Why you should fear Cyprus

A bank run on the tiny island nation will have major consequences for the future of the eurozone.

By Anthony Mirhaydari Mar 20, 2013 2:18PM

Stocks have been suffering rare spasms over the last few days in response to the fast changing situation in Cyprus, where a proposed bailout from the eurozone has broken a taboo of hurting depositors with a proposed tax on savers. European leaders wanted a 10% tax on deposits, much of which is foreign money from wealthy Russian oligarchs.

 

But in the process, they shattered the thin tranquility that had settled over the eurozone banking system and its sovereign bond market. Nice going guys.

 

For U.S. investors, this seems like something that can be safely ignored. But it can't, because Europe has once again -- through policy errors -- stressed the vital yet fragile connection between its banks and troubled countries like Spain and Italy. That's a big deal. Here's why.

 

For one, just stepping back a moment, it's worth noticing that while the Dow Jones Industrial Average continues to act as if nothing was wrong, leading issues like emerging market and semiconductor stocks have all sliced lower into new downtrend patterns. Not a good sign.

Technical measures of market strength, including breadth and momentum indicators, have also weakened over the past few days. Clearly, something is shifting deep within the bowels of the market.

 

 

Why Cyprus?

 

The island nation, by offering attractive deposit rates and relatively lax oversight, became dependant on offshore financing activities to boost its economy. The influx of deposits, which stand at €72 billion or nearly 300% of GDP, enabled its banks to take on risky investments, pushing its asset base to almost 700% of GDP. In comparison the U.S. deposit base, depending on how you count it, is just 69% of GDP.

 

Europe copyright Photodisc, SuperStockIn response to a need to recapitalize the Cypriot financial system, after it suffered losses related to the Greek debt default (the problems are compounding now), the European Union and the International Monetary fund proposed a €17 billion bailout -- which would've made Cyprus the fifth Eurozone country to receive aid money -- which was to include a €5.8 billion contribution from depositors.

 

Then all hell broke loose, the Cypriot parliament rejected the idea despite a veiled threat from the European Central Bank that it would pull its support for the country's beleaguered banking system. All the while, to prevent a catastrophic run on deposits, the country's banks have been closed and are expected to remain closed through next week.

 

Why does this matter? The stakes couldn't be higher.

 

It's a continuation of the trend towards a more aggressive, democratically-led backlash against the German-led austerity-first approach to the Eurozone crisis. We've seen local populations grow increasing wary of the high umemployment, EU/IMF/ECB oversight, and loss of sovereignty associated with prior bailout programs. And Spain and Italy -- which haven't received formal bailouts -- are seeing protests grow against the Eurozone's new deficit targets and the region's ongoing economic malaise.

 

Now that Cyprus has rejected the deposit tax, upholding the rights of private property holders, it could very well be forced to leave the Eurozone. This would break another taboo, the irreversibility of the euro.

 

And all of this calls into question the health of banks in countries like Spain, which like Cyprus doesn't have the resources to fully guarantee deposits in its financial system.

 

If Cypriot deposit flight turns into a contagion, leading to bank runs in places like Spain, banks there would be forced to offset the loss of liabilities by selling assets to shrink their balance sheets-- including the sovereign debt of Spain and Italy -- causing borrowing costs to rise again. Higher borrowing costs would further damage the deficit positions of these countries, requiring more political unpalatable austerity measures.

 

It's a downward spiral.

 

The resulting tightening of credit would deepen Europe's new recession and throw the finances of too-big-to-bailout countries like France, Italy, and Spain into disarray.

 

 

I don't think investors are properly discounting the downside risks here as they dismiss Cyprus as irrelevant. In response, I'm adding the ProShares UltraShort Europe (EPV) -- a double inverse ETF -- as well as a short position against Spanish bank Santander (SAN) to my Edge Letter Sample Portfolio.

 

Disclosure: Anthony has recommended EPV to his clients.

