The market is on an upward trajectory with no clear end in sight. Market performance is ominously similar to that of 2007 when the market was ignoring the early stages of housing defaults and bank failures. Today, the performance is similar to 2007, just with different issues getting ready to create an existential crisis for the U.S. markets. If the European debt crisis and fears of a governmental shutdown come to fruition, the U.S. market could easily slip back into recession and America could relive the crisis of 2008.
The European debt crisis has been shoved to the back burner by investors in the first days of this year. It is unclear what the ECB’s contribution to the ailing nations of Europe will be, but it is clear that the issues of Greece, Spain, and Italy will not go away. Italy in particular poses a tremendous threat to the U.S. economic turnaround. With Italy being the 8th largest economy in the world, its debt is held by nearly every domestic bank and in turn is essential to the United States’ ability to prosper. The question is no longer “if” Italy will default, but rather “when.” Italy’s Monti spoke with European Council president Herman van Rompuy and said that it is in Germany’s “enlightened self-interest.” What is bound to happen is for this to go from Germany’s interest to the United States’ interest, because of how closely tied our banks and government are to their debt.
This poses a substantial crisis for our nations largest banks that hold a substantial amount of Italian debt. US banks like Goldman Sachs (NYSE:GS), Citibank (NYSE:C) and Morgan Stanley (NYSE:MS) have already unloaded up to 300 billion Euros of Italian debt, but that is miniscule in comparison to the roughly $800 billion that U.S. banks still hold. This marks a time when US banks could need another bailout from the US government to offset the tremendous losses due to European debt woes.
This brings forth another major issue facing the American economy: the political situation. The Republican Primary is underway and soon the both candidates will be in place for the November 2nd vote. In the meantime, President Obama and House of Representatives have a great deal of work to accomplish to, among other things: raise the debt ceiling, deal with taxes into 2013, and weigh if a European debt intervention is necessary. At the same time, both parties will be attempting to hold-up legislation to prove their parties allegiances. This poses a tremendous amount of uncertainty for the financial markets because it is not clear what the future landscape will look like for America. If one piece of the puzzle: taxes, the debt ceiling, or a lack of European intervention, the US could fall back into a recession. This is a risk the fragile American market cannot handle.
In the wake of the potential for an Italian debt crisis and the primary season underway with South Carolina on the 21st of January, The U.S. economy is functioning much like it did in August 2007. Major threats are in place to disrupt the slow-moving recovery that could creep up on the market at any time. Hopefully United States politicians do not put their party ahead of policy and allow America to dip into another recession due to bank failure in the wake of European debt. GS, C, MS and other top banks could be in jeopardy. Let’s hope this does not prove to be reminiscent of 2007 when ignorance was at its height in ignoring the signs of banking defaults and the housing bubble.
Today, the crisis could be similar in nature, with the only difference being in what causes the contagion to spread across the world and double-dip.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.