Cyprus Will Bring The Red With It

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 |  Includes: QQQ, SPY
by: Paulo Santos

As I write this, Cyprus is rolling out a bailout scheme where, to get a bailout from the EU, the Cyprus government will launch a tax on all bank deposits. This tax will be 6.75% on balances below 100000 Euros, and 9.9% on balances above 100000 Euros.

This will probably be enough to provoke a gap down on futures for the major indexes (SPY and QQQ) as they open on Sunday, and then bring the markets down during Monday.

The logic

Cyprus itself is rather tiny and irrelevant. However, one must remember that several European countries are under bailout programs (Ireland, Greece, Portugal) or close to needing help (Spain, Italy). With the Cyprus bailout on the news, it's likely that there will be speculation that bank runs could take place in these countries, out of fear that the same might be tried there as well.

While ultimately I don't expect very visible bank runs to develop, it's also a fact that a slow bleeding of deposits has been underway for some time now. Yet, what really matters is that the market will most likely speculate on what could happen, be it realistic or not.

We thus have a clear setup for a sell-off of some size as the euro crisis again takes center stage for a while, beginning on Sunday and at the very least, affecting the Monday session.

Overbought nature and near-record margin debt

Given that U.S. markets are extremely overbought and margin debt is near records, this event might also unleash a longer lasting dip, perhaps as long as 2-3 weeks. At this point, it's hard to believe that it might go beyond that due to the Federal Reserve's continued buying of assets at an $85 billion per month clip.

Conclusion

Cyprus provided a clear catalyst for a long-overdue correction. It's likely that the correction will start right this Sunday with a gap down in the futures, and then lead to more bleeding during Monday. Given the overbought nature of the markets and the extreme levels of margin debt, the correction could conceivably go on for 2-3 weeks - even with the Fed providing support.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.