 

Be sure to check out Anthony's new investment newsletter, the Edge, and his money management service, Mirhaydari Capital Management. A two-week free trial has been extended to MSN Money readers. Click the link above to sign up. Mirhaydari can be contacted at anthony@edgeletter.c​om and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below. 
 

97Comments
Mar 20, 2013 2:58PM
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the market is up 80 points today because Ben Bernanke is still pandering to his wall street and banker friends.  Forget out earning interest on cd's, or the little guy....no, let's hellp the crooked wall street and banksters.  Instead of serving jail sentences, they are out on their yachts.
Mar 20, 2013 2:41PM
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Remember Europe shot a nobody Duke in 1916 and it lead to Two World Wars.  Could this cyprus thing be our Arch Duke Ferdinan of this century, and lead to a world economic collaspe it is not that far fetched. I was wondering why the Russian govenment was so interested in this and now I see it is one of the places they are hiding all the money they have stolen from their people.
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Why is everyone cutting down Germany?  It seems they are the only ones that are trying to keep everyone solvent.   Germans have money because they build things to sell. The PIIGS do not have money as they just give what they do have away on Social programs.  Someone has to pay for these programs.    There is no such thing as a "free lunch".  It all comes back to who makes what for cash.  The Germans do, so now they are the bad guys.  I think they are the Good guys in all this.   Northern Europe makes money while Southern Europe spends money.
Mar 20, 2013 3:28PM
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It is now clear as a very blue sky where all the bailout money is guaranteed.  US taxpayers via the Fed is propping up world markets.  Bernanke is continuing the financial confiscation of wealth at home to keep the world economy from trashing.(it will eventually)  Cyprus will have to keep its banks closed, why? the slightest hint of confiscation will cause depositors to flee....where?  anywhere but the Cypriot Banks.  Wait till next week when and if they reopen....I would pull my money so fast it could challenge light speed.  Things aren't getting better they're getting ugly.   

Mar 20, 2013 3:48PM
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If they can close the banks , and, your access to your money , not to mention tax it , it's gone ! And , this example is just the beginning , your account is already being looked at by some lawmaker here as well !
Mar 20, 2013 3:24PM
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Part of the Greek bailout was a haircut for bondholders. The Cypriots got clipped pretty good. Now the ECB wants another pound of flesh. More importantly is that if this goes through and private accounts are taxed, a precedent will be set. On the basis of this precedent private accounts will no longer be safe from expropriation by the taxman. A mason jar of gold and silver coins buried in the backyard will be the only safe way to preserve your wealth as this string of dominos fall and takes the debt based monetary system with it.
Mar 20, 2013 3:41PM
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I agree, Tony. I am also noting that the major banks and investors are betting more and more on hope instead of any sort of professional analysis. If you have your money in Wall Street, it appears you are no better off than keeping it with bookies in an alley. Come on... Central Banks have extended too far and didn't put a penny into job recovery and management caps. Hired-in losers who can't do what they were hired to do are still getting huge severance while the economy-stabilizing people are broke. The FACTS are FACTS not conjecture. Destroy the banks, start over. Wall Street is a joke.

 

Shouldn't Wall Street be crashing the Dow right now. Bernanke is continuing to dilute the Dollar and funding markets of businesses that do not hire. What EXACTLY causes the Dow to rise in an adverse situation? Investors are praising disastrous aspects, not recovery!

