CREDIT MARKETS CONTINUE TO WAVE THE WARNING FLAG
One of the primary reasons for our move to sell equities in mid-January was the warning shot the CDS market was sending. Specifically, we said:
As the problem of debt refuses to go away and in fact, quietly spreads, we’ve seen another slow development over the course of the last few weeks – problems in Greece appear to be worse than originally expected and credit default swaps are sending warning messages again. The term structure in Greek CDS recently inverted as investors are now increasingly concerned of a default in the next few months. This is something we saw in 2008 before the financial markets nearly collapsed. That time the inversion was in Lehman Brothers and Merrill Lynch CDS.
As the problems in the banking sector unfolded in late Summer 2008 the sovereign debt of the big three developed nations began to skyrocket before reaching a crescendo in early 2009. What’s alarming with the situation in Greece is the similarities in CDS price action. The recent uptick could be serving as a warning flag of things to come in 201o and 2011 when the problem of debt has potential to rear its ugly head again. Barclays might not have been too far off when they said the probability of a crisis would grow in 2010.
Well, this situation has only worsened in recent weeks and the equity markets have dipped over 5% since our “must sell” signal. Jim Reid at Deutsche Bank is reiterating the concern we expressed several weeks ago that this is looking increasingly similar to the action in the markets heading up to the Lehman bankruptcy:
“The danger for every risk asset beyond IG credit is that if higher quality assets see forced re-pricing then it surely has to impact the riskier end of markets. The situation is increasingly reminding us of August/September 2008 when the credit market was sending out a strong sell signal to the equity market. Failing a quick sovereign bail-out, the credit markets are sending out a similar sell signal.”
Reid goes on to note that the markets appear to be accelerating what the governments hoped they could heal with time. In essence, we’ve put all our chips on the table with the hope that our banks would earn their way out of this crisis and that the problem of debt would slowly heal itself. But as we’ve described time and time again with our comparisons to Japan, this is an incredibly risky maneuver and will ultimately result in kicking the can further down the road. The likelihood that we will ultimately solve a debt crisis with more debt is looking increasingly slim. We’ve said it before and we’ll say it again, the classic Keynesian response of print and spend simply does not apply to this balance sheet recession.
The crisis in Europe is evolving as Greece is no longer the only concern. Portugal now appears to be on the brink of a political crisis and the next domino in line is Spain. Spreads continue their Lehman-like action:
Equity investors would be wise to take note. There is simply no reason to be taking outsized risks in such an environment.
There are NO buyers….
TPC Reply:
February 5th, 2010 at 7:25 AM
Nasdaq futures just moved 14 points on no news. The action even has the volatile, headless chicken feel that it did during the Lehman BK.
chris Reply:
February 5th, 2010 at 7:50 AM
whoa this lehman comparison doesn’t quite make sense to me. if you are telling me that the EU’s issues with the PIIGS is going to lead to a decline in the worldwide equity markets of over 50%, i guess i want to see something more than impressionistic metaphors, maybe some analysis…
why would you own this market now? you would own it if you wanted to buy low, if you thought you could sell higher from here…which i do. as tpc rightly says, nothing outsized, but if you are not ready to unfurl your sails when it is windy, you will never sail anywhere. in the case of the financials in particular, the regulatory risk seems to me to be oversold. (i wasn’t so sure last week when i was out of the market) i will take the 6 more months of 0% borrowing while people spend the time trying to define proprietary.
Gutfreund Reply:
February 5th, 2010 at 8:16 AM
I was saying the same thing in 1997! I still can’t figure out what happened.
Duncan Reply:
February 5th, 2010 at 8:29 AM
In the last 6 months I have learned never to doubt the ability of the market to whistle past graveyards!
I sincerely hope this marks the start of a major sell off but I think the optimists will have another mindless bash at “buying the dips” as if that is some sort of cure all alpha generating strategy.
