Tuesday Thoughts – markets fracturing?

Markets did pretty well in my opinion last night – I reckon that after months of disappointment with European intransigence, with new and growing concerns about Italy and enduring focus on the US debt ceiling, let alone Greece there was an excuse for a crash last night.

Sure the DAX in Germany was down 2.33%, the CAC in France down 2.71%, the FTSE lost more than 1% and the S&P 500 was off 1.8%. But this is just give back of last week’s bounce when we could have seen a full-blown run for the exits. So I am concerned about what might happen in coming days if markets find the excuse. 

As I noted yesterday the European debt troubles that have, if anything, worsened in the past week. The reason I say that is that I think many, most probably, interested bystanders thought that when the Greek deal was done the Greek deal was done. But that’s not what we heard out of Europe over the weekend with the papers such as the Financial Times and Reuters reporting that the chances of a Greek default had rocketed up the ratings again due to an impasse between the Governments of Germany, Netherlands and Finland and their banks and insurers who they feel should take a haircut, or at least participate in wearing some of the pain of the Greek rescue.

While these latter-day European Nero’s try to work out a solution the market, like Alexander the Great across Asia, went looking for the next territory to conquer. Strangely Spain was not the next target but Italy and pressure has been growing on the Italians over the past couple of weeks.

If you ask me why Italy and not Spain my answer would be that as a trader, Italy made more sense in terms of profit potential and ease of execution (pardon the pun). That is Spain’s bonds and CDS spreads had already blown out quite a bit more than Italy which had been relatively quite over the past few months. You can see it toward the bottom of the chart above where the green Italian line is catching up with the yellow Spanish line. The scale of the chart is distorted by Greece’s massively expensive CDS spreads but the magnitude of the move it worth the bet.

This made Italy a “cheap” market to attack. Equally, as we showed yesterday (chart again above)  the Italian debt pile is second, in terms of GDP only to Greece within Europe so shining a light and attacking this nation was the natural selection of traders.

And so it has been – while we know learn that Europe is still trying to save Greece traders smell blood in Italy and are now trying to knock it over. Italian politics isn’t helping so markets, equities and the Euro, are off sharply last night.

I’m on the record as saying that I think the real value of the Euro is closer to 1:1 with the USD and at 1.40 we a re a long way from there as you can see on the chart above. But I feel like it’s headed toward at least 1.35 (green line) and should go lower. Europe is a fractured state full of populations with nothing in common than a pseudo geographic proximity. there is no fiscal transfer and this crisis is showing there is no appetite for a move toward a more United Federation or Commonwealth style arrange that we see in the US or in Australia.  

Back Home in Australia  markets (other than the AUD/USD) are pricing in a small-scale GFCII. The reality is that the GFC never left us and the post stimulus bounce has just washed through both our own economy but more particularly the domestic economy.  

The money markets are pricing in rate cuts (that’s the light blue line) – although you can see from the chart the fact that the curve then rises again suggests this is just market price action rather than any real conviction. I don’t think there is little chance of an RBA cut without a global financial meltdown but the risks are growing. For the equity market we’d highlight the 4450/73 region we have talked about in our weeklies in the past (apologies for no weekly on Saturday – family fun got in the way).

We’ll see how this plays out but it just makes the world all the more uncertain and the risks of markets fracturing is growing.

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.

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