Once again the ugly and terrifying European sovereign debt monster has reared it's ugly head. Combined with pending end of US QE II and related US debt ceiling woes - equities and commodities around the globe are pricing & bracing for worse case scenario possibilities.
For the past few months banking experts and financial pundits have been split over the 'contagion effect' of a Greek default and a bond market 'brush cut.' The dire situation in the Mediterranean is rapidly becoming obvious. 3 year Greek bonds trade with an effective yield of almost 30% and an explosive CDS derivative domino market just itching to be triggered. A full blown Greek default has already been effectively 'baked' into the Baklava cake! Greece is over 300 billion Euro in debt and it's budget deficit is more than 4 times the Euro zone 'limit' at 14+% of GDP. The Greek economy has only marginally delevered to this point. Credit to the Greek government has actually increased recently. Credit ratings have hit the rock bottom 'CCC' (avoid at all costs) level. Our happy-go-lucky friends at Moody's Investor Service's is 'warning' ALL lenders remotely connected to the Greek debacle. Three key French banks (Soc Gen, BNP Paribas, & Credit Agricol) with significant credit exposure are the latest candidates to get the Moody evil eye.
Since last May when IMF and Euro zone members reluctantly coughed up an additional 110 billion Euros in a bailout/rescue package along with associated hard core austerity programs social unrest and protest has been the order of the day. To this point Greece has not taken their 'belt tightening' as hard as losing the 7th game of a Stanley Cup final - but discontent and anger will certainly grow during the long hot summer months.
Since then unemployment in Greece has grown almost 5 % to the current 16.5% level. Under 24 year old unemployment exceeds a crushing 40+%! One in three Greek workers are 'currently' employed by the government. The 'reshuffling' Greek government continues to spend almost 50% of it's GDP - an obviously unsustainable pace which will ultimately result in accelerated job loss. To make matters worse another 60 billion Euro infusion is needed by the middle of next month. The big US banks have been generously supporting European banks having lent almost 30% from their 'books' over the past 2 years & with over $US40+ billion of total exposure.
The ECB currently holds 190 billion Euros of Greek IOU's against a total net equity capital base of 82 billion Euros. A 50% Greek bond market 'haircut' would therefore effectively wipe out the ECB and sink the central bank. The contagion effect would be catastrophic to say the least. The top 3 directly exposed countries to Greece are Germany (26b Euro), France (20b Euro) & UK (3.2b Euro). Adding basket cases Portugal & Spain and possibly heavy weight Italy to this toxic mess makes this 'structual' challenge more than 'transitory' in nature. It is the toughest test of the resolve and discipline of the Euro zone in it's short history. Should Euro financial heavy weights Germany and France fall out of love the resulting divorce would be messy indeed and make a world wide economic 'double dip drubbing' a certain reality.
In the US, fixed income Guru and newly minted Treasury bond bear, Bill Gross, who manages over $1.2 trillion in assets, told CNBC Monday that the US is 'actually' in worse shape financially than Greece after all entitlements are factored into the equation. Pimco has no intention of buying any treasury bonds after the Federal Reserve spends the last of the $US600 billion bailout bonanza. His tone and demeanor was dire to say the least. Definitely not a great way to start the week.
The aptly named 'Misery Index' which is the sum of unemployment and inflation (CPI) rates has hit a fresh 28 year high. Almost as miserable as a Vancouver hockey fan! The index has risen significantly since BHO took office from 7.8% to 12.7% Google searches for 'Double Dip Recession' have returned to bearish levels of this time last year! Fragile consumer confidence threatens consumption levels for the summer and back to school months. American households are quickly losing their sense of humor and patience.
On the plus side, total household financial burdens have eased considerably since Sept '07 reflecting businesses and individuals actively adjusting to changing circumstances. Housing starts are flat (which is better than negative) despite significant inventory supply. US Corporations are flush with capital and strong profits continue to roll out throughout much of this uncertainty. Retail cash registers are ringing for the time being and we are beginning to enjoy some of Al Gore's global warming at last!
The DJIA and S&P both sit 7% below recent recovery highs in early May. They are both consolidating in critical moving average territory and slightly above long term weekly up trend lines. They both 'feel' like they could quite easily retest the lower early March and Jan 1st levels of another 3-4% lower. Sharply lower recent crude oil prices should add significant support to those levels and fatter consumer's wallets.
In the commodity sector, Brent-Cushing spread levels have hit record levels of over $US20/bbl. Markets look to be well supplied in the short run despite rising world wide consumption levels. Crude oil has broken a recent short term congestion distribution range and will find significant support in the $US88-92 range. The break at the 'pumps' will be welcome news for American drivers this summer. Natural Gas looked all set to breach the $5/mcf level recently but has settled back into the $US4.50 range based on lower crude prices.
Gold refuses to correct below the $US1,500/oz level and looks to break out into new all time high territory should credit issues accelerate. The 'gold barometer' is clearly signalling anticipated increased inflation levels and possibly QE III expectations. Silver continues to compress in the mid $US34-6 range still feeling the ill effects of recent crushing CME margin pressure.
In the Agra sector the grains have corrected recent strength primarily based on current prevailing economic 'slow down' concerns and anticipated credit contraction. Growth and economy sensitive Copper futures has rallied into key over head resistance and potential break out territory of $US4.25/lb.
In Canada, the 'Forest Slump' misadventure fiasco appears to have spread throughout the entire TSX resource sector. Selling has accelerated recently with the TSX a full 10% + below recent recovery high territory. Beleaguered shares of SinoForest have broken $CD4/sh this week in a stunning fall from institutional grace. Lower than expected earnings were reported compounded by accelerated 'non-recurring' write downs based on new international accounting standards. It will be an additional 3 months before an 'independant' analysis is complete. At minimum, it will give a little more time for the trees to grow! Until that time 'CasinoForest' remains a highly uncertain unquantifiable speculation at best. Should the 'worst case' scenario emerge for TRE it could unfortunately tarnish current resource excitement and reduce upside for a whole chunk of related sectors.
In the misery loves company category, RIM has also disappointed investors and analysts with lower than expected earnings and sharply lower future guidance. This bad news has resulted in a stock price below 2007-08 end-of-world levels. RIM has been a key bell weather for the TSX for many years and it's negative effect could quite easily mute sector and index upside for the summer months. Based on current earnings, low single digit P/E, and cash flush treasury RIM will be an ideal candidate for potential merger or takeover activity for those hoping to do battle with the Apple communications behemoth.
Bottom Line: It is almost impossible for equity/commodity markets to deal with the steady flow of dire/tragic 'macro' related issues and events that we receive on almost a daily basis. Most major indexes have mapped out short term distribution type topping patterns primarily based on significant assorted economic head winds. Strong bottom up micro corporate fundamentals are in place for concerted upside once the major sovereign credit and debt issues are realistically and effectively addressed.
For those of the bullish ilk who may need reminding or to be cheered up a little;
the world is growing (3.2%); the US is growing (2%); floods/tornadoes/tsunamis are not permanent; debt is transitory; IPO conditions are vibrant; companies are loaded with cash ($US1.9 T); bargain Fed interest rate policy appears to be locked in until after the 2012 election; key blue chip companies are well into the black and attractively valued, and most importantly almost everybody is braced for the downside.
Look for major equity and resource markets to move from 'risk aversion' to 'liquidity conversion' before long!
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