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!