European Shares Fall Lower On News That Van Rompuy Is Tasked To Develop A European Nation Sovereign Debt Default Mechanism … US Treasures Fall Lower In Front Of QE 2 Announcement … Japan Shares Enter Their Fourth Week Of Falling Lower … Both The US Dollar And Volatility Rise

Financial market news for November 1, 2010


The EU Leaders’ European Economic Governance Summit of October 2010 concluded with an announcement assigning Herman Van Rompuy to design a sovereign debt default mechanism. This immediately turned the European stocks lower. Bond Vigilantes called interest rates higher on US Treasuries, turning their value lower. A higher US Dollar, rising volatility and other factors signaling a coming downturn in US stocks.

The European Shares fell on news that Herman Van Rompuy has been tasked with preparing the legalities and procedures for a nation’s sovereign debt default. European Financials, EUFN, fell 1.5%. Europe Small Cap Dividends, DGS, fell  1.6%.  Spain, EWP, fell 2.7%. Italy, EWI, fell 1.8%, Austria, EWO, 1.2%. European stock, VGK, fell 0.6%. Financial Times reports that European Central Bank President Jean-Claude Trichet warned that a future rescue mechanism for indebted countries, designed to shift responsibility to investors from taxpayers, could inadvertently push up their borrowing costs, citing European Union officials.

The Yen, FXY, closed 0.15% lower at 122.74.   

The US Dollar, $USD, rose 0.35% to 77.31, stimulating the Developed Currencies, DBV, to manifest what may be an evening star candlestick, but this will require a day or two of trading to confirm. The Dollar Bull ETF, UUP, rose.

The USD/JPY rose.

The Euro, FXE, closed lower 0.24% lower at 138.36. The chart shows that today’s value is in the middle of a broadening top patter. As Street Authority relates: when you see the broadening top, the market will eventually drop.

The EUR/JPY, traded lower as can be seen in the chart of FXE:FXY

Irish and Portuguese credit defalut spreads established new records; and Ireland and Portugal’s borrowing costs hit record highs as the bond markets digested the outcome of the EU Eurozone Summit establishing a sovereign debt default mechanism.

The FT reports that borrowing costs for Ireland and Portugal hit record highs yesterday as investors assessed EU proposals to force them to take a greater share of losses in future bail-outs. “People do seem shocked about the idea of a future eurozone debt restructuring, but this should not have been a surprise unless you really believed that the German taxpayer would always underwrite everything,” said Erik Nielsen, Goldman Sachs’ European Economist.

In an interview with Spiegel in article The Crisis Has Deeply Shake Us Chancellor Merkel has said, “We have to find ways to harmonise the competitiveness among European countries” but added, “This should not be done by simply targeting the average or gearing ourselves to the slowest. Instead, we should always learn from the best.” Merkel also refused to say whether she had consulted her coalition partner, the FDP Foreign Minister Guido Westerwelle, before making a deal with French President Nicolas Sarkozy on treaty change in return for watering down proposed economic sanctions for debt and deficit rule breakers.

The sovereign debt default mechanism is a 180 degree turn from the sentiment expressed in May 2010 as reported by Bloomberg reporters James G. Neuger and Gregory Viscusi in EU Backs Stiffer Deficit Sanctions, Rules Out Default Mechanism and as I reported that EU Finance Ministers Announce European Economic Governance And Call For A Monetary Union With Seigniorage Authority To Issue Eurobonds.  

