A trader’s strategy guide to prior week’s market movers and their lessons for the coming week for traders of all major asset classes via both traditional instruments and binary options
See part 2 for weekly preview of likely market movers for the coming week
Over the past weeks, I wrote about how from a technical viewpoint the major risk barometers like the S&P 500 charts looked resilient despite miserable fundamentals. Last week, I noticed signs of cracks in that resilience, & wondered how long that could continue. Now we know.PRIOR WEEK: The Reality Of Bad Fundamentals Hits The Charts
Last week saw the biggest declines in risk assets since October 2008, when the current Great Financial Crisis really got going, and ended in the March 2009 market lows. For example, the DJIA lost 5.75 %, and the S&P 500 -7.19%. Most major global indexes went from being comfortably positive to firmly negative for 2011.
Oddly, at first glance, none of basic the fundamentals being blamed for the collapse are new. You’ve probably heard about these ad nauseum this week, so we’ll keep it brief.
- The EU sovereign debt and banking crisis is looks mostly (ok, somewhat worse) like it’s where it was last year, another round bailouts linked to austerity measures to defer an eventual Greek default, supported by yet another round of farcical bank stress tests. Ireland and Portugal needing more help is also old news. Spiking GIIPS bond yields are worrisome but nothing new. Ok, one new thing, the Greek part of Cyprus is now ready to join the bailout club, so now we can call them the “GIIPS-Cs”. The only really big change in the EU’s approach, haircuts for GIIPS-Cs bond holders (a game changer for sure because it raised bondholder risk and thus must raise yields to compensate for that added risk), as we’ve noted in the past weeks’ posts) is already a at least 2 weeks old, and it was clear to most intelligent observers that from both a financial and political perspective, some kind of restructure/partial default was due at some point. The EU couldn’t afford to offer a guarantee on GIIPS-C debt forever, and voters in both funding and debtor countries were losing patience with the pain of paying for bailouts or austerity programs imposed from them
- Slowing growth in virtually every major economy has been a given for months at minimum. So the worst US manufacturing ISM reading shouldn’t have been too shocking.
- The US debt ceiling fight was long assumed to be something that would be resolved, or at least deferred; and after some drama, it was, at least for the coming months.
So it’s not enough to simply blame the combination of the above. We need some explanation for the timing – what happened this past week? More importantly, what does it tell us about next week and beyond?
So what were the fundamental changes behind the technical collapse we saw on the charts? Here are the main market drivers of the past week’s panic
The short version: the assumptions of government support for private investors are no longer valid on either side of the Atlantic. That means risk assets are far, well, riskier, than before, and markets are justifiably scared.THE US
The first suspect is the one truly new fundamental factor, the end of the first round of the US debt ceiling fight and the new reality it revealed – that the assumed “Washington put” (some kind of serious spending to prop up the economy when things get really bad) can no longer be taken for granted. In the long run that ‘s a good thing, the US does need to cut spending and get its deficit down, and there will be no “good” time to do that in the coming years of slowing growth. Spending cuts will hurt growth, period. However markets didn’t believe the time had come when Washington might really say no. Surprise, it probably has. The debt fight showed just how much political opposition there is for any new stimulus spending that isn’t matched with a countervailing cut somewhere else in the budget. See here for more on this.
This is a huge change. Remember last summer how Appaloosa hedge fund founder David Tepper correctly called a new rally once QE 2 was announced, and how often QE2 was cited by Morgan Stanley and others as the fuel behind the most of the rally that began late last summer and which really took off once QE2 became a reality? Tepper reportedly said in June that he felt Bernanke might kick in QE 3 if the stock market really tanked, but that was before the latest debt ceiling fight revealed the likely political opposition to more stimulus. We leave aside the considerable evidence that QE 2 did little but sustain asset prices, given that added liquidity is not going to help when the private sector and households are trying to cut debt and spending. Some form of QE 3 might yet appear, perhaps once again at the Jackson hold gathering in late August (where QE2 was officially born last year), but the odds are lower.THE EU: IMPOSITION OF HAIRCUTS BACKFIRES: ACCELERATES CONTAGION
Here too, assumptions that the EU would ultimately guarantee GIIPS-C bond debt were proven wrong less than 2 weeks ago, and the effects really hit this week for Spain and Italy, either of which alone is considered too big to rescue.
Just about 2 weeks ago, the EU’s latest Greek rescue plan revealed that the private sector was going to be hit with 20% haircuts on its Greek bonds. Leave aside the likelihood that the losses will probably be much higher (they’re instantly worth less now that haircuts are in the picture, and who said Greece could pay back 80% of their debts?).
As we’ve warned for weeks, because GIIPS-C bonds now come with unknown risk of loss, their yields are rising as the very private sector needed to buy this debt now needs much higher yields to compensate for the unknown risk. While yields on these bonds had been rising throughout the prior week’s as the second annual Greek bailout came together, this really started backfiring after the latest EU rescue plan of July 25th. Trouble for the too big to bail nations of Spain and Italy started almost immediately. By Friday July 29 Moody’s had put Spanish government bonds on review for downgrade and had downgraded or placed on review a batch of major Spanish banks. Meanwhile Italian stocks, which had just hit near term highs, went into freefall, with the FTSE Italia MIB falling from 19000 on July 25th to 16000 as of August 5th, a nearly 16% drop. The carnage was far worse with Italian bank shares due to their heavy exposure to Italian and other GIIPS-C bonds. Trading in certain Italian bank shares was periodically suspended. This sudden severe deterioration in far too big to bail Italy in turn has been scaring markets worldwide andbeen a major drag on US markets this past week.
The ECB and EU are well aware of the risks of imposing haircuts on bondholders. That the EU is imposing these anyway suggests that the funding nations, particularly Germany, are no longer willing to bear the cost of bailouts alone, even if that risks the very existence of the EZ and Euro, at least as we know it.
With both Spanish and Italian 10 year bond yields nearing the 6-7% range that for the other GIIPS meant
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