Mar 20, 2013 3:10PM
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The "bull case for equities" is just that: bull.
Mar 20, 2013 4:05PM
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I have a question for you Tony.  Well maybe a little more comment than question. At the close today if everyone who owned stocks all e-mailed into one central location the value on the line at the bottom of their account we would get say a 1XXXXXXXXXXX Amount.  So we have all these folks walking around thinking they are worth that figure at the bottom of their account.  If something were to happen and everyone attempted to sell and were successful by this time tomorrow what would the wealth number be?  You see we have so many folks in this market walking around on a bubble thinking oh they are so well off because they are worth some number we all know in practicality to be false.  What would you consider a fair percentage value if all accounts positions attempted to sell at one time.  I know the markets would be closed like the banks are today in Cyprus if this was attempted.  But you get my drift?  Somehow as a measure we need to have an estimate of the actual saleable value.  My contention is the value of cash in the the bank plus resources owned and a little good will should be and historically be the value of that specific stock.  Correct?  And this has to have been calculated somewhere by someone.  It is my contention this market is so full of fluff the Dow itself probably only has a fair value of about 7000 at present. Your thoughts Tony.  Thanks
Mar 20, 2013 2:56PM
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A busy restaurant chain in southern California, Farmer Boys, was founded several decades ago by five Cypriot brothers, all raised on a farm, and I'll be they're very glad they migrated to the US when they did.   Now there are over 70 sites.

Mar 20, 2013 4:34PM
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Of course our stock market is doing well.  There is a new chant going on at the floor of the stock exchange.

 

"PRINT MORE MONEY !!!"

"PRINT MORE MONEY !!!"

"PRINT MORE MONEY !!!"

Mar 20, 2013 3:17PM
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"Success is the sole earthly judge of right and wrong." Adolf Hitler.

 

Germany will accept that confiscation in small bills.

Mar 20, 2013 4:45PM
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If Ben{Mr.I should be locked up in a sanitarium}does not stop printing 85 billion a month,inflation will not be our only problem,we are going to run out of trees!They better make room in the fed building for the squirrels and birds.

Mar 20, 2013 5:41PM
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Whats more important than Cyprus is whats going on with eurozone's overall GDP, which is still contracting and was the worst last qtr since '09.  As long as they stay in recession there will continue to be a steady drumbeat of dire predictions related to Europe and sovereign debt.  Perhaps we're in for a repeat of last year, with markets nose diving in the middle of the year while everyone gets sick to death of hearing about Europe.   Remember "DOW down on Europe worries" every other day?

 

Then again, Anthony's been calling it wrong since December, when the S&P was still around 1450, so who really knows.

 

Only one thing is certain, socialism (or socialist leaning goverments) always ends badly.  Until people finally figure that out, accept it, and stop the endless spending, we'll continue getting endless stories like the above.

Mar 20, 2013 4:09PM
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Toilet paper Benny Bucks.......TO THE RESCUE!!!!!
Mar 20, 2013 5:01PM
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Here's the formula for a Mirhaydari post:

-Negative Information about things

-The obligatory "Here's why."

-Usually a "Moreover" or two in there somewhere.

-Lots of Charts

-Bad investment advice.

 

I did like that map today, though.  That was way better than the usual "grumpy investor" picture.

 

Mar 20, 2013 3:27PM
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Too bad that MSN can't get the RUT2K readings fixed..
Mar 20, 2013 5:19PM
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DON'T LOOSE SLEEP OVER CYPRUS.

 

NO PLACE TO HIDE

 

You should think about hiding.  big ben has no choice he has to raise asset classes. this is economics 101 but most people have no clue why or what he is doing. The next line will be is look how all those investors made money on the refloat of the economy. Instead of look some jobs are being created to help our economy. if you didn't invest whose fault was that. exxon has a program for the small investor to start with a $ 300 deposit.

Mar 20, 2013 4:40PM
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Is this guy ever right? Even a broken clock is right a couple of times a day, but not Tony. Wrong, wrong and wrong again. One rule to remember, make that 2 rules to remember; don't fight the fed and the trend is your friend. It really is that simple. If I listened to Tony I would have missed out on a 10% gain this quarter. He shorted the market and is probably down a minimum of 10% ytd. Keep listening to him folks andkeep  losing money in an up market.
Mar 20, 2013 5:02PM
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Another great article Dr. Doom, the  European market is up pretty good today. They don't even take Cyprus very serious, then why should anyone think that it will have any effect over here! Stupid people must follow advice from this one.
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