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It's Still All About The...

Daily State of the Markets
Friday, March 22, 2013

Good Morning. If there was any doubt as to what is driving the action in the stock market at the present time, Thursday's session should have erased it. In short, it's all Cyprus/Europe all the time as once again the algo's pounded the indices yesterday whenever a headline hit the wires that put the state of the banking system in question. Conversely, when we saw comments, rumors, tweets, or headlines suggesting that the bailout of the Cyprus banks was back on track, the indices popped higher.

As evidenced by the whopping 1.1% decline on the S&P so far (-0.81% on the DJIA), everyone in the game assumes that the bailout deal will get done at some point. This is like the fifth (or is it the 15th?) go round in the European bailout game and so far at least, no country, regardless of the its level of fiscal irresponsibility has been refused. So, it is a decent bet that the deal will get done. However, the reason for Thursday's weakness was that there now appears to be a deadline involved. So, yep, you guessed it; here we go again.

In short, the ECB announced it will only continue to provide emergency liquidity assistance to the banks of Cyprus (LOL, I literally typed "Greece" just then - old habits!) through Monday unless the government can agree to a rescue package with the EU/ECB/IMF. And it's probably a safe assumption that no other banks in the Eurozone are going to lend the Cyprus banks money for operations right now. So, if the ECB's liquidity were to dry up, poof... the banks are toast.

And if you remember your European crisis playbook, the crisis is and always has been about the banks. Again, no investor in the U.S. stock market gives a hoot about the economy of Greece, Italy, Spain, Portugal, Ireland, and/or Cyprus. Sure, if the Eurozone economy struggles it is bad for those who do business with them. And a recession in the Eurozone is clearly bad for China. But the bottom line is that stock markets don't get crunched to the tune of 15-20% because France's economy is slowing. No, this is about the viability of the banking system.

The deep, dark fear during this entire ordeal - a drama that is now entering its fourth year - is that bank failures in Europe would create a global banking crisis. And of course, a global banking crisis would cause the economies of the world to stop on a dime. Then boom, you've got a global depression on your hands. So, while the U.S. Fed and the ECB can perhaps bail out a handful of banks here and there, there just isn't enough money anywhere to keep a still-fragile banking system together if a real shock hits the system.

Thus, the game that is playing out right now is to find ways to restructure and recapitalize the banks that are in trouble. On that score, it turns out that the banks in Cyprus, while funded and backed by oodles of Russian money with questionable origins, are basically insolvent. And given that the government has apparently decided that it is okay to abscond with people's money, the public is likely to pull a big slug of their cash out of the banks - assuming the banks ever reopen, that is. The anticipated run on the banks will cause bank balance sheets to take a hit. This, in turn, makes the banks in Cyprus, more insolvent - if there is such a thing.

And THIS is why the Monday deadline established by the ECB is important. It means that there is now an identifiable line in the sand which, if crossed, could put the nightmare scenario in play. And THIS is why stocks sold off on Thursday - because of the fear and uncertainty over what might happen.

So, the Cyprus government has until Sunday night to find a way to come up with 5.8 billion euros. There are several plans being floated around and word was last night that a "Plan B" was ready to be announced. However, the troika seems to prefer the cold hard cash that would come from a bank tax over the smoke and mirrors approach involving new "funds" created by new loans. And of course, the people of Cyprus as well as the powers that be in Russia are none too pleased about the idea of someone picking their pockets.

Frankly, the deal will probably get done. But there is also a decent chance that a deadline or three will come and go before a final, final deadline is finally met. Remember, we've seen this movie before. And in the end, the hero doesn't die. But he does manage to get beat up on occasion along the way.

With the Monday deadline looming for Cyprus to come up with a plan that the troika will approve in order to qualify for the 10 billion in bank bailout funding, the headlines are likely to come fast and furious today. As I wrote above, it's really all about the banks. So, if a plan is put forth that (a) the Cyprus Parliament and (b) the troika would both approve, stock traders may breathe a sigh of relief. However, given the possibility that this situation could easily drag into the weekend, it may be best to curb your enthusiasm until a deal actually gets done.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
- Shanghai: +0.16%
- Hong Kong: -0.50%
- Japan: -2.35%
- France: +0.14%
- Germany: +0.11%
- Italy: +0.72%
- Spain: +0.32%
- London: +0.34%

Crude Oil Futures: +$0.48 to $92.93

Gold: -$6.00 to $1607.80

Dollar: higher against the yen, lower vs euro and pound

10-Year Bond Yield: Currently trading at 1.928%

Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: +4.20
- Dow Jones Industrial Average: +38
- NASDAQ Composite: +10

Thought For The Day...

The art of being wise is knowing what to overlook. -William James

Positions in stocks mentioned: none

Follow Me on Twitter: @StateDave

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