?  Well, it could be tied to the reasons behind the explosive two week surge.

One of the strongest drivers behind investors’ desire to take on more risk—for example, by purchasing equities—is a rise in the value of the euro vs. the US dollar.  The correlation is so strong that many algorithmic computer trading programs use it as a key signal to buy or sell stocks.

The day the stock rally began, the euro surged, and as it did, more programs piled on to buy more stocks and more often, cover short positions in stocks.  Short covering—-as opposed to new money entering to buy—explains why volumes fell as the stock rally gained momentum.

But what could have caused the euro to rally?

According to Deutsche Bank, via Zero Hedge, the European (especially the French) banking system was in full panic mode when the rally began.  It was suffering from a horrible funding run, where existing funding sources were refusing to continue lending.

As a result, these banks were being forced to sell assets, and since European asset prices were so depressed, these banks sold assets that held the most in the world at the time—US dollar assets.

And to bring these dollars back home to pay off departing lenders, the banks had to convert these dollars into Euros.

The result?

The euro goes up. The dollar falls.

And just like that, a huge BUY stocks signal is generated.  The global trading robots take over, and a massive rally “comes out of nowhere”.

Meanwhile, don’t forget, the European banking system is in panic mode.  The evidence? French bond yields were surging, especially against the German 10 year Bund.  Other core European credit markets kept on deteriorating.  And critically important Spanish and Italian government bond yields were blowing out as well, with Italian yields nearing the catastrophic 6% threshold once again.

The world was fooled.

The world began to falsely believe that the European debt crisis is on the road to healing (it isn’t) , and that THIS wast he reason behind the rally.

Instead, the real reason could have been the OPPOSITE.  The European banking system is falling apart and as a result, inadvertently caused the US dollar to fall as it tried to save itself from imploding.

As Zero Hedge points out, once the world understands what just happened, the entire bounce could reverse itself in a matter of days.

Nothing has been fixed.  Nothing can be fixed, anytime soon.

Stocks are extremely vulnerable to a violent correction.

Global Financial Meltdown?

October 8, 2011

Finally, we see a relief rally, with the S&P500 jumping a little over 2% last week, but not after tumbling to a new 2011 low of 1075.  This coincidentally was almost exactly 20% below the highs of late April, and thus the point at which a new bear market would officially begin.

Volume was strong, but much of that was also related to the strong intra-day sell-off that touched new lows.  Volatility fell, but it’s still uncomfortably high.

In macro news, the news was mixed, at best.  ISM manufacturing was not as bad as expected, but still uncomfortably close to falling below the deadly 50.0 mark.  Factory orders fell.  ISM services met expectations, but its employment component fell to the lowest point in 18 months. Initial jobless claims are stuck above 400,000 as usual.  Consumer credit collapsed, falling by almost $10 billion, when it was expected to rise by almost $10 billion.  September’s nonfarm payrolls came in slightly better than expected, but the beat was due to a one-time event.  Headline unemployment remained stuck at 9.1%, but the broader measure (U-6) shot up to 16.5%, which is higher than it was last September (2010).  What’s worse, the average duration of unemployment crept up to 40.5 weeks, which is another all time high.  And the employment-to-population ratio (perhaps the most important gauge of the US employment situation) remains stuck near multi-decade lows at 58.3%

Technically, on the weekly charts, the S&P500 is in a strong down trend that began in May.  A simple 2% bounce  did nothing to even come close to breaking this down trend. On the daily charts, the S&P is at a crossroad.  If it breaks back down next week, the recent bounce will break down and the larger down trend would resume.  But it’s also possible that the bounce continues for another week or two, before breaking down.

Last week, in an interview on the BBC, an advisor to the IMF, Robert Shapiro, blurted out a stunning bit of truth:

“If they can not address [the financial crisis] in a credible way I believe within perhaps 2 to 3 weeks we will have a meltdown in sovereign debt which will produce a meltdown across the European banking system. We are not just talking about a relatively small Belgian bank, we are talking about the largest banks in the world, the largest banks in Germany, the largest banks in France, that will spread to the United Kingdom, it will spread everywhere because the global financial system is so interconnected. All those banks are counter-parties to every significant bank in the United States, and in Britain, and in Japan, and around the world. This would be a crisis that would be in my view more serious than the crisis in 2008.”

