Europe's endgame threatens us all

The final act of the eurozone debt crisis will force the United States down a painful path.

By Anthony Mirhaydari Jan 13, 2012 5:22PM

On Friday the 13th, the eurozone's existential nightmare plunged to new depths: Credit analysts at Standard & Poor's who cut America's AAA rating in August made good on their threats and cut France's AAA rating by one notch. They also handed two notch downgrades to Italy and Spain, according to widespread media reports.

 

This was done in response to a disappointing European Union summit back on Dec. 9 where, instead of addressing the structural issues at the heart of the crisis there -- namely, inadequate banking regulation and lack of true fiscal union -- or measures that could stem the crisis, the focus was on stricter budget discipline and austerity measures. That's the same mistake we made in 1937. And that same mistake was why the Great Depression lasted so long.

 

The team at S&P wasn't impressed and took action as Europe plunges headlong into a new recession. This, combined with the collapsing Greek bailout, has markets reeling and Wall Street analysts cutting their economic growth estimates. It couldn't come at a worse time.

 

The reason the downgrades are so significant is that Europe's bailout fund -- the one that's supplying rescue funding to the likes of Greece, Portugal, and Ireland -- operates by taking seed capital provided by the likes of Germany and France and using it to attract outside, private capital. But now, with the creditworthiness of France and Italy being called into question, the bailout fund's credit rating will come under pressure. As it stands now, Germany will be the only AAA-rated country standing behind the bailout fund. Not good.

 

All of this will make it harder for Europe to raise the cash it needs to keep Greece going.

 

The other issue is that as part of the new €130 billion Greek bailout hammered out in October, Athens was supposed to negotiate a 50% reduction in its debt load with private creditors. This would alleviate the budgetary pressures and was the crucial first step in unlocking its new rescue funding.

 

Friday, we learned that the talks have fallen apart. I'll spare you the details, but essentially eurozone banks and eurozone politicians have been played by hedge fund managers who are now positioned to profit even if Greece defaults on its debt in March -- which now looks increasingly likely.

 

So, what does this mean for you and me?

 

The rapid deterioration of the situation across the Atlantic, after a brief holiday reprieve, threatens to pull the U.S. economy down into recession in 2012 via financial market turbulence and a slowdown in global trade. Asia is already catching cold with Singapore, rest stop between Asia and Europe, suffering a 4.9% annualized drop in its economy in the fourth quarter as manufacturing activity plunged 22%. 

 

Friday's developments, along with Thursday's terrible retail sales report, has Wall Street analysts falling all over themselves to cut their GDP growth projections. JPMorgan economist Michael Feroli cut his first quarter estimate to just 2% and expect policy uncertainty near the election to weigh on growth later this year too.

 

Expect more of this as the two temporary tailwinds that supported the American economy recently -- savings withdrawals and cheaper gas prices -- both reverse.

 

Now, with Europe's woes pulling down growth and Washington embroiled in bitter divisions, Federal Reserve officials are out in force trying to talk up the potential for another round of money printing, or "quantitative easing."

 

But as I illustrated in my last post, this is a terrible idea since instead of supporting growth, it is likely to merely encourage Wall Street to push up commodity prices, inflate gas prices, and cause more economic damage just as the $600 billion "QE2" initiative did in late 2010 and early 2011. 

 

Not only that, but Republicans are not going to be happy if the Fed chairman Ben Bernanke is seen as toying with the dollar to boost President Obama's reelection chances. Not with anti-Fed presidential candidate Ron Paul still in the running.

 

It's like this: Europe's debt crisis has reached its final stages where the like of Greece have no choice but to consider debt defaults and possible exits from the eurozone, something that will increase the pressure on Europe's banks and the countries that must stand behind them. This, in turn, will increase the pressure on "core" Europe creditors like Germany and France, weakening their ability to save troubled-but-not-yet-doomed countries like Italy and Spain.

 

All the while, America faces a stark choice between a new recession that will weaken its own debt problems or having another go at dollar devaluation, commodity price inflation, and having its central bank become a political punching bag. Pick your poison.

 

 

As for stocks, I still believe we're still in the midst of what will prove to be merely a bear market rebound, albeit a very, very powerful one.

 

There has been a massive shift in sentiment as the temporary boost in U.S. economic data, intermission in the eurozone debt crisis, and the positive seasonality of the holiday trading season combined into a confidence inspiring concoction. It's reaching extremes now just as the fundamental data turns sour.

 

According to the folks at Sundial Capital Research, for only the 19th time in 25 years, fewer than 17% of individual investors have a bearish outlook for a second consecutive week according to survey data. At the same time, large, heavy hitting S&P 100 options traders are eagerly snapping up put option protection against market declines. Right now, there are 171 put options outstanding for every 100 call options.
 
Historically, ratios this high have presages poor periods of market performance with an average 30-day return on the S&P 500 of -1% with only 33% of all days positive (out of 131 days) over the past decade. Reversing the situation, when calls were more popular than puts, the 30-day return averaged +2.1% and was positive 67% of the time.
 
I guess this was a Santa Claus rally for the record books. But that doesn't change the fact that it was merely a distraction, a head fake on the path to lower prices.

 

Check out Anthony's investment advisory service The Edge. A two-week free trial has been extended to MSN Money readers. Click here to sign up.


The author 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.

 


 

55Comments
Jan 14, 2012 10:41AM
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I think its a bit of a stretch to claim that this will effect "all" of us.

 

Sure, the unemployed, young, old, those who lost their house, their savings, their retirement, whats left of the middle class, those with stagnant wages, those with no benefits, the poor.  Pretty much everybody other than the 1% old boys club will be effected, but not all. 

 

Those that matter will continue to do just as good as they have beeen.

Jan 14, 2012 10:26AM
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This is old news and has been discounted by the market already.

