European Crisis Intensifying at an Accelerating Pace: For the Near-Term, Avoid Commodities

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Includes: AAPL, FCX, GDX, GLD, GOOG, IEZ, INTC, RIO, SLV, T, VALE, VOD, XLE, XLF
by: James A. Kostohryz

The news out of Europe today seems surreal. German Chancellor Angela Merkel and French President Nicolas Sarkozy are apparently working very hard to ensure that the European financial and economic crisis intensifies at ever accelerating speeds.

First, the leaders of the two largest countries in the EU categorically rejected the notion of issuing Euro Bonds or of implementing any other mechanism to guarantee the sovereign debt of nations perceived to be default risks such as Spain and Italy. The leaders reached this momentous agreement despite the fact that the values of Spanish and Italian bonds have been collapsing precipitously. The French and German leaders seemed oblivious to the fact that if the bond market collapse proceeds much further, it is going to be “lights out” for the entire Euro project.

Second, the French and German leaders pitched a cacophony of almost insultingly empty rhetoric at the market regarding proposals to require balanced budget provisions in national constitutions as well as a host of other fiscal constraints. What are the chances of such legislation passing with the required unanimity? Nil. These leaders must know this, and everybody knows it.

Third, and perhaps most notably, Sarkozy and Merkel came up with the brilliant idea of biting the hand that they need to be fed with. Specifically, they are proposing a tax on financial transactions. This is utterly bizarre. European governments need bond investors around the world to lend them money and to provide liquidity to their bond markets. So what do Sarkozy and Merkel do? They propose increasing the costs and risks for prospective creditors and to shutter liquidity in the bond markets that these creditors are supposed to invest in. Brilliant!

With leaders like these at the helm of the European Union, who needs saboteurs?

INVESTMENT IMPLICATIONS

Economic and financial risks around the world are intensifying at an accelerating pace. The recent rally in the equity markets has provided a gift for investors that wish to lighten up on their exposure to stocks and to short sellers that wish to position themselves for a retest of recent lows around 1,100 on the S&P 500.

In my view, this most recent Franco-German summit has significantly raised the probabilities that global equity markets will test and penetrate recent lows. In the US, I believe that it is increasingly likely that the S&P 500 will slouch towards the 950-1,020 zone.

Commodity-oriented stocks and ETFs such as Freeport-McMoran Copper & Gold Inc. (FCX), Rio Tinto plc (RIO), VALE, Energy Select Sector SPDR ETF (XLE), iShares Dow Jones US Oil Equipment Index ETF (IEZ), SPDR Gold Trust ETF (GLD), iShares Silver Trust ETF (SLV) and Market Vectors Gold Miners ETF (GDX) should be avoided on the long side, and shorts can be considered. Furthermore, it should be noted that the Nasdaq 100 as a whole, and many stocks such as Apple (AAPL) and Microsoft (MSFT), derive well over a third of their net income from Europe. Therefore, the technology sector is vulnerable to turmoil in Europe.

In terms of long-term prospects and valuation, many equities such as Microsoft (MSFT), Apple (AAPL), Intel (INTC), Google (GOOG), AT&T (T), Verizon (VZ) and Vodafone (VOD) and even some financials such as XLF and Goldman Sachs (GS) are not unattractive investments at current price levels. However, I believe that all of these stocks will be available at significantly lower prices over the course of the next few weeks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.