Meltdown?  Check.

Global?  Check.

Worse than 2008?  Check.

And who is Robert Shapiro?  Well, aside from being an advisor to the IMF, he was formerly the US Undersecretary of Commerce.  He has a PhD in economics from Harvard.  He has overseen the US Census Bureau. He was a fellow at the Brookings Institute, Harvard, and the National Bureau of Economic Research.

Does he know what he’s talking about?  Check.

It’s coming folks.  Whether it’ll happen in 2 to 3 weeks, 2 to 3 months, or sometime after that.  There WILL be another global financial crisis, and it WILL be worse than 2008.


October 1, 2011

The S&P500 crept lower, slipping almost half a percentage point last week, on moderate volume. Volatility also crept higher, up about 4%.  The month (September) ended a quarter that was the worst since early 2009….during the depths of the last market meltdown.  Also of note, September’s loss was the fifth consecutive monthly loss in the S&P500.

Something’s changed in the character of the stock market.  Buying on the dips has not been working. Instead, selling on the rallies has.  This is a trait of bear markets.

In macro news, the data were mostly poor. New home sales were weaker than expected. Consumer confidence also disappointed; but consumer sentiment was better.  Durable goods orders were much worse than experts predicted; instead of rising 0.2%, they fell 0.1%.  Initial jobless claims fell just below 400,000. But this was so unexpected that the BLS itself cautioned that the results may not be accurate.  Personal income was the shocking disappointment of the week. Instead of rising slightly, it fell…..for the first time in a long time.  And the personal savings rate fell to the lowest level in two years, suggesting folks are not saving because they need to pay for everyday basic needs.

Technically, the two month consolidation—which began after the late July and early August plunge—seems to be resolving itself to the downside.  The 50 day moving average has not functioned, beautifully, as a source of resistance.  All breadth and momentum indicators are still very bearish….on both the daily and weekly charts.  More ominously, other non-equity markets are just now starting to fall apart. Copper, corn, precious metals, oil and others are all imploding.  These markets—while affected by equity markets—also feed back into equity markets, and in this case, will provide additional downside pressure.

What’s causing the global equity markets to keep melting?

Well, we all know about Euroland. Yes, it’s a time bomb waiting to go off.  But it’s not the only reason risk markets are crashing.  The other, not totally related, factor is the pricing in of a US and global recession.

It’s becoming more clear that the US, Euroland, Asia, Latin America and Australia are all slowing down to the point where they will soon (in they haven’t already) be in recession.

The ECRI, which has successfully called all of the recessions of the last 20 years (and more critically, has not erred by calling for recessions when they didn’t actually happen) just announced that the US is entering into bad recession.  What’s worse, there’s nothing policymakers can do to stop it now.

And even worse than that, this recession is NOT predicated on an implosion in Euroland.  If or when THAT happens, this recession….according to the researchers at ECRI…..will become even more severe.

Good times!

On another note, BCG—one of the world’s premier consulting firms—recently released a paper arguing that the root cause of the ongoing global recession is the massive excess debt build up that peaked in 2007.  What’s more interesting is that BCG is putting a figure on the amount of debt that must be reduced in order for the world’s major economies to resume sustainable growth.

BCG simply reverts back to a sustainable debt-to-GDP level of about 180%.  As a result, their researchers argue, that over $20 trillion in excess debt must be eradicated….in the world’s major economies.

That’s funny.

Because this author argued that the US economy alone must shed about $20 trillion in debt—for the very SAME reasons that BCG employed.

When did world-renowned BCG publish its paper?  September 2011.

When did this blog publish it’s virtually identical argument? December 2008.

Almost THREE YEARS earlier!