European Lost Decade?

Seemingly out of nowhere, the S&P500 rocketed 7.4% almost retracing the losses from the prior two weeks. Volume was moderate, and volatility fell substantially.


The markets cheered to an emergency intervention by the world’s leading central banks, which banded together to provided slightly cheaper dollar funding to the ECB so that it could then feed the dollars to the dollar-starved banks within the eurozone.

Almost universally, the world’s leading financial and economic experts expressed surprise at the equity markets’ reaction, noting that the substance of the action was almost trivial. And to support the argument that stocks over reacted, almost all other risk markets reacted far less seriously. US Treasuries for example, in a true risk-on environment, would be expected to sell off massively. Yet they barely budged, suggesting that the wise folks in credit land are far less optimistic about this central bank move.

In fact, many have argued that for the central banks to throw out another crutch to capital markets, the central banks must have been very worried about how fragile the European financial system actually is. Some funding statistics were flashing red, suggesting that conditions were returning to the near meltdown state last seen in 2008. What’s scarier is that these funding sirens were not turned off by the central bank scheme. These funding stresses are still flashing red.

Economic data were mixed in the US but decidedly bearish in the rest of the world. New home sales disappointed. The Case-Shiller home price index disappointed. Chicago PMI beat expectations. Initial jobless claims crept back up over 400,000. ISM manufacturing came in ahead of expectations. Nonfarm payrolls missed expectations slightly. The headline unemployment rate beat, but only because three hundred thousand unemployed folks abandoned the workforce. Reflecting similar trends, the labor force participation rate fell to a new secular low, the lowest rate since 1983. Average hourly earnings fell; they were supposed to rise. And the average duration of unemployment rose to 40.9 weeks, the highest level ever recorded.

In Europe, PMI readings across the major eurozone  states are all in contraction territory, almost confirming that Euroland is already in a recession.  China’s most recent PMI also plunged into the 40’s, which is a stark warning that its economy is about to hit the reefs.  And Japan’s latest export figures have been plummeting.

Technically, the S&P in merely one week has completely eliminated its oversold status, from the prior week.  As suggested here last week, a bounce was due.  We more than got one.  And given how the markets are now reacting almost perfectly in concert with government interventions, it’s  now very difficult to tell which way the next couple of weeks are headed.  If hints of further intervention keep arriving, then there can certainly be more upside movement in stock prices.

But sooner or later reality—or gravity—will kick in. It always does.

In fact, one of the world’s prominent experts on global financial and economic matters, Willem Buiter, recently published his outlook for Europe, and it was not good.

Simply put, Europe will either choke slowly for the next ten years, or it will die suddenly of a heart attack.

Assuming Europe doesn’t die of sudden cardiac arrest, Buiter condemns the continent to recession over the next two years.  And eurozone output won’t recover to its 2008 level until after 2016.

As a result, Buiter believes that Europe overall picture will be “similar to, or below” Japan’s Lost Decade.

Terrific. And keep in mind, Buiter is assuming that Euroland will not implode in the meantime.

So the stock market can merrily whistle past the graveyard, as it did last week, and several times in late 2007 and early 2008. But one of these days, weeks, or months, the policy gimmicks will no longer fool even the perma-bulls in the stock markets.  Credit markets seem to better understand the downside risks, and sooner; stock markets always seem to be the last to ones to “get it”.

But “get it” they will. They always do, in the end.

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