Disconnect Leaves Market Vulnerable
Courtesy of Karl Denninger of The Market Ticker
What to make of market structure……
Let’s put up a few charts.
This is the dollar (white line) .vs. the SPX (colored candles), 180 day hourly.
The important part is that there has been a rough negative correlation for the last year or so that broke after the "mini-crash" last Thursday:
That’s a problem folks. While a handful of days do not a pattern make, we are all interconnected and this is coming from the Euro:
Recognition of the debt issues in Europe began this slide, and it has accelerated.
The bad news is that the so-called "intervention" provided you a grand total of about 12 hours of solace before it began to bleed back off, and we are now plumbing the "panic lows":
China’s market has recognized that Europe is a huge part of their market, and is currently in "Bear market" territory, off more than 20% from the top. But our market blithely ignores what has happened over there, as if nothing matters to us – so buy buy buy buy buy!
Cisco’s John Chambers was a bit cautious last night in his comments, and with good reason. We are interconnected, and a good part of our business – in fact, more than in Asia – is in Europe. Europe has a GDP roughly equal (actually slightly larger) than ours in the United States "all-in", and the issues there are simply not over, no matter how much people would like it to be otherwise.
The point here folks is that we’re trading ~50 handles on the SPX, or about 5%, over where the correlation says we should be. Given the usual multiplier between profits and stock price this looks reasonable if Europe’s austerity measures take a mere 1/2% off their collective GDP.
But I believe that’s fanciful. Greece’s austerity measures, if they actually enact them, will place the country into an intentional economic depression – and they have to, in order to restore balance. But Greece is such a tiny piece of European GDP that it probably doesn’t matter.
This is not true for Spain and Portugal, however. Spain is #5 in the European Continent (including Britain) and about half of Germany. But Spain and Italy combined are somewhat larger than Germany and both are in trouble in the area of public spending and debt-to-GDP levels.
More important than absolute debt-to-GDP levels though are deficits, because in order to stop the accumulation of additional debt those deficits must come down or be eliminated. Spain and Italy are in trouble in this regard, with Spain in far more trouble – their deficit-to-GDP numbers look like ours at roughly 11%. Italy is around 7%.
If these deficits are brought down to no more than 3% they will have a dollar for dollar percentage decrease in GDP, and may have more due to the multiplier effect.
I generally discount the multiplier effect of government spending on GDP, although there is no clear consensus among economists on that point. (The GDP multiplier is the number of times a dollar "turns" in the economy once introduced.) Discounting this hurts the impact on the way up, but in this case blunts the impact on GDP.
Nonetheless if we were to see the Spanish GDP decrease by 8% (compared to what it would be without the changes) over the next two years as they come into line with the 3% requirement, and Italy’s contracts by about 1.5% per year (or 3% over two), and nobody else enacts austerity, believing that this will have a negligible impact on economic activity in the rest of the world is a fantasy.
The entirety of the rebound this week has been predicated on the "stability" of the European situation. I see no evidence for that. Beyond the fact that the European "package" has to be ratified by parliaments and they’re trying to bail out broke nations with contributions from those very same nations(which is clearly an insane plan and is almost certainly doomed to fail) there’s the fact that the market has already called "NUTS!" on the so-called package in the place where it matters – in the currency markets.
Beware the belief that the skies are clear folks. We did this two years ago with Bear Stearns and SocGen, and everyone called for you to "get back in the pool" post those events. But the respite you earned was only a few months in duration, after which the underlying idiocy came to the fore and overwhelmed the sell-side ToutTV pushers.
If you listened to those of us who were calling for you to run far away and seek high ground in January of 2008 when the first cracks in the credit picture appeared, you were safe when the tsunami came ashore in the fall. If, on the other hand, you viewed the water pulling back after SocGen and Bear Stearns as an opportunity to run out into what was formerly water-covered sand and pick up some "free fish", well……
