Equities got giddy last week when the world’s central banks, lead by the US Federal Reserve, lowered the global cost of borrowing dollars. Regardless of the market’s reaction, the whole thing smells of desperation and, quite frankly, everyone should be questioning the Fed’s move.
First of all, the situation in Europe is a solvency crisis, not a liquidity crisis. European banks need over one trillion euros in new capital. Providing more cheap credit is not going to do anything other than give those European banks facing liquidity troubles a few more weeks on life support.
Speaking of which, it’s now clear that Europe is fast approaching its Lehman moment. Forbes noted that a large European bank was on the ropes the night before the Fed intervention. We also see France and Germany are implementing plans to nationalize large banks that fail. I can assure you they’re not doing this because things are going well over there.
As for the market’s reaction to the Fed’s move… it could kick off a short-term, end-of-the-year rally, depending on how much the market falls for the “this time we’ve got a REAL solution” tripe coming our of Europe. But you must remember that none of the proposed solutions address the underlying problems Europe’s banks are facing.
Technically, the Fed’s move brought the market to major resistance. Unless the market moves higher aggressively to start this week, we’re heading back down in short order.
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Truly, the only reason to buy into a stock rally here is based on the belief that the Fed or someone else is going to be providing more juice in the near future. The US economy has clearly begun to roll over in a big way: Retail sales, GDP, and unemployment numbers are all being massaged heavily to make the situation look better than it is.
This is clear in corporate earnings, which just posted their worst sequential drop since the first quarter of 2009, when the economy and markets were both falling off a cliff. These kinds of drops don’t happen if everything’s going well.
Across the pond, Europe’s banking system is experiencing a solvency crisis on par with 2008. The markets believe that Germany and France will save the day by revamping the EU arrangement. However, this doesn’t mean other EU members will agree to their suggestions (the idea of a German-lead EU is completely unpalatable to many EU states).
So I don’t expect a viable solution to emerge in Europe this week. The math doesn’t support any of the proposals EU leaders have come up with yet. And the fact it was the Fed, not the IMF or ECB or EFSF, that stepped in to save the day last week should be a major red flag that Europe’s out of ideas.
The markets seem to sense this, as the euro hasn’t cleared resistance in any meaningful way yet. And unless we get above 135 and stay there, we’re heading a lot lower in the near future.
To conclude, in the short term, the markets are moving based on hope of more juice from the powers that be. However, the reality of the financial system today is downright frightening. The US economy is rolling over in a big way. Europe is imploding. China is heading straight into a hard landing. And on and on.
Heck, Europe alone could derail the entire financial system temporarily. The region’s entire banking system is insolvent (with few exceptions). European non-financial corporations are running massive debt to equity ratios. And even EU sovereign states require intervention from the ECB just to meet current debt issuance, to say nothing of the huge amount of sovereign debt rollover that is due over the next 14 months.
The impact of this will be global in nature. The EU, taken as a whole, is:
- The single largest economy in the world ($16.28 trillion)
- China’s largest trade partner
- Accountable for 21% of US exports
- Accountable for $121 billion worth of exports for South America
So if the EU banking system and/or economy collapses, the global economy could enter a recession just based on that one issue alone (ignoring the other issues in China, Japan, and the US).
This is the reality of the financial system, no matter what the talking heads say. The IMF, Bank of England, and others have warned of a systemic collapse. Do you think they’re doing this for fun?
Many investors will have their portfolios wiped out in the coming carnage. It could be next week, or it could take place next year -- but we are heading into a crisis that will be worse than 2008.