Today, the Euro tumbled heavily against the dollar punching a straight line from US$ 1.38 to 1.344, the HSI shed over 900 points (4.85%) and whole indices like the EuroSTOXX50, Nikkei225 and any pick of non-German euro indices are back at levels not seen since the aftermath of Lehman Brothers. Hong Kong is getting there, but it has a China premium in volatility-adjusted performance.
There is yet no true liquidity crisis, earnings are better and there are some economies that are still around to do fair growth: China has fared better, Japan has been a positive surprise after the earthquake, and there are a whole host of countries in parts of Europe that are by all measures doing fine. In the Lehman times, if you dare recall those memories, it was a totall immolation of nearly every asset worldwide because of a liquidity shortage and great political uncertainty which was only lifted by concerted global political and monetary co-operative action. Sure, the indices I picked provides selection bias towards this particular crisis, and the Dow jones or S&P500 won’t do that to the same degree (although the comparison is stupid as there would be a swap of two different biases against each other). Furthermore, there are no particular news out today that would necessarily cause the market to fall that much (4% across Euroland, similar for US futures and MSCI Apac): I could call that the Fed does not want to provide stimulus, if you’re shocked that the IMF also has eyes and revises global growth downwards then I’m shocked you have the brains to formulate the initial thesis that “The IMF will conclude that all is well” and sales of previously owned homes in the US were even up! Sure, fall a bit, but making new 2-year-plus lows across several different indices over this?
The analysis that can be drawn from this is that the markets are expecting enormous problems. Although things haven’t really crystallized on a single issue or a set of solutions (Lehman was easier: Problem – banks are poorly capitalized because of housing derivatives and extreme under-regulation. Solution – pump money in and regulate banks), markets at the moment fighting if not strong fundamental economic problems at least their own tendency for fear, or both. Bulls are loosing at the moment. Part of the problem is that the problem is ill-defined: unemployment and poor housing in the US, poor bank- and government capitalization in Europe coupled with near recession to be starved away, fears of bad debt and provincial/municipal crashes in China, currency concussion in Japan and generally fears of falling exports there and everywhere. How do you solve this? Everyone needs to get their act together in conflicting and separate ways. Co-operation is necessary to agree to something politically worldwide that carries weight with the markets but it isn’t even an option at the moment! Even though neither of the problems need be damning in themselves, the absence of bright spots policy-wise or even the inability of anyone to figure out how things could become good again cumulates to the current market situation where the future is seen as on fire.
Things are looking really, really bad in short. What the world markets have experienced is therefore the equivalent of a slow boil (recall Al Gore’s frog in An Inconvenient Truth) going from the initial blasters of igniting the gasoline (banks including Lehman following the 2007 housing bust), enormous flooding of ample liquidity and the steady increasing of the temperature with the subsequent one-by-one emerging problems from the list above (and beyond, the above is just a small sample). What is the real thing to fear right now? It’s that all that liquidity might be gone if the temperature increases more, and instead of a boiling kettle investors will again find themselves in a red-hot frying pan! If this happens, there are few buffers, a lot more government debt and associated reluctance to bail out, associated increases in tax to maintain service levels, the list goes on. We’re less prepared for a credit crunch shock three years after we fought the last one than we were then!
What may spark this disaster I write of? A bunch of things. Bank failure wouldn’t be untrue to history, but that in itself is more likely to be sparked by deterioration in the credit quality (forget about the ratings, think about actual, fundamental ability to pay and issue debt at the market price) of any Euro country such as Spain, Italy, or France.
What is the implication for markets?
Forget about them bottoming at 2009 levels in Europe, and think carefully about whether the US will be back there. Asia is a different ball game, but just from a magnitude perspective; the direction will be the same. Thus, things will look really grim, and we will be freestyle diving with no reference points. But lets consider where we can trade off before that happens.
- Clear battle lines appear in the euro short term. (Less than a month.) These are at US$ 1.287 to 1.259, corresponding to December 2010 and July 2010 bottoms respectively, and coinciding with Oct-2008/Feb-2009 lowest weekly closes. I don’t advise going long before 1.265, but that is where significant enough short term support can be found to actually bring about a significant short term bounce to either 1.287 or 1.32 before continuing down should liquidity dry up.
- The Dow Jones have became a personal favourite for these trading time frames, and I reiterate my calls for a fall to around 9 500 (May 2010 lows), after which it could bounce back towards 11 000 given good enough fundamentals from Washington. Those same factors could however push it firmly down towards the 8 300 levels in the presidential race, so this needs to be watched closely and with a certain amount of discretion in the longer term.
- I reiterate my longer term calls for the HSI to at least test around the 17 000 level, and most likely then rise back to around here (18 000 to 19 000 or fall towards the lower 15 000’s. However, it seems that market fears have brought the move forwards a lot more than I expected.
- Sweden’s OMX 30 is trading where it was about September 2008 (BLB, you should know what this means), so take your pick from todays levels of 870: 100 point fall, consolidation after the initial March-09 rally; 200 point fall, hook that sparked the 2009 initial off-the-bottom rally; or 300 point fall, past 4-year bottom. My bet is 100 points, quick bounce to a small, insignificant level, and then a likely revisit of the 2009 lows at -300 points if either liquidity dries up or world growth and exports tumble.
- Nikkei 225 is too scary to call, but the short term-allure is of course for the nearby 2009 lows. That said, the currency (JPYUSD: 76.2 at the moment) is probably one of the few that will go up against the dollar, so if you have the cash, either pick your companies carefully or just plainly find ways to buy the bonds in Japan. Shorting stocks also sounds fun, who wouldn’t want more of an appreciating asset?
It is a grim picture we are looking at, but if liquidity is truly trying up, it will be time to put your napkin on, crack a few principles and ideas about being long, and make omelet on that hot plate. Hopefully the associated chaos will actually prompt people in power to do something about it, so if you’ve got a hearty breakfast you can go back to work normally and have a profitable, happy, long day.
[3/10/2011 Edit: cleaned up some writing misses, formatted and clarified some things. The analysis is the same and no numbers were changed.]