 

The author of this article is like the boy yelling "Wolf" one time too many. The dim witted like Endeavorless are always (and only) attracted to the negative news repeating the same old crapola over and over again.

 

At worst, Europe will go into a recession, and at best, it'll muddle through. To imagine that the European union will disintegrate is to ignore its past problems and history of dealing with them.

Jan 14, 2012 10:25AM
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Only if you are blind or have no idea how the system works,Europe hurts as does the world as it follows the up and down of America's economy.

 

Waiting on the new paper tiger economies like India,China to bear this burden is too much hope and expecting way to much as you can see by the world markets and currency.

The safety net is gone and  that would be , The good old U.S.A. that sold it's family business's for profits. In the end, greed leads us to it and we cannot get out of this paper bag.

 

True options will not be addressed as no sacrifice will truly be made just kick it down the block.

 

Sad.

Jan 14, 2012 2:09AM
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Threatens

 

Guess the good old rich boy networks are working in Europe.

Jan 14, 2012 12:51AM
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Open-mouthed The reason of the big crash in 1929 is the big bad boys took all the money and then they ran. There are now too many big bad boys making a lavish living off wall street.  It looks like it is going to be worst this time when hell breaks loose.Disappointed But they say that crash only happens when no one expects it so at this point it is not to be expected as there obviously some degree of expectations therefore there won't be any crash?Tongue out
Jan 14, 2012 12:43AM
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"Today, we learned that the talks have fallen apart. I'll spare you the details, but essentially eurozone banks and eurozone politicians have been played by hedge fund managers who are now positioned to profit even if Greece defaults on its debt in March -- which now looks increasingly likely." .....Quoted from the article.

Right there is a key problem not only for Europe but the world. Wall Street type scumbags. Why aren't these people being rounded up and shot?


Jan 14, 2012 12:33AM
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Greece and Portugal will default in March. Then we can go in and purchase the countries. Then we can work them like we are treated on our jobs in America, Like an overworked dog. Smack them and smack them hard. They are lazy.
Jan 13, 2012 11:26PM
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Countries are too big for their financial britches. Spending more than they have then wanting to be rescued. The United States is included. Printing stimulus money without a vote from the citizens then rewarding failed companies of their choice. That is not democracy. Companies making bad business choices should pay the price we all pay. The politicians with their specials laws that favor only them are getting rich while poverty row grows for workers.
Jan 13, 2012 10:54PM
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Look at the writer's record of predictions; History does repeat itself. I have seen enough of this bogus /pessimistic/anti-American prognosticator, and this is the last column of his I will read. Do your own research re: stock investing, and ignore the media-biased political BS. 2012 will most probably be a very good year if you are long the right stocks. Pessimists generally do not last in the long term.
Jan 13, 2012 10:36PM
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The Russian tanker ship and US Coast Guard ice breaker made it to Nome, Alaska .. so heating fuel cost will fall from the $9.00 a gallon expected price.  Of course it is only minus 31 F below zero and the crew have to drag hoses across the frozen shore fast ice for six miles to unload the 1.3 million gallons.  Now what was this problem about EU credit freezing up?
Jan 13, 2012 10:36PM
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so the clouds part to show the true sky.... or at least a glimpse. Yeah as i read below undelivered and pawned off like a puppet while the power people made him look like a fool. that was the bail out I am referencing.... it was like no way and then the classic head turn and you must help these people. No one helped me. In fact they laughed while they made the local action to replace my business with tax payer ran programs.. yeah i was made to help pay for my demise. I have no sympathy. I am not angry however and looking for an answer. Join in .

Jan 13, 2012 10:29PM
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Seems like back in the 80's there was this entertaining thought, globally about converting over to the Euro and metrics system of measure. I can't help but think how things would be today if we would have embraced this idea? I'm sure as the global economy matures we will see soon enough. Problem is as the world leaders and business organizations continue to exploit the globe we will have less and less stability. China seems to be on the home court presently. Democracy is the visitors.

In God I Trust, who else is there?

Jan 13, 2012 9:14PM
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The FED wants more QE3.  There are lots of things I don't necessarily like about Ron Paul, but the one thing that matters is that he is hellbent on getingt rid of the FED.  Getting rid of the FED basically annhilates Wall Street.  Destroying Wall Street means the 99% win!  America wins.  Why?  With inflation rising, soon about to rip out the behinds of the middle class, continued money printing to save Wall Street and the 1% will send the country down a hyperinflationary spiral..  you really want to pay $5 for a loaf of bread and $10 for a gallon of gas?  (not a problem for the 1%)

 

I'm done with Obama.  He overpromised and underdelivered.  I don't care what else Ron Paul does or doesn't do, but getting rid of the FED is what a true American would do.  Romney, while possibly the shrewdest businessman, is another Wall Street shill, and the rest of the GOP pool are either Tebow-wannabes and/or blathering idiots.

Jan 13, 2012 8:08PM
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Sad Oh yeah sure that's why dow is always winning despite europe but more like despite itself.Disappointed
Jan 13, 2012 7:14PM
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The official economies of Italy and Spain and their real economies are two parallel universes. For example, it is estimated that the mafia has close to $300B in loans. It’s a rough estimate of course because if it were official, they would have to pay taxes on it. By this account the mafia is the number one bank in Italy. In Spain you have thousands of people who own luxurious beachfront properties and who report annual incomes of less than $20k (or don’t report at all). The son in law of the Spanish King just got involved in a $100M scandal; you can be sure that nothing will happen to him or the King’s daughter.

Italy and Spain do a lot of business under the official radar. They aren’t prosperous economies but they are not starving to death either. If the official 20% unemployment in Spain were real there would be a civil war; they have a history of that. Take their official figures with a ton of salt.

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