1. GREECE: The Third Annual Greek Spring Breakdown -Another Big Game of Chicken
A Greek default and EZ exit remains the biggest near term threat. As we predicted in last week's post, reaction to the election results had potential to dominate market sentiment IF the election raised the threat of Greece reneging on its bailout commitments and defaulting. It did, producing the worst case scenario result: either a coalition or another election that ultimately sets Greece on course to renege and/or default.
Greece remains the nearest knife at the EZ's throat, and so we expect news related to the chances of a sudden exit and default to again dominate sentiment across risk asset markets.
The argument that a Greek default was mostly priced in died this week, as most major stock indexes and the EUR got bitch whipped mostly from Greek election results. It isn't Greek default per se that scares people, the EU can afford that one (as for Greece itself, few care). It's the fear contagion: that financial and credit markets freak, flee the EU, the other GIIPS are forced into default and/or the EUR gets printed into oblivion or disappears, etc.
Given that no one expects any quick resolution, Greece is likely to hit the markets in one of 3 ways:
- The best case scenario for the coming week is that there are no major negative surprises from Greece
- The worst case would be that there are, and they push up the odds of the feared sudden exit and related contagion as other GIIPS and even the core EU nations get slammed in financial and credit markets.
- The middle and likely case: leaders on both sides continue to buy time, make threats but leave options open, and Greece continues to exert downward pressure on markets.
Specifically, the consensus is that there will be new elections that put the left wing anti-austerity/bailout agreement Syriza party in charge, putting Greece on a collision course with the EU, which obviously cannot allow the precedent of reneging on bailout agreements. ECB Executive Board member Joerg Asmussen has rejected any change to Greece's reform program if Greece is to remain in the EZ. Greek's banking system is utterly dependent on the ECB, and as Italy's former PM Berlusconi learned, it plays hardball when needed.
What's clear thus far is that Greece doesn't want to leave the EZ, but that the political will for continuing with the bailout program seems exhausted, yet the ECB insists they continue. Hmmm. Of course, this is all part of the normal negotiation in the annual spring break (down) in the Greek drama.
The fate of Greece is a political matter decision and thus particularly unpredictable in the short term given the number of players. We don't know what politicians on the Greek or EU/creditor side will say or when they'll say it; however here are specific events to watch this week.
- Final attempt at coalition and avoid another election: By early this week we'll know if final attempts over the weekend to form a coalition were successful. If not, then another election is coming. It's expected to bring in a more radically anti bailout regime
- Greek bond redemption: While Greece has enough cash to avoid further defaults until June, there's a ~€450 million bond redemption due next week. With a hung Parliament and possible default looming anyway, it's likely that Greece will use its 2 week grace period to delay payment until the end of May. This would both save cash and maintain uncertainty and pressure on the markets and EU to offer Greece a better deal. The delay is good for Greece, bad for global markets as it feeds fears of Greek default.
- EU Spin Control: Given the likely bearish effects of the above, expect some spin control from other EU officials. If markets are desperate enough for some positive news (and at technical support levels anyway) that might inspire some stabilization or even a bounce for risk assets).
Longer term, Greece's fate is clearer. Unless the EU, particularly Germany, decides to spend a lot more in debt forgiveness and other growth inducing aid, Greece will default, exit the EZ because it can't afford to do otherwise, and suffer even greater contraction in the coming years, at least before the benefits of reduced debt payments and a devalued currency begin to spur growth similar to that experienced in other post default situations (like that of Iceland).
Will MAD Threat Continue to Work?
The big question is, how long is the longer term? Leaders in both Greece and the EU clearly want to keep Greece in the EU. Like the US and Russia during the Cold War, the threat of Mutually Assured Destruction kept both sides minimally cooperating.
Expect all parties concerned to try to buy more time while they figure out how to reconcile Greece's inability to live up to its agreement with the EU's inability to set a precedent of a GIIPS nation reneging on its commitments to repay and still getting aid.
2-3. OTHER EU: SPAIN, FRANCE, & GERMANY, OH MY!
While Greece remains the nearest term threat, Spain and Italy are the bigger ones given that their debt loads are too big for them to be bailout out under current conditions.
For now Spain is the more pressing concern as its bond yields (cost of borrowing) rise, and are likely to rise further as it proceeds with bank reforms. These are necessary, but are likely to result in more bank debt becoming sovereign debt. The danger is that Spain faces an Irish scenario, given that bad bank loans represent such a large part of Spanish GDP
Specific events to watch include:
- Monday: Italy is selling 10 year notes, which are the benchmark for determining current market sentiment about Italy's creditworthiness. Expect the ECB to insure demand is acceptable. That means a good auction (expected) may not boost confidence much, but a bad one should be very bearish.
- Tuesday: EU Finance Ministers meetings: Might produce some comments of note.
- Thursday: Spain sells 10 year bonds. As with Italy, the sale is the latest check on its creditworthiness and could move markets if it exceeds or misses expectations.
Theoretically the May 15 meeting between newly elected French President Francois Hollande and Germany's PM Merkel should be a huge potential trouble spot. Hollande campaigned and won on a promise to renegotiate the EU fiscal pact and weaken its austerity measures. Merkel is opposed. Hollande has already begun moving closer towards Merkel's position and the consensus is that their meeting will produce a growth pact as a compromise to offset some of the pain of the fiscal pact, and the Franco-German EU leadership team will continue forward, ultimately with some grudging additional German compromises. See here for further details
The thing that might complicate the above scenario is if Merkel's party suffers badly in regional elections this week and she feels pressure to stand firm to protect the EUR's value.
On Wednesday Germany is due for a 10 year bond auction, which could hurt sentiment if it's unexpectedly weak.
