The market woke up today to the realization that Greece really isn’t the problem. While the world has been focused on Greece they weren’t paying attention to the real problem child – Italy. Now, that interest rates on 2-year Italian bonds have soared past 7% the realization that Italy is effectively “toast” has rocked the markets.
This led to a blood bath in the markets today as the markets continue their record streak of daily triple digit moves on the Dow. Volatility in the markets, both up an down, have been nausiating for individuals trying to be long term investors. First there are five straight months of negative market action dragging the S&P 500 down almost 20% to only see it rebound by 20% from the lows in one month. That one month rally pushed the S&P 500 index to a recent peak of 2 standard deviations from the 50 day moving average. That push higher, like stretching a rubber band as far as you can in one direction, had reached a point to where a correction was very likely and only a catalyst was needed. Italy was the match that was thrown at the can of gasoline.
It is now critically important that the index holds on to support around the 1220 area and doesn’t revert back onto a short term sell signal. I said recently on the radio program that even though a “short term” buy signal was in place, after the rally in October, that it was not a “healthy” one due to the excessively weak state of the domestic and international economies. While today is a stiff reminder of how quickly gains can be taken away nothing of substantial technical consequence has happened and therefore DOES NOT change our recent stance on the market…for now.
With that being said – what caused today’s rout? The real problem is that the Italian bond market is a $2.2 Trillion debt market and far too large for the ECB, or the yet to be funded European Financial Stability Fund (EFSF), to bail out. This, of course, is only the tip of the iceberg when you realize that Ireland, Spain, Portugal and Greece are all just a hiccup away from a financial crisis themselves.
The “contagion” effect is already spreading throughout the Eurozone and as rates rise across Europe funding becomes a real issue and already the ECB has two recently failed bond auctions that really show the concern by lenders to Europe. With the Eurozone already very weak economically rising interest rates will also push the various economies into recessions which will reduce income further exacerbating their ability to pay their debts. The issue of trying to solve a debt crisis with more debt, and leveraged debt at that, is a foolish experiment when real reforms are what is needed.
Of course, the real issue is that we continue to try and bail out the financial system because defaults by Greece, Italy and Spain, if they were allowed to happen, would trigger CDS (credit default swap) events that would effectively bankrupt the major banks. This leads us to doing more of the same rather than resolving the issues that need to be critically addressed and soon.
Therefore, we are going to certainly have more crises coming out of Europe, and ultimately America, as the world is now globally intertwined with each other and these events are shared by all. The excesses that have been accumulated over the last 20 years are now coming home to roost and the leaders of the various countries need to come to grips with the reality of the situation and begin to take real action. Otherwise, and this is already starting to happen, the credit markets will begin making decisions for them and that is NOT a good thing for anyone. Time is running out.
As we continue to churn through this secular “bear” market period and, much more importantly, the debt deleveraging cycle, crisis events and recessions will be much more frequent. The longer that we continue to try and bailout issues rather than resolve them the more impactful the eventual unwinding will be. For individuals in 2000 that were looking to retire the blow up of the Tech bubble in 2000 set them back. The bursting of the credit/real estate bubble in 2008 was worse and set them back further. Now, 12 years later, those same individuals are still hoping to retire and the resolution of a global contagion of debt and deleveraging in the next 6-18 months will likely be larger set back than before. Time is commodity that investors only have a finite amount of.
This is why we continue to recommend an investment strategy that focuses on income over growth, capital preservation over risk and “reality” over “hope”.