Euroland Deathwatch: Who’s Next?

November 26, 2011

Even though the week was shortened by Thanksgiving, the S&P500 managed to give up an astounding 4.7%.  Yes volume was light, not because there was no conviction, but because of the fact that the trading week was essentially only three days long.  Volatility confirmed the equity sell-off; the VIX jumped by almost 8%.  Breadth was also negative; several indicators such as new highs less new lows deteriorated.  Momentum was also decidedly bearish.

In macro news, the US data was mixed to negative.  While the number of existing home sales rose slightly more than expected, the median price fell almost 5% year-over-year.  The second revision for Q3 GDP growth came in far less than expected, at 2.0%.  Durable goods orders fell, but they fell less than predicted.  Personal spending rose less than expected; incomes rose slightly more.  Initial jobless claims were slightly worse than predicted, as was consumer sentiment.

Technically, the October bounce is officially over.  The downtrend that began on the daily charts is continuing at a dizzying pace. In fact, it’s very possible that we’ll see a bounce because stocks are oversold on a daily basis. More worrisome are the weekly charts, where the S&P500 is looking like it could head right back down to its October 4 lows and break beneath them.  The next important level of support would be around 1,010 the lows touched in the summer of 2010.  Should this level not hold, there is very little support anywhere in the entire 900-1,000 range.  The S&P would be in danger of zooming toward the levels reached in late 2008.

The reason for last week’s plunge was—as predicted—escalating the Euroland crisis.  Sovereign bond yields in Italy, Spain and Belgium exploded wider.  The yield on the Italian 10 year, for example, closed at 7.26%. It was under 5% as recently as August—just a few months ago.

In some ways, the markets are beginning to price in the sovereign and bank destruction of the rest of the PIIGS, especially Italy and Spain.  Is the demise of these two nations fully priced in? No, not at all. Especially when one considers the likely contagion effects.  It’s perfectly plausible that if Spain and Italy implode, then not only would their economies collapse into depression, but that the entire eurozone would be at risk of collapse.

And that’s precisely what the markets are just beginning to price in—the effects of a eurozone collapse on the strongest core economies: France and Germany.

How do we know this?  The same signals that raised red flags for the weakest of the PIIGS two years ago—widening sovereign spreads and CDS.

French government bonds, for example, have almost always traded very tightly with German Bunds.  Until now.  At one point last week, the French 10 year was yielding two times more than the German 10 year.  The markets are beginning to price in the effects of a collapse in Italy and Spain on France.  And if this spread to Germany keeps widening, the markets will be effectively pricing in the break-up of the entire eurozone.

The most grim indicator of the impending collapse of the eurozone began to surface last week.  German government yields began to turn up. Up until now, when PIIGS’ yields widened, money flowed into Germany, pushing down the yields on the Bunds.

For the first time, scared money is leaving the eurozone entirely.

Where is it going?  To the least ugly alternative, for now: the US. Treasury rates have continued to grind down, finally crossing under those of Germany.  And the US dollar has been grinding higher, in an almost perfectly inverse relationship with the euro which has been grinding lower.

Folks, this is getting ugly.

Is this it, the end of the eurozone, right here, right now? Probably not. It would be very surprising if the financial and political elites did not pull another rabbit out of a hat, if only to buy some more time before the eurozone ultimately implodes.

But this is only a matter of timing.  Today, it seems almost certain that, sooner or later, the eurozone will collapse, and by doing so, a tsunami of financial and economic destruction will crush the rest of the world.

European Bank Run: Did it Just Begin?

November 19, 2011

Well that didn’t take very long.  Only one week after calling the Eurozone a “dead man walking”, we witnessed the global equity markets tumble—hard—due to a series of risk implosions in the Eurozone.  The S&P500 lost almost 4%.  Volatility rose almost 7% yet volume was moderate, as if to suggest that true panic selling had not occurred, not yet.

While Euroland macro data was downright recessionary, the US data was mixed, for now.  Producer prices rose slightly less than expected. The same thing happened with consumer prices.  Industrial production was slightly stronger than predicted.  Initial jobless claims were just under 400,000 but as many insightful analysts point out, the drop in claims has more to do with folks losing benefits, rather than with these people getting jobs. The Philly Fed survey disappointed, and the index of leading indicators came in a bit stronger than expected.

Technically, the downtrend has returned in the S&P500, in the daily charts.  In other words, the strong bounce that dominated October looks like it’s been killed.  The key question is whether this downturn will turn into something ugly, or will it merely be a minor pullback?

