Background
The rally in EU stocks and the Euro began their latest rally in the summer of 2012 with the ECB’s announced new OMT program to buy supposedly unlimited amounts of bonds from any EU nation agreeing to submit to the ECB’s conditions for giving the aid.
These conditions are politically unpalatable, thus no nation wants this aid and the ECB has not had to spend a Euro thus far. It’s been nothing but verbal support. Yet, that was enough to restore confidence in Spanish and other GIIPS block bonds. Their yields fell, confidence increased, and the EUR began its rally based on this presumed reduced solvency threat.
Of course except for lower borrowing costs, based purely on confidence that the OMT program will work, the situation of the GIIPS nations has not improved, and indeed has deteriorated.
Events In Italy Threaten That Confidence
For reasons discussed above on Monday’s highlights, the rising risk of Berlusconi’s return to power means that Italian policies could again send Italian borrowing costs soaring to compensate for perceived credit risk. Of course, a lot can happen before and after the Italian elections, so Berlusconi’s return to power is far from certain.
Events In Spain Are The Big Threat
However the corruption scandal in Spain threatens the ruling coalition in Spain. For all its considerable faults, it remains the one most likely to continue to cooperate with the EU and avoid a bout of EU solvency crisis, or worse.
However it defies reason how markets can retain any confidence in long term Spanish solvency given the toxic combination of its deteriorating economy and utterly corrupt leadership. Highlights of Mr. Rajoy’s leadership include:
Within about a month, from May to June 2012, Spain
- denies its bank sector needs a bailout,
- pulls off its largest bank nationalization and bailout ever (Bankia’s 19 bln euro bailout)
- continues to insist that its banking system is “solvent” or in great shape,
- then suddenly, on the weekend of June 8-10m requests €100 billion from the EU to recapitalize its banks
- June 10: The day after getting the money, Rajoy admits the coming year will be “a bad one,” including further GDP contraction and rising unemployment
- Recently, Spain admitted that even after this bailout, some of its biggest banks have negative value (aka insolvent)
Then this past week, after denying all corruption allegations, he admits to at least some. He’s accused of receiving over 300k euros in illegal payments over the prior decade.
In sum, we have the current confidence in the EU’s recovery resting on the ongoing solvency and recovery of Spain, a broken economy that can’t repay its debts, run by leaders who consistently don’t tell the truth about their economy until they need another bailout. Markets believe that bailout will come when Spain accepts OMT conditions. However we’ve no clear evidence that Spain will agree to the OMT’s conditions. Why should it. So far the EU continues to bail out Greece due to fear of contagion, so why would it deny Spain, which is a much bigger contagion threat.
It’s so easy to just print more Euros. Heck, when faced with contagion threat, it looks almost like sound, responsible policy.
EU Crisis Complacency Firmly In Place
Given the negative events in the EU this week, the EUR had its first real down week since the start of the year. However most analysts agreed that with indexes at decade highs, risk assets such as stocks and the EUR were due for a normal (5%-15%) correction anyway, and that the pullback should be viewed as both temporary and as a buying opportunity.
Indeed investor confidence in the EU continues to improve, and hit an 18 month high on Monday
Complacency Justified?
As we wrote in our conclusion to our summary of all 2013 forecasts here, and in our subsequent weekly reviews and previews, we’re very skeptical about the prospects for stocks, risk currencies, and other risk assets to head much higher. Why? Here’s the short version.
1. Technical Resistance
Look what happened the last two times stocks were at these levels. We use the long term monthly S&P 500 chart below as an example of what happened worldwide.
Click to enlarge
I’m far from the only one to notice this. So if you doubt me, see here, for more from Nomura bank’s Bob Janjuah.
2. Is This Time Really Different?
Yes, but not in a good way. When risk asset markets peaked in 2000 and 2007, the fundamental picture was widely perceived to be very good. Growth everywhere, no EU or US sub-prime crisis, contagion was just a medical term, etc.
The current rally is not the product of actual wealth creation or even the belief that it’s coming. Rather it’s the result of coordinated central bank intervention causing asset price inflation through lots of real (or threatened) printed fiat currency and historically low interest rates forcing those seeking yield into riskier assets. This isn’t the place to go in depth into why this policy can’t last, but it’s widely understood that it can’t.
Me: scan links esp 130207-5 at top of page for bearish articles to support w/ few sentences
Of course, plenty don’t believe all is well. Some of the latest evidence includes:
- As we discussed in last week’s post here, after saying last summer that it was merely auditing its gold reserves held abroad to make sure all is kosher, suddenly Germany is repatriating its gold from foreign storage facilities. It claims there’s no issue of trust, of course.
- This move comes as part of a series of steps we mentioned in the same post here that Germany has been taking to prepare for future EU turmoil.
- We already know that Japan and the EU ex-Germany are struggling.
- As for the US
- Per David Rosenberg, Dow Theory Says To Be Bullish, But I Can Think Of 8 Reasons To Be Bearish
- Yet even Dow theory guru Richard Russell is skeptical about the upside potential:
Dow theory guru Richard Russell has alerted his subscribers that a Dow theory buy signal seems to be on the horizon. But he warns that there are other technical indicators that give him pause. “Wait, note that the relative strength index (RSI) is at its severe overbought zone for the first time in almost two years,” wrote Russell. (from businessinsider.com Thursday market wrap)
Given the above technical and fundamental picture, we remain unfashionably bearish, without even touching on geopolitical risks in Southeast Asia (Japan/China) and the Mideast (Israel/Iran/Syria/Egypt, etc).
