Greece, US Economy, Markets…Road to nowhere

Last night’s price action reinforced just how tenuously poised markets are at the moment. The Greek debacle continues with European politicians and central bankers so removed from the action that the Greek population are taking things into their own hands. As if it was ever going to be any other way. At the same time the data in the US continues to weaken and it seems to us that if the US isn’t back in recession then it is very close.

At the end of trade the Dow Jones was down 1.48% to 11897, the S&P off 1.74% 1265, the AUD off 1.02% to 1.0576, the EUR down 1.85% to 1.4179 and the VIX Equity volatility index was up 16.76% to 21.76 and looking it’s heading toward the mid 20’s level we highlighted in the weekend wrap. So it is a dangerous time in markets.

Let’s look at the European and US situations separately and then try to tie them back to what they might mean for markets at home and abroad.

Greece:

There are no pleasant options for Greece and I really struggle to see how they won’t eventually default in some way shape or form. The Northern European politicians and central bankers can sit and pontificate in their ivory towers as much as they like about what constitutes a default but at the end of the day the Greek population and politics will determine what happens unless Europe opens its Cheque book.

Look at what happened overnight, we had a day of action in Greece, Greek Banks were downgraded to B ratings, French banks are getting dragged in for downgrades now because of Greek exposures, the Prime Minister effectively resigned around lunchtime only to come back later in the afternoon and say he was forming a new government.

All the while it is clear there is no appetite in the rest of Europe to actually share any of the burden by kicking in more money. Fair enough I get that, but if European Governments won’t I must assume they think the chances of ever getting their money back are remote so a default is on the cards.

But austerity is killing Greece. They already have an official unemployment rate of around 16.5% and if we add the usual unofficial quotient we’d end up north of 20% I’d guess. As I have written before I truly believe that at some point a politician in the European periphery will, with the people behind him or her, stand up and say enough is enough, we’re out and repudiate both their debts and the EUR currency.

Are we there yet? No, but while the Nero’s fiddle the people of Athens are protesting – politicians can only resist or oppress their people for so  long. If Europe wants this crisis solved on their terms they’ll need to stump up the cash.

In trying to stop a Greek default leading to contagion with Ireland and Portugal we are seeing the preconditions for Greece to have no option BUT TO DEFAULT grow.

Time will tell – this could take a while.

US Data

Across the pond in the US the data reminded people that this is probably not a weak spot but more likely a return to post crisis slow growth weak trend after the sweet spot induced by QE2. One of our favourite Canadian/US Economists, David Rosenberg of Glushkin Sheff said overnight that he is 99% sure there will be another recession in the US by the end of next year. Unfortunately we have to agree with him.

It is a similar story to what we believe is happening in Australia with regard to increased savings and less demand for credit and something we think the RBA underappreciates. CNN reports that Rosenberg says ,

that consumers have just begun clearing debt from their ledgers (see chart, right) and that as that deflationary process plays out, spending will slow, weighing on job growth. Adding to the pressure, government and the Federal Reserve are trying to wriggle out of the stimulus game.

“So we still have this credit contraction shock as it pertains to the broad consumer sector, and, going forward, no fiscal cushion,” Rosenberg writes in a note to clients Tuesday.

Rosenberg adds that as the extent of the economic slowdown becomes apparent, the stock market may finally sag. The S&P 500, recently about 6% below its 52-week high at 1285, could test last summer’s lows near 1000, he says.

But getting back to the data overnight the US CPI dat was fairly benign as you’d hope given where the economy is at but it was the Empire Manufacturing Index which fell from 11.88 to -7.79 against expectations of +12 that really shook things up and suggested that economic weakness can not be ignored.

So what does it mean?

For us we are taking cover on any exposures to risk assets because the fingers of instability are just so great at the moment and we don’t trust policy makers to act in the best interests of the global economy and markets but rather their own constituencies.

Equally we believe that the Bellwether market for the globe, the DOW, is at risk of breaking the trend line that has been supporting it since the lows of 2009 as you can see on the chart below.

If this trend line breaks then the “technical” target would be around 10,800 or around 9% lower than this mornings close. On the ASX200 we still want to see how it looks at 4473. The Australian market underperformed on the way up so hopefully we can also underperform on the way down. But a break of 4473 at a time when the global and Australian economies and markets are looking weaker would not be a good sign and suggests a move all the way back to 4200 – at least technically.

For the AUD and Interest rates it probably implies lower levels as well. The 1.02/035 zone is really important support for the AUD/USD and if that breaks then we could see a full retracement back to the start of this rally at 0.9700. There is however a lot of support at the moment though. In Australian interest rates markets shrugged off Governor Stevens warning yesterday with only a few point sell off and the index buying and weak offshore situation has 3 year swaps around 5.10% at the moment. I still think we’ll get a chance to pay fixed below 5% at some point here.

It is a dangerous time to be long risk assets and options cover (long puts) is a must because we just don’t know how bad this might all get. But when the sun finally shines on the global economy again there is so much money to be put to work that markets will roar higher. But we don’t know how long this will take or from what level that will be, it could be substantially lower. So for now, circumspection is our core and enduring theme.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial adviser we are happy to help and if you are an adviser and would like to join our network we are also happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecuities.com.au

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