On Monday, in an attempt to calm market fears, the Cypriot government, EU, ECB, and IMF reached a deal to save the troubled banking system of Cyprus. However, I believe this deal is more likely to signal the beginning of a stock market sell-off than the end of one.
1. Depositors Take Loss
To me, the big story from the Cyprus deal is, without question, the fact that depositors with over 100,000 euros will face substantial losses. This matters because of the possible contagion issues. For example, if you were holding 300,000 euros with a Spanish or Italian bank then why wouldn't you move the money to a German bank? Doing so would ensure German backing of your funds, a far superior option to Spanish or Italian backing. Goldman Sachs Asset Management Chairman Jim O'Neil put it best when he told CNBC "Cyprus Can't Put Genie Back in Bottle." The full impact of eroded confidence in the EU banking system will likely be seen in the coming weeks.
2. Stock Market Reversal
As shown by the chart below, at first, the stock market opened higher with the Dow hitting a fresh all-time high, but gains quickly turned into losses as the session continued. Simply put, this is not a good reaction to the Cyprus deal. The stock market staged a late day move off the lows following comments made that suggested the Dutch Finance Minister was re-thinking his use of the word "template" to describe the Cyprus deal. In any event, the damage has already been done. I doubt that depositors in Spain or Italy will take comfort in the "clarification" put out by the Dutch Finance Minister. The damage has already been done.
3. VIX Fails To Spike
Yes, as expected, the VIX moved higher throughout the day on Monday as fears grew over the potential contagion impact of the Cyprus deal. At the end of the trading session, the spot VIX closed at 13.74, up just $0.17 or 1.25% for the day. As shown by the chart below, the VIX ETFs closed the trading session lower. What is important here is that the market does not appear to be all that "worried" about the implications of the Cyprus deal. The lack of a major surge higher in the VIX suggest that the market is complacent about the situation. Of course, this is just the condition needed for a major sell-off to develop.
4. European Banks Struggling
Finally, as shown by the chart below, the poor performance of the European banks is a concern. The broader stock market has yet to take notice of the weak performance of these stocks. Perhaps, the recent weakness in European banks in the canary in the coal mine. If nothing else, the price action suggests that things in Europe are getting worse, not better.
I am of the belief that the Cyprus bailout is the beginning of a market sell-off, not the end of one. The precedent setting decision that depositors are being forced to take losses, intraday reversal in the stock market, lack of response from the VIX, and poor performance of European banking shares are the reasons why the Cyprus sell-off is not over.