EuroIntelligence comments EU Leaders Trigger Another Bond Market Crisis: “We believe that the EU leaders remain complacent about the future of the eurozone, as they push their narrow national interests. We have been warning readers of a gulf between the German position on future crisis resolution in the eurozone and that of other EU member states, and that the fundamental conflicts of the first half of this year remain unresolved. The summit only agreed some minimum parameters for Herman van Rompuy’s next task force, but the difference of the positions on the crisis resolution mechanism remain extreme. Germany wants a bail-in mechanism to replace the EFSF, as a result of which European bond spreads have risen again. Investors understand that the German proposal will dramatically increase the probability of future sovereign default in the eurozone. The EFSF is not a solution to a crisis resolution, it is merely a temporary arrangement.” Yesterday, Irish 10 year-spreads move towards 5%, and Greeks spreads towards 9%, as investors igested the implications of last week’s summit. Reuters quotes Lorenzo Bini Smaghi as saying that it was easy to talk about an orderly crisis resolution mechanism, but much more difficult to implement it – a criticism of the German approach. “In advanced economies the restructuring of the public debt would have to involve a much larger number of financial assets and liabilities, including those of the domestic banking system, vis-a-vis residents and non residents … It can be easily seen that there can hardly be anything ‘orderly’ in such a process.” …. This whole chain of events shows clearly that EU leaders continue to underestimate the complexities of a monetary union. The structure is simply not capable of handling default, while simultaneously ruling out bailout and exit. The resistance to the German plans in the European Council remains severe, and we simply cannot see Greece, Ireland, Spain, or Portugal agreeing to a crisis resolution mechanism, whose main effect would be to drive up their bond rates. It would be like turkeys voting for Christmas. Expect this to run well into next year. In fact, we would not be surprised if this debate were to continue right until the expiry of the EFSF in 2013.

Daniel Gros writes in EuroIntelligence article Liquidate Or Liquefy?: “The obvious way out should be controlled rescheduling and/or restructuring in order to avoid turning parts of the euro periphery into ‘zombie countries’.

Brent Radcliffe in Yahoo, Ivestopia writes: “Defaulting on sovereign debt can be more complicated than defaults on corporate debt because domestic assets cannot be seized to pay back funds. Rather, the terms of the debt will renegotiated, often leaving the lender in an unfavorable situation, if not an entire loss. The impact of the default can thus be significantly more far-reaching, both in terms of its impact on international markets and of its effect on the country’s population. A government in default can easily become a government in chaos, which can be disastrous for other types of investment in the issuing country.”

On February 25, 2010, the Euro, FXE, stood at 111.35 and six trading days on March 5, 2010 later it plunged to 109.75. It was at this time that Drago Tzvetkov of the Atlantic Council wrote on the Threat of Sovereign Debt Default relating:  The Atlantic Council’s Global Business and Economics Program hosted a conference call with Professor Leszek Balcerowicz on the Euro debt crisis.  Balcerowicz, a former Finance Minister of Poland, shared his views on the measures needed to ensure Eurozone unity and assessed the current difficulties facing European nations as they attempt to rein in public spending and decrease their deficits.

The financial crisis has entered a new phase.  What began as a series of mortgage defaults soon became a crisis of bank insolvency.  The dire state of Greece’s budget and debt points to a more chilling aspect of the crisis: insolvency of sovereign nations.  EU leaders have yet to outline a concrete plan.  With fourth quarter GDP numbers in the Euro-zone looking dismal, unemployment high, and economic growth low, selling a “bail-out” plan will be politically unpopular. Dr. Leszek Balcerowicz analyzed three options for Greece and Europe to mitigate damage to Europe’s economy, and the Euro itself:

  1. Fiscal adjustment to prevent default: Greece needs to make “radical and deep” adjustments, including fiscal changes to cut excessive spending.  This should be coupled with aid from the IMF, which should provide conditional crisis lending.
  2. A bail-out by EU governments: While acknowledging that this is not a long-term solution and that it is “not politically feasible” given German public opinion, Balcerowicz put the bailout option on the table.  The negative risk of the resulting public resentment would sow further distrust of the Euro project.
  3. The departure of Greece from the Eurozone: Monetary independence would allow Greek authorities to depreciate the currency but ignore the fundamental causes of its budget distress, and add skyrocketing Euro-based debt to Greece’s woes. With no constitutional or legal mechanisms for leaving the Eurozone, the Greek public would not be willing to enter “politically unchartered waters.”

Recommending fiscal discipline as the only viable option, the former Polish Finance Minister and architect of the “shock therapy” that led the Polish economy communism to the global marketplace said, “Shocks from time to time are great educators.  I don’t know of any country which would have suffered because of excessive fiscal discipline.”  He emphasized that Greece should face the consequence of its actions and be expected to implement the necessary reforms.

The Emerging Currencies, CEW, rose 0.17%, stimulating the Emerging Markets, EEM, to rise 1.1% to close at 46.63, but below their October 13, 2010 high of  46.85.    

