Greece IS a big deal
Posted by Ray on April 27, 2010 under Main | 
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Apparently the markets, that wonderful forward looking discounting mechanism, did not see or have fear what is happening in Greece. It is safe to assume that this proves that the markets are not efficient and it fails to see potential problems. What is interesting is that Greece and Portugal were not or should not have been a surprise to the markets since we have all known about the issues with the PIIGS for months now. How anyone could have been surprised by this news today is beyond me. I guess the junk rating on Greece may have been a surprise, but come on, when the 2 year note was yielding 11% how in the world can it be anything other than junk?
The market has gone up for 8 weeks in a row and while the talking heads thought this perpetual “tortoise rally” was normal anyone who has even a little investment experience knew it was not. I still remember Dennis Kneale, last week, calling people who held cash “fraidy cats” because the market is back and it will be a bull market forever. The world does not work like that and the risk trade has been, frankly, out of whack. Money has been pouring in to everything from high yield to emerging markets in the expectation of a steady 1-2% a day. This was verified from mutual fund flow data reported last week which showed investors moved more money into equity funds, for the first time in a longtime, and, in my mind, confirmed we must be near a top, dumb money always moves in after fantastic rallies.
Whether or not this was a top remains to be seen, but it certainly looks like it from my lens. I have been wrong before and might be again, which I admit. However, even though I was wrong it doesn’t mean that the markets were right either. Earnings are better, I still see some misses in revenue though, but the underlying macroeconomic data has merely gone from very bad to just plain bad. When we cheer a 57% confidence reading that is a problem because that it is a horribly low number. The housing data is not verifiably strong when you have, like in October, a rush of people buying for the tax credit right before it expires. If the housing numbers stay “strong” for May then you may say housing is rebounding, but I highly doubt we will see such strong numbers at that time. Housing is a key indicator because it employs so many people and homes were the collateral that were the bad debt sitting on bank balance sheets.
Unemployment remains incredibly high, use the U-6 data not that foolish headline number, which is a severe problem. Given that weekly claims have stabilized at -450K is horrendous at best. That number shows that private employers are still shedding jobs and I am confident that the employment report next week will show “stellar” job creation in the government sector and in the temporary help area, those are not good areas to see growth in. I am a believer that the temporary help is just that, temporary and will not convert into fulltime employment, we would be seeing that conversion by now, but we are not. Housing problems plus high unemployment will keep the economy down for some time.
On top of the squishy soft economic data being heralded as a full blown recovery, don’t get me wrong less bad is a welcomed improvement, we have a sovereign debt crisis. People claim that Greece is only 2% of Europe’s GDP and dismiss their troubles. That is a bad idea because while they are right about Greece they conveniently forget that all the PIIGS account for some 13% of Europe’s GDP and they are all in trouble. Spanish and Italy’s bonds have been trading lower pushing their yields up over 4% and Portugal was officially downgraded, that is all really bad news. Each country, individually, is not a big deal, but combined we are talking about the potential to default on hundreds of billions of dollars worth of sovereign debt.
To put this into prospective, France owns some $781B of PIIGS debt, if they all default what will happen to France? They will be in trouble, of course. Then there is Germany, how much PIIGS and French debt do they have? I do not know, but I assume a lot. What will happen to Germany if they get stuck with declining value of all that paper? They will have to bailout their banks, I assume France would have to do the same for their banks as well. That, basically, puts the banking system in jeopardy again, in less than 2 years. What I am explaining, probably in a horrible way, is what contagion looks like and it doesn’t end there either. The U.K. has exposure to all these countries and they are already in horrible financial shape and the series discussed above makes the U.K. susceptible to the contagion.
U.S. banks have exposure to both European banks and sovereign debt which means out fragile banking system could face another challenge. Let us not forget that the U.S. is also heavily indebted, along with Japan, and people may start to question the safety of U.S. Treasury debt, as they should I might add. From my lens, in a worst case scenario, meaning this all happens, it would be a coin toss as to which country goes next, either Japan or the U.S. given their immense debt loads. This scenario is unlikely or has a low probability of happening, but it is possible and it could trigger a global currency crisis.
This explains why gold went up today in the face of a stronger dollar and a rush of selling from the market. Even silver held its own today in the face of dollar strength. This shows that gold is still a flight to quality, it is also in a bull market as well, and it is a trusted currency. In fact, gold’s rally today is why I think it is possible for a global currency crisis because if this was another credit crisis, like 2008, it would have sold off for liquidity, but it did not. I am not sure if I would be buying gold right now because I already own a position, but if I did not own any gold I would be a buyer.
All is not well in the global markets and people should stay nimble as to where to put their assets until things settle down. I would say this decline is extremely bearish and way overdue, the higher the market went the worse the selloff would be, which could make it worse. It was insane to think that volatility would not comeback and that people went from sheer panic a year ago to such utter complacency this year. The worst part about all of this is if this does trigger another crisis what can the Fed or the governments do to calm the markets or remedy the situation? Nothing, they already spent all their ammo and they even had to borrow some to boot. I am not saying this will trigger another crisis, but it certainly has all the ingredients for one, if you look at the big picture.
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