The New, New Normal
I’m fairly certain that when the G20 convened, many of the attendees believed that as a result of their high-minded meetings, some brilliant announcement would be given to the markets and once again the world would be deemed safe, at least for a little while. Instead, the Cannes meeting ended with no solutions and not even a pledge to find solutions. Is this the new normal? Papandreou is on his way out, which means the odds for passage of the latest rescue plan are improving, but at this point, that means very little for long-term Greek prospects.
Last week the ECB reversed its rate increase from earlier this year, cutting short-term lending rates by 25 basis points to 1.25%. This should hardly come as a surprise with the Eurozone economy deteriorating at a faster pace than was expected. Markit, a global financial information services company, reported that Eurozone GDP fell at a quarterly rate of 0.5% in October with little chance for a pick up in the near term. Output fell and new order inflows contracted at the fastest pace since June 2009. Eurozone PMI fell to a 28 month low of 46.5 in October, dropping from 49.1 in September. This is the sharpest drop since November 2008.
In Germany, whose strength has been keeping Europe afloat, industrial production dropped 2.7% in September, on the heels of a 0.4% drop in August. German factory orders dropped 4.3% in September.
One of the most concerning trends last week was the rise in Italian bond yields, with the 10 year soaring at one point to 6.64% while at the same time German bund yields dropped 2 basis points to 1.79%. Italy is rapidly approaching the levels that pushed Greece, Ireland and Portugal into bailout mode, but this time the stakes are markedly higher. Italy’s economy is the 8th largest in the world and its bond market is the third largest! That’s a bigger problem that all the aforementioned nations combined and it is highly unlikely that Berlusconi’s majority government will survive. Contagion anyone? Over the weekend Italy rejected an offer for IMF assistance, but conceded to intensive monitoring with published quarterly fiscal results. Talk about too little too late!
It is amazing to think that just 11 days ago, on October 27th, the market soared on promises that the EFSF would magically be expanded and levered up by some as yet still unidentified sources and all would be well in the world! Once again, China was touted as being keen on getting involved. Is anyone really surprised at this point that they aren’t? Then in what can only be described as irony on a global scale, the ECB left China after being rejected and headed over to Japan, who debt to GDP is nearing a mind-boggling 228%, with hat in hand looking for support. That’s like going to the neighborhood crack dealer in search of rehab options!
Italy is now clearly being targeted as the next bailout candidate, but there just isn’t enough firepower to handle the land of linguine. It needs to refinance $413 billion in the coming year with market rates currently at levels that it simply cannot afford. How much more can the ECB take on? They’ve already bought over $100 billion of Italian bonds since August, with very little impact on yields.
Greece’s default appears more likely and more imminent that ever before and there are entirely too many under-capitalized European banks, which means, systemic risk. This coming at a time when Italy, (remember that this is the 8th largest economy in the world) will need to refinance $413 billion! Ah fusilli!
For anyone who thinks that Europe’s woes won’t creep across the pond, keep in mind that between 15% and 20% of S&P500 sales and exports are derived from Europe. Europe is also China’s largest export market, so this has significant global implications outside of the danger to credit markets.
Bottom line – there is no end in sight to the Eurozone debt crisis and the U.S. will not go unscathed. To make it even more exciting, countries responsible for half of global GDP will be holding elections in the next year, and we all know how candidates love to take advantage of a crisis and stir the pot! Volatility and fear will be the norm. Invest accordingly.
