NOTE: Every week or two I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive it at the same time as my clients. You can sign up at the top right hand corner of the website. I will also be posting the notes on my blog with a time delay from time to time.
Originally sent to clients Tuesday, September 13.
There can be no real bottom – just an emotional bounce – without some resolution to the European issues in general and to Greece in particular.
– Jim Cramer Monday (Sept 12) on Mad Money
BNP, Societe Generale and Credit Agricole together hold nearly $57 billion in Greek sovereign and private debt…. French banks also held more than €140 billion in total Spanish debt and almost €400 billion in Italian debt as of December, according to the latest figures from the Bank for International Settlements. If either of these latter two governments were to default, their banking systems could collapse and take the French system with them.
Fears about Europe are again dominating markets. The basic problem is simple: Greece and the other PIIGS – Portugal, Ireland, Italy and Spain – have too much debt. They are dependent on new bond buyers in order to pay off old ones and continue operating. As investors key in on the issue, they sell the bonds and demand higher interest rates which intensifies the problem by increasing interest costs.
The concern is the impact on European banks which own a lot of this sovereign debt and have additional exposure to these troubled countries. The big three French banks – BNP Paribas, Societe Generale and Credit Agricole – are currently in the spotlight due to concern about their exposure to Greece. Ireland and the banks exposed to it were the focus last November (“Top Gun FP Client Note: Europe Leads”, December 2, 2010). Greece is a small economy and a default there would likely be contained. The real fear seems to be the much bigger economies of Italy and Spain.
The European Central Bank last month expanded its support for European bond markets by buying Italian and Spanish sovereign debt (ECB Govt Bond Purchases Chart Attached). This move was opposed by Germany’s top ECB representative, Jurgen Stark, whose resignation last Friday rattled financial markets (“Banker’s Exit Rattles Markets”, The Wall Street Journal, Saturday, September 10, A1). Germany is the economic backbone of the EU which probably cannot survive without its support. The European Financial Stability Facility (EFSF) is the other option for bailing out troubled countries.
The situation is analogous to the subprime crisis which played out in the US in 2007 and 2008. The banks were sitting on huge amounts of subprime mortgages and mortgage backed securities. When the housing market started to tank, so did the value of these mortgages and mortgage backed securities. The banks had to take huge writedowns which impaired their capital. Investors worried if the banks were solvent which further intensified pressure on their business.
The last few years have been the most volatile for all of recorded history.
On Monday, The New York Times ran a front page story on increasing stock market volatility in recent years. The charts below show the increase in 2% and especially 4% intraday and closing price swings compared to previous decades. Since the start of the century (2000), intraday price swings of greater than 4% have happened 6 times more frequently than they did in the previous 4 decades.
This has certainly been the case the last few weeks with stock markets regularly reversing intraday as they did, for example, yesterday when the S&P surged 20 points in the last two hours to finish in the black on rumors of Chinese interest in buying Italian bonds.
As far as I am concerned, any trading between 1100 and 1230 on the S&P is just noise. 1100 is the intermediate low (August 9) established in the wake of the S&P downgrade and 1230 is the high of the reaction rally (August 31). We have been lurching up and down in that range on average volume for the last month. In my opinion, things won’t get interesting again until one or the other of those levels is tested.
NOW IS THE TIME TO INVEST WITH TOP GUN: If you have been thinking about investing with Top Gun, now is a good time to give me a call or send me an e-mail.
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