Euroland Deathwatch: Who’s Next?

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.

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One Response to Euroland Deathwatch: Who’s Next?

  1. MarkS says:

    Scary stuff Paul… Watching the bonce but agree on the downward trajectory.

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