Cyprus…..a Market Tipping Point?

While the week ended on another Fed-inspired high note (the S&P rose 0.6%), the weekend began with a stunning development in Cyprus, a member of the euro. More on this below. US equity market volume was abysmal, as one would expect when retail participation is missing (ICI confirmed another weekly OUT-flow by retail investors from US stock markets).

Meanwhile, the US economic ‘recovery’ continues to struggle to gain any serious momentum. Although retail sales (ex-autos) rose more than expected, the actual ‘un-adjusted’ sales FELL, for the first time since 2010. Import prices rose more than expected; this hurts profits and GDP growth. Producer prices rose more than expected. Consumer prices also jumped more than expected; this affects the ability of consumers to buy more goods, which in turn, hits economic growth. The Empire State manufacturing survey rose less than predicted. And finally, consumer sentiment collapsed. In fact, it missed expectations by the greatest margin ever.

Technically, the S&P ended the week even more overbought and over-bullish than it was the week before. Being so stretched, the US equity markets have become extremely vulnerable to even the slightest excuse for a sell-off. And as the weekend began, Cyprus could develop into that slight excuse, and possibly much more.

What happened? Simple—the EU for the first time since the crisis began several years ago, has decided to impose LOSSES on bank depositors. Normally, bank equity holders and then bank bond holders take the brunt of banking writedowns, not bank depositors who understandably do not believe that they are speculating of even investing in a bank. Instead, they are simply storing or warehousing their money for safe-keeping, almost always giving up all chances of significant returns on their money, in exchange for the guarantee that their deposits will be safe.

To add to the insult, the Euro area offers (normally) a guarantee that all deposits, in Euro area banks, under 100,000 will be protected. Even worse, as late as Friday the day before the confiscation was announced, the government of Cyprus publicly insisted that depositors will be protected.

And then boom, the opposite happened.

What are the implications? Well, the most important implications will be in the rest of the Euro area, not Cyprus which is a tiny part of the entire project. The bottom line is that the Euro leaders are gambling with the entire Euro area financial system. If depositors in Spain , Greece, Italy, etc. begin to worry (and after this bombshell in Cyprus, why would they NOT worry?) that their deposits in their respective banks may also be at risk of confiscation, then they would naturally begin to pull money out of their banks.

This would trigger a bank run, not just on one bank, but on the entire Euro financial system. If this run gathers steam then not only would global equity markets plunge, but the entire Euro project would almost certainly blow up.

Cyprus could be a major tipping point, for markets and for the global financial system.

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