Preview from Europe: Fear Trumps Hope as Dow Falls Below 8,000

by: The Mole

The public euphoria surrounding Obama’s big day out failed to lift equities. The regional banks were laggards and a drag on the S&P while chip stocks led the NASDAQ’s fall. Take State Street Bank (NYSE:STT) for example, who were meant to be one of the “safe” plays in financials. Despite better earnings, they finished down 59% after a shambolic investor call in which it became apparent that they had a major issue with off balancesheet vehicles. If taken back on the balancesheet it would cost $23bn in unrealised losses on bonds.

It seems that the only stocks that can be counted upon at the moment to deliver are IBM (NYSE:IBM), Wal-Mart (NYSE:WMT) and McDonalds (NYSE:MCD).

Today’s Market Moving Stories

  • The torturing of Irish bank equities continues unabated as fears that nationalisation beckons for both Bank of Ireland and Allied Irish Bank (AIB) (which at one stage yesterday traded below BoI). Indeed the market capitalisation of AIB is now just €397m, which is less than that of the 70% stake they own in their Polish subsidiary Bank Zachodni. The only good bit of news came yesterday from rating agency Fitch who quite generously reaffirmed the sovereign credit rating of Ireland at AAA with a stable outlook!?!
  • BoE governor Mervyn King said that conventional monetary policy had become less effective under the current stressed conditions and that targeted asset purchases would begin in a “matter of weeks”. He also saw that inflation would fall below 2% soon and nodded approvingly in the direction of more benign neglect of the British Peso saying a fall would help the economy. This of course is the safety valve of adjustment that the smaller Eurozone countries now lack.
  • Prof Nouriel Roubini’s, aka Dr Doom's, latest estimate is that the value of financial bad assets is $3.6 trillion. This would make the US financial sector effectively insolvent, since its combined capital is only $1.4 trillion. Roubini concluded that there is a systemic banking crisis. Calculated Risk says the estimate is too high, putting residential credit losses at $1-1.5 trillion and other credit losses at $1 trillion. But this would still imply that the US financial sector is effectively wiped out.
  • Yves Smith has done the math on US house prices, based on the estimate by the National Association of Home Builders, who predicts another 29% fall in price this year, which will put the accumulated total price fall since 2006 at close to 50% by end-2009. This estimate is reasonable, as it includes some price overshooting. It was never clear why prices should merely revert to trend in this crisis in view of the credit crunch.
  • The US ABC consumer confidence survey fell to –53 from –49 in its latest week.

More Banking News
Yes we are all getting tired from reading about banking woes but sadly unless you understand and keep up with these daily developments you have no chance of understanding the current markets. Take sleepy boring old Belgium for example, not a country that springs to mind when you think leverage or speculative asset bubbles, yet even they are mulling over a second bailout package. They have already forked out €20bn. The country’s KBC bank has been under the hammer in recent days, falling from €16 to under €10 a share in three sessions.

Elsewhere, the surreal Royal Bank of Scotland (NYSE:RBS) situation takes a new twist with reports that ABN (most of whom they bought as the top of the market) may buy back some of its units from the former Scottish raider (at a deep discount!)

French banks are to get €10.5bn in fresh aid in return for the populist move of scrapping executive bonuses. Its second largest bank has just announced that it managed the rare feat of breaking even in Q4 2009. Germany’s basket case bank Hypo Real Estate (owner of Depfa) gets a further €12bn in debt guarantees. There’s talk that Credit Suisse (NYSE:CS) will show a CHF 6bn loss for 2008.

CDS Market Widening Eurozone Government Bond Spreads
The alarming widening in government bond spreads has reached crisis levels for what are seen as the peripheral members of the Euro club i.e. Ireland, Spain, Portugal, Greece and Italy. This spread reflects the premium of extra interest that investors demand to lend to the governments of these countries versus where they would be happy to lend, for instance to the Federal German government. Before this crisis reared its ugly head these spreads ranged from as little as 0.10% for Ireland to 0.40% for Greece. They have now blown out to 2.00%+ with no relief in sight, making the cost of funding for these already hard pressed countries higher.

There is a theory that this spread widening is not being driven by people actually physically selling the bonds of these countries but that they are being manipulated by complex derivatives called CDS (credit default swaps). These are bets on the credit worthiness of a country. As hedge funds and speculative hot money put on these bets it drives bond spreads wider.

One novel and cheap way for the ECB to show that they stand square behind the member countries of the Eurozone would be to intervene in this CDS market and underwrite these insurance bets. This would immediately lead to their collapse, giving those who have placed these bets a bloody nose. But this kind of out-of-the- box thinking simply seems beyond the mandarins in Frankfurt. It would prove a far cheaper solution than printing money to buy the bonds of these countries which is what they may eventually be forced to do.


  • Earnings today from former private equity powerhouse Blackrock (NYSE:BLK) (expected EPS $1.02), Seagate (NASDAQ:STX) (-$0.04) US Bancorp (NYSE:USB) ($0.22), Apple (NASDAQ:AAPL) ($1.39) and eBay (NASDAQ:EBAY) ($0.39).
  • Ericsson (NASDAQ:ERIC) are to cut 5k jobs in anticipation of a fallout in customer orders.
  • German steelmaker ThyssenKrupp (OTCPK:TYEKF) was cut to a sell at Morgan Stanley as was easyJet (EJETF.PK) at UBS.
  • Mining giant BHP Billiton (NYSE:BHP) is to take a $1.7bn charge and slash 6k jobs as it closes an Aussie nickel mine.

Data Today
We get news on the state of the US jobs market today at 09.30 GMT. The pace of deterioration is likely to intensify: the market expects December jobless claims to rise by 85k from the previous 75.7K, while the unemployment rate likely rose to 3.5% from 3.3%.

Minutes of the MPC BoE January meeting are also out at 09.30 GMT. They should show a unanimous vote for a 50bp cut and suggest that the bottom for base rates rate has not been reached yet. It will be interesting to see if the debate on quantitative easing is heating up. All this is bound to lead to another torrid day for the embattled British Peso.

And Finally… The TARP Song

Disclosures: None