Where Is Europe Taking the Global Economy?

by: Wall Street Sector Selector

All the news coming out of Europe for the last two weeks has roiled global currency and equities markets and in many ways it’s starting to feel like 2008 all over again.

Here are some things we need to pay attention to:

  1. The “Ted Spread,” the difference between the interest rates of short term U.S. T Bills and interbank loans is rising, which indicates increasing perceived credit risk in the global economy.
  2. LIBOR, the London Interbank Borrowing Rate, is rising, which indicates a growing reluctance to lend and increasing worry about counterparty risk between banks.
  3. The Bank of Spain has been making the news lately, ordering Spanish banks to raise their loan reserves against potential real estate losses from a crumbling real estate market.
  4. The Bank of Spain took over CajaSur, a regional bank on May 22 and several other Spanish banks have either merged or are in discussions to do so.
  5. The Greeks are already discussing potential modifications to their planned austerity programs.
  6. The Euro remains under intense pressure.
  7. The equity markets of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) are all in bear markets.

So as one looks across the global landscape, we see growing banking and credit strains in Europe, continued pressure on the Euro and a lack of leadership regarding what really needs to be done to resolve this situation.

All of this points to potential lower growth and continued problems that could easily spread around the world.

The only period in recent history comparable to what we’re seeing today is “The Great Depression,” and its stock market action is eerily similar to today’s in many ways.

click to enlarge

chart courtesy of Washington’s Blog

One of the fine blogs I read is Washington’s Blog, and in a recent article they published this chart from The Great Depression and pointed out that the big, second leg down in the Dow was triggered by a credit crunch and bank failures in Europe.

Fast forward to today and we have had our initial crash, an approximately 60% recovery and now see the potential for a growing credit crunch in Europe.

I’m certainly not predicting a second crash as many of the ultra-bears are, however, today’s situation bears an eerie resemblance to the 1930s and my simple conclusion is that we’re definitely not out of the woods yet by any means. The problems in Europe and with the Euro won’t be resolved overnight and so we can expect continued volatility and uncertainty in the days and weeks ahead. If Europe doesn’t resolve its problems, this could have ominous implications, to say the least, for the global economy.

Disclosure: Long EEV, YXI, SKF, PSQ, EFZ, VXX and S&P 500 put options