The Bear Market in stocks that commenced on October 14, 2010, endures as the world shares, ACWI, traded up to 44.89; but resides below the 10-14-2010 high of 45.13.

The Bear Market in bonds, that commenced on October 13, 2010, endures as total bonds, Bonds, BND, traded unchanged and remains below the 10-13-2010 high of  82.62. The 10 to 20 Year US Government bonds, TLT, fell 0.4%. The Zeroes, ZROZ, fell 0.8%. World Government bonds, BWX, fell .2%

The bond vigilantes were active today, in front of the US Federal Reserves QE 2 announcement, calling the Interest Rate on the 30 Year US Government bond, $TYX, higher to 4.017%; its charts suggests that a breakout out through triangular consolidation is at hand. And the Interest Rate on the 10 Year US Government bond, $TNX, rose to 2.659%. the Interest Rate On The 2 Year US Government Note, $UST2Y, traded unchanged at 0.34%. Higher interest rates means The End of Credit has commenced.

Finviz Chart shows that the Japanese shares, EWJ, have now entered their fourth week of falling lower. Japan, EWJ, fell 1.0%; fell its chart is terrifically bearish. The 200% Japan EZJ, fell 2.9%.

A number of bearish factors indicators emerged today.

Junk Bonds, JNK, fell 0.4%, suggesting that peak investment liquidity has been achieved.

New York Composite Shares, NYC, traded a massive 18, 798 contracts, manifested bearish engulfing and fell 0.5%.

Nasdaq Community Banks, QABA, fell 2.1. Banks, KBE, fell 0.5%. 

Consumer Staples, XLS, fell 0.45

International Utilities, IPU, fell 1.0. The 200% Utilities, UPW, fell 2.3%.

International Dividend Payers DOO fell 0.5%.

Clean Energy, ICLN, fell 1.0%

Health Care Small Caps, XLYS, fell 1.8%; US Healthcare Providers, IHF, fell 0.35.

Mortgage Finance, KME, fell 1.5%

Volatility, VXX, rose. 

I expect bonds, BND, to continue to fall lower as the US 30 Year Interest Rate, $TYX, to rise over 4% on growing concerns that QE 2 monetizes debt. And hence as a result, I expect the major currencies, DBV, except the US Dollar, $USD, component, turn lower, and to a lesser degree, I expect the developing currencies, CEW, to turn lower as well, causing stocks, ACWI, to fall lower. Deft deflation will get actively underway in both bonds and stocks this week.

Concerns over the European Financials, EUFN, and their exposure to sovereign debt of Portugal, Italy, EWI, Ireland, EIRL, Greece, and Spain, EWP will turn down all European stock.

Concerns over US Banks, KBE, and the US Community Banks, QABA, and the Mortgage Financiers, KME, will turn down the US Shares, VTI, and the Russell 2000, IWM, which is so critically dependent upon low-cost and easy access to financing.    

The fall lower in Tax Managed buy Write Opportunities, ETW, since October 1, 2010 is definitely a  canary in the stock market coal mine warning investors to get out.

Mike Mish Shedlock presents the Trader’s Narrative Sentiment Overview: Week Of October 29th, 2010 documenting the bull ratio is now slightly above 70% – something we hadn’t seen for almost 3 years; this is a contrary indicator suggesting that it is now time to go short.

A number of stocks represent excellent short selling opportunities as they have not fallen as of yet.. These include Nicholas Financial, NICK, which traded unchanged. The Asian high yielding financials, DNH, rose 0.4% manifesting a dark filled candlestick suggesting that the end of its rally is over. Poland, EPOL, fell  1.4%; the yen carry trade investments in it will cause a fast fall. Nanotechnology, PXN, fell 1.05. Small Cap Consumer Discretionary, XLYS, fell 1.2%. Retail, XRT, fell 1.0%. Small Cap Pure Growth, RZV, fell 0.9%. Solar Energy, TAN, fell 1.3%. The Russell 2000, IWM, fell 0.7%. Sweden, EWD, fell 0.35. I will provide a no-charge listing Chart List of ETFs And Stocks To Sell Short For A Debt Deflationary Bear Market through the end of the end on for one’s reference.

Bottom line: the investor should be have gold in one’s personal position or be short stocks and bonds; preferable the former more so than the latter.


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