And for clues to the answer, we turn to the source of last week’s selling, the eurozone.

Two weeks ago, Italy’s sovereign debt market began to implode, meaning that bond prices melted down and bond yields skyrocketed. As if this wasn’t problem enough, last week several other non-core European states joined the bond market meltdown party.  Spain, for example, saw its bond yields soar to new crisis highs.  And the big problem is that if Italy—the third or fourth largest national borrower in the world—is too big to save, then certainly the combination of Italy and Spain are also too big to save.  Together, if they melt down completely, these two bond markets will almost ensure the collapse of the eurozone.

To add insult to injury, the investors in these wobbly government bonds—mainly large banks in Europe (and around the world)—are also starting to teeter.  French banks, German banks, Italian banks, Spanish banks, British banks, and even US banks were getting slaughtered in their respective markets—both from the equity and credit side.

And there’s more.  As more of the eurozone begins to suffer from financial contagion, the two most important “core” sovereigns have begun to teeter.  France’s government bonds began to sell off, and sell off severely…..especially last week. Investors are worried, rightly so, that France is no longer a triple A credit risk, and are fleeing before a downgrade materializes and far more severe losses are imposed in the French bond market.

Finally, even Germany has begun to feel the pressure.  Investors are wisely asking—if can no longer assist Germany to prop up the rest of the PIIGS, can Germany go it alone?  Sadly, but correctly, the answer seems to be no.  And this is being expressed in Germany’s CDS spreads which have steadily been widening, especially over the last two weeks.

What’s also interesting is how the global media is finally starting to drop hints that something awful is brewing in Euroland.  Here are some very fresh comments from around the world:

“Many investors are no longer just fretting about the possibility of a default here or there. They are now starting to worry about the chances of the euro itself breaking up.” (Financial Times)

“The euro is still relatively stable but bond markets are screaming distress. “One of them is wrong. We suspect the bond markets are right” ” (Financial Times)

“The big danger for some investors and strategists is that eurozone bond markets might be broken beyond repair. Matt King, a credit strategist at Citi, thinks the point of no return was passed long ago. He compares the situation to the triple A collateralised debt obligation market in 2008 when investors rushed to sell at almost any cost. But the scale of the problem is bigger than in 2008.” (Financial Times)

“Nervous investors around the globe are accelerating their exit from the debt of European governments and banks, increasing the risk of a credit squeeze that could set off a downward spiral.” (New York Times)

“Experts say the cycle of anxiety, forced selling and surging borrowing costs is reminiscent of the months before the collapse of Lehman Brothers in 2008.” (New York Times)


Several times over the last year, we’ve suggested that observers get some popcorn, and get ready for the financial fireworks that would soon explode around the world.

Perhaps, instead, now is a good time to put on a seat belt!

Eurozone: Dead Man Walking

November 12, 2011

The S&P500 went on a wild roller coaster ride last week, closing on Friday with a 0.85% gain for the week.  Volume was very light. Volatility was virtually unchanged.

The big story of the week was Italy, as predicted here.  Essentially, the nation’s bond market blew up, and was rescued from a total collapse by the European Central Bank, which created money to buy up Italian bonds.

And by the end of the week, two governments had fallen.  Greece lost its prime minister and so had Italy.  In their place, two “technocratic” governments will assume power. And exactly what will change? Precisely nothing. The two replacement governments are blatant puppets of the financial elites; in fact one, the Greek leader, is a career central banker.  So they will actually accelerate the enactment of austerity policies, policies that will further punish the Greek and Italian societies, for the sole purpose of rescuing the banks that loaned money to Greece and Italy.

And as the beatings continue, the economies will further deteriorate, and the debt loads will further expand.

These two states are on a highway to hell, and nothing that just happened—politically—will prevent the impending disaster.

Meanwhile in macro-land, it was a light week.  While consumer credit jumped, all of the increase came from federal student and auto loans. Wholesale trade dropped, which is a bad sign for upcoming GDP growth reports.  International trade, while still abysmally subtracting from GDP, was slightly less bad than expected. Initial claims were just under 400,000, but as always will be revised higher next week. Import prices were much higher than forecast, which will also hurt upcoming GDP data.  And consumer sentiment improved slightly, but was still 25% below its 30+ year average level.

Technically, the S&P500 has still not broken the downtrend that began in early May.  The S&P has not jumped well above the 1,300 level needed to break this downtrend.