4 - 5. US: TWO BIG NAME STOCKS AND THE FED
Last week JPMorgan Chase (JPM), the largest US bank in terms of assets, reported billions lost on bad trades and undermined confidence in the critical US financial sector. News concerning the loss, which apparently came from negligent risk management, and market reaction could continue to move markets this week. Also, Facebook's IPO is expected to be the largest for any internet stock ever, and so might prove market moving if it exceeds or misses expectations
The FOMC's April Meeting minutes will provide the latest look at Fed thinking and influence expectations about the likelihood for additional US stimulus (a key market moving consideration over the past year).
6-9. Other Key Calendar Events
Here are the other important calendar events to watch this week that we didn't mention above.
Tuesday: German ZEW survey and US CPI, retail data, as well as Empire State Mfg index and TIC Long Term Purchases
Wednesday: UK - BoE Gov King Speaks and inflation report, EU - ECB Pres. Draghi speaks, US - Building Permits, Housing Starts, Industrial Production
Thursday: US - weekly first time jobless claims, Philly Fed Mfg index
Friday/Saturday: G-8 Meetings
Consult any good economic calendar like that of forexfactory.com for additional events and details
10. TECHNICAL PICTURE
Our preferred risk asset barometers, the S&P 500 weekly chart look primed to test lower support levels.
For example, the weekly S&P 500 chart shows a bearish head & shoulders pattern that suggests a test from its 1350 level at the end of last week to ~1300, where its 50 week EMA also resides, so 1300 is the next test. A break below that suggests the next real support is around 1230-1200.
So breaches of the 1300 level suggest similar further declines for other risk assets.
S&P 500 WEEKLY CHART
Source: MetaQuotes Software Corp, globalmarkets.anyoption.com
01 may 13 0300
4 LESSONS AND RAMIFICATIONS
So practically speaking, what do you do?
1. Stocks: EU Crisis Periods Bad For Risk Assets In General
Given the still elevated level of most indexes relative to recent years, they remain vulnerable to bad news. By region, most European stocks remain riskiest, followed by Asia and then the US as the least of a bad bunch. We're not keen on new long positions in any of them, unless you're a very long term investor and getting a very stable dividend, so that you treat these as long term bonds, bought with cash you won't need.
After an over 2 year break, we hope to renew our series of articles on the best currency diversified income investments from our coming site, thesensibleguidetoforex.com (companion site to our coming book on safer, simpler ways to avoid being over exposed to the USD or any other one currency, The Sensible Guide to Forex: Safer, Smarter Ways to Prosper from the Start (Wiley & Sons, 2012). Stay tuned for details.
2. Forex: A Bad Time To Be Overweight Most Risk Currencies
- USD, JPY The Least Ugly: Yes, the USD will continue to benefit while the EU continues to deteriorate and drag down the EUR, assets denominated in it, as well as currencies (and assets denominated in them) most closely connected to the EUR. Anything related to the CHF will be dragged down as long as the SNB continues to buy Euros and sell Swiss Francs in order to keep Swiss exports cheap. History has not been kind to central banks attempting long term currency manipulation.
- The AUD (and to a lesser extent NZD) move with the fate of China, which has not yet bottomed, though is still growing, so their fundamental picture isn't as dire as that of the EUR and CHF (which would be great if the SNB would let the market determine its value).
- That leaves the CAD, USD and JPY, though the BoJ might intervene periodically. The USD remains the least ugly for now. While the CAD is a risk currency it's more tied to the US than the other risk currencies, and the US is currently disappointing expectations less often than China, though China of course is still growing faster. The CAD is also the major currency most likely to see rate increases in the coming year, and least likely to be subject to dilutive new stimulus measures, given recent data.
3. Gold: Short Term Uncertain, Longer Term Bullish
Given the above fundamentals and those we've discussed in prior posts (slowdowns or stagnation in most major economies and chances of severe shocks from the EU), dilutive stimulus programs from the ECB, BoJ, Fed, and SNB should favor gold's recovery. Meanwhile, with EU fear peaking again, liquidity is a priority and so gold is breaking down. We await its stabilization and new signs of stimulus programs before resuming new long positions.
4. A Key Lesson From The Past Week
Regardless of what happens to Greece, the ECB is likely to be forced into further stimulus. Indeed, the combination of poor economic performance and recent election results in the EU has even senior German economic officials like Finance Minister Wolfgang Schauble considering accepting greater inflation, prompting shocked headlines in the German press questioning the safety of the Euro as a store of value.
The Fed remains open to more stimulus and is keeping rates low. Most central banks are turning more dovish, like the BoJ, ECB, BoE, and RBA just to name a few.
Such policies may be the best for their economies and debt burdens, but risk gutting the value of assets held in most of the most widely held currencies. There are safe, relatively simple ways to protect yourself without opening bank accounts throughout the world or hiding gold bars under your bed.
However you do need to prepare yourself, because just like you need to be diversified by asset class and sector, so too you need to diversify your currency exposure, and not be hostage to the policies of any one central bank or government. Even if you spend in one currency, you're still exposed to its loss of purchasing power. We'll have an article up detailing how this much beloved (by politicians) tax works within the coming week - stay tuned for: The Most Common Fatal Investor Mistake: Inadequate Currency & Hard Asset Exposure.
I've been thinking about solutions for the past number of years, and have set them out in The Sensible Guide to Forex: Safer, Smarter Ways to Prosper from the Start (Wiley & Sons, 2012).
A wave of advanced review have been very favorable, as it's the first book to show mainstream investors how to get forex diversification while avoiding much of the risks and complications involved in traditional forex trading that have made this market too risk and unsuitable for most investors. We hope to have these reviews, as well as book excerpts and ongoing conservative investment and trade ideas up as the companion website comes online soon and begins its build out.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.