"If Italy goes down, the European dream is over."- “Ignore Egan-Jones at Your Peril” (.pdf), The Absolute Return Letter, November 2011- Front Page Headline, The Wall Street Journal, Monday, November 21, A1
In “The Road Map Into Year End” (November 7), I highlighted two things to keep our eye on: Europe and The Debt Super Committee. Unfortunately, in the intervening two weeks, negative developments on both fronts have broken the back of a budding year end rally.
“Europe will continue to be in the headlines. Greece is at the forefront and I am hearing more and more chatter about Italy the last few days”, I wrote. Two days later, the yield on Italian 10-year bonds broke above the closely watched 7% level causing the S&P to drop 47 points (-3.7%) (“Italy Fears Rattle World’s Investor’s”, The Wall Street Journal, Thursday, November 10, A1).
The European Sovereign Debt Crisis is now progressing toward its climax as larger and more systematically important countries become the focus of concern. Italy’s government bond market is Europe’s largest at €1.6 trillion. €200 billion of it comes due in the next six months. “A country is bust when the markets decide”, Societe Generale’s Albert Edwards wrote three weeks ago. Should Italy have trouble rolling over this debt, all of Europe will be staring into the abyss.
Yields on Spanish and French debt are also rising. Only Germany remains a safe haven in the mind of investors. But can Germany carry all of Europe on its shoulders? Will it submit to do so if asked?
In this context, it is worth reflecting on the failure of the Debt Super Committee. The United States has important advantages over Europe such as the dollar’s role as the reserve currency in the global financial system and our ability to print money. But make no mistake: we are travelling down the same path as Europe and the Committee’s failure to reach a compromise to begin putting our finances in order only moves the day of reckoning closer.
Short term traders are pointing to support around 1185 which represents a 50% retracement of the October rally.
Take the last six weeks of 2011 to put your portfolio in order because the escalation of the European Sovereign Debt Crisis is likely to precipitate a nasty bear market in 2012.