Interestingly, the S&P500 is essentially UNchanged for the entire year. Investors in virtually any other asset class—from Treasuries, to commodities, to high yield bonds, to investment grade bonds—have earned more year to date.  Even more interestingly, the S&P500 is today essentially where it was in the late 1990’s, almost 14 years ago. So the S&P has been dead money for many investors, for a very long time.

A few days ago, internationally renowned economist Nouriel Roubini published an essay in Reuters in which he argued that the eurozone’s disintegration is no longer a risk, but an event that can no longer be prevented.

Amazingly, Dr. Roubini published papers and gave speeches in 2006 arguing that the risks of a Eurozone disintegration were far higher than most experts understood.  But what’s most amazing is that the risks that Roubini warned about over 5 years ago are precisely the issues that are now leading to the eurozone’s death.

The heart of the argument is that—politically—the Eurozone will not do what is necessary to save itself.  Namely, it must integrate fiscally and politically (to boost growth and control debt) .

What is happening, instead, is recessionary deflation.

And the nation-state at the center of the impeding break-up (ie. the tipping point) is Italy.  Italy, according to Roubini, is “too big to fail, too big to save, and now at the point of no return”.  Therefore, “the endgame for the eurozone has begun.”

First, we’ll see defaults.

Then, we’ll see exits.

And finally, we’ll see the break-up of the monetary union.

So as the world breathes a sigh of relief that two of the PIIGS have changed governments, Roubini reminds us that it’s too late.

The eurozone is a dead man walking.

Italy….the Elephant in the Room

November 5, 2011

Last week, the S&P500 gave back about 2.5% in another volatile trading period. The VIX index jumped up 23%, yet volume was moderate.  The upward momentum, that was created in the strong October bounce, seemed to weaken.  Market breadth in the bounce also weakened; the number of stocks setting net new highs declined.

On the economic front, there were quite a few releases.  Chicago PMI met expectations.  ISM manufacturing missed expectations; even more critically, ISM services also missed.  Since the ISM reports are some of the most important leading indicators of economic growth, these two misses paint a bleak picture of the economy, suggesting that a recession is now more likely. Initial jobless claims were slightly better than expected, as were factory orders.  The big number of the week—the October jobs report—missed.  Only 80,000 jobs were created vs. the 90,000 that were expected. What’s worse is that the BLS’s (Bureau of Labor Statistics) birth/death model added a mythical 103,000 jobs, so that eliminating these fictitious jobs (even after adjusting for seasonality) means that the TRUE jobs picture was far more bleak—jobs were actually LOST in October.

The major catalyst of last week’s roller coaster ride in risk markets was Greece and its internal struggle to impose austerity onto its own citizens, austerity designed to bail out the European banks that lent money to Greece.

Risk markets reacted to the possibility that Greece may not succeed in condemning its citizens to decades of harsh austerity, especially if they were to be given a chance to vote on it directly.

In the meantime, a monstrously greater threat has been growing in Euroland—Italy.  This distinguished member of the PIIGS has managed to rack up over $2.5 trillion in sovereign debt, more debt than in any other state in the Eurozone or in the European Union.  In fact, Italy has so much sovereign debt that only two nations in the WORLD have more—the US and Japan.

Over the last two years, the difference between what Italy pays on its debt and the rate that Germany pays on its debt (the spread) has been widening steadily.  The spread is a measure of the credit risk of the nation with the higher yielding debt. In this case, Italy’s spread has blown out to over 4.5 percentage points over the comparable German debt.

And that’s a problem.  The credit markets are now saying that Italy’s debt is far from risk free.  And this widening of the spread is exactly what happened to Greece, Ireland and Portugal before all three required bailouts.

The problem, more specifically, is that unlike the other three PIIGS, Italy’s massive debt load is too large to be credibly backstopped by, well, anyone in the world—the rest of the Eurozone, the EU, the IMF, the US, and China.

And while equity (and other risk markets) have been busy “bouncing” over the last four weeks, Italy’s debt problem—the elephant in the room—has been getting progressively worse.

Many economic experts are sounding the alarm, namely that Italy is fast approaching a tipping point, one that would almost certainly tip not only the Eurozone into an economic and financial crisis, but most likely the rest of the world as well.

And unless the ECB suddenly changes colors and decides to print hundreds of billions of euros (with which to buy up hundreds of billions of Italian debt), then the chances we’ll see such a disaster are getting to be uncomfortably high.

So while all eyes are on Greece, we really ought to be preparing for the much more devastating threat that ‘s brewing in Silvio Berlusconi’s back yard.