TPC Reply:
February 5th, 2010 at 8:31 AM
No one ever said the market was going to fall 50%. In fact, I’ve been pretty adamant that I believe there is a buying opportunity in the not too distant future. Countries don’t just go bankrupt like corporations. Greece will get bailed out, Portugal will get bailed out, etc. But in the meantime, the credit markets are sending warning flags that continue to tell us to be cautious here. There is no reason to be a hero and go on a spending spree with so much uncertainty in the markets.
“The term structure in Greek CDS recently inverted as investors are now increasingly concerned of a default in the next few months. This is something we saw in 2008 before the financial markets nearly collapsed. That time the inversion was in Lehman Brothers and Merrill Lynch”
To be fair, in 2008, the term structure of US debt was also very flat, which is not the case now, nor is it the case in EuroLand. Me thinks greece will not be the new Bhatulism.
PIIGS are not big part of global economy. I think the risk will be “contained” (lol) for certain period time. As to China, although I agree with Chanos 120%, I don’t see a collapse in near future. the RE bubble in China is similar to stage 2004-2005 of US but in much larger scale. as long as asset price keep rising, the wealth effect will keep feedback loop going on. Just heard a story that the housing price in some area rose 100% in a week (LOL). Slowdown in China? there is no slowdown. The beast of asset bubbles is already out of cage, unless they want to put a bullet in its head, it will be at large much longer than people could imagine.
I am going to use this sell off to add more precious metal to my long term holding and start shorting long term treasury for intermediate term trade.
TPC,
You must believe in the free lunch just like the government. We can bailout or bankruptselves with ourselves? I dont see that working
TPC Reply:
February 5th, 2010 at 9:44 AM
Did you actually read my thoughts? The whole gist of my writings over the last year have been that there is no free lunch. You can’t just print money when the economy dips and have a recession with no losers.
Elaborate….
LZ Reply:
February 5th, 2010 at 10:24 AM
The question is who is going to pay this “free” lunch. They can make rules to transfer wealth, believe or not, They can transfer wealth from savers to spenders, from workers to speculators, from taxpayers to banksters, from stock bears to stock bulls. “Havenots” can go bankrupt with country “haves” will party on.
TPC Reply:
February 5th, 2010 at 10:28 AM
Your taxes haven’t gone up yet, but they will. The government is going to hit us in all the little places – sales tax, real estate taxes, state taxes, etc. But don’t be fooled – they will tout the fact that they have kept the national tax rate for most Americans at the same level.
We are all paying for the mistakes of others. The idea that you can have a healthy capitalist society in a world where the prudent pay for the mistakes of the imprudent is simply laughable, tiresome, and quite frankly, infuriating.
DH Reply:
February 5th, 2010 at 1:50 PM
Your already paying a big tax when you receive 0% on your savings and the banks are allowed to pocket the spread.
You just said that countries cant go bankrupt like corporations? And that there will be a bailout for Greece. ?
TPC Reply:
February 5th, 2010 at 10:17 AM
I’m being realistic. I’m not telling you that I condone it. We live in a bailout world where everyone is convinced that we can just keep spending money to cover up the problems.
I wrote the Fed on several occasions in 2008 asking that they seriously consider a RTC type approach or a Swedish nationalization approach. I was a constant advocate for “controlled demolitions” of the banks. I did no condone these bailouts in the form they happened. I would have much preferred that we used the FDIC and other measures to properly put these institutions out of their misery.
There absolutely is no free lunch, but the government responses continue to be this misguided Keynesian spend and print policy. You can’t solve a debt crisis with more debt. This is not your classic cyclical business downturn. I’ve been repeating this mantra for well over a year now and unfortunately, I have been dead right.
jt Reply:
February 5th, 2010 at 10:46 AM
on the issue of a member of the Eurozone not going bankrupt you may want hear a different view from the Troika conference
http://2010.therussiaforum.com/news/session-video3/
TPC Reply:
February 5th, 2010 at 10:55 AM
Got that video in english?
jt Reply:
February 5th, 2010 at 12:45 PM
on the video screen (right down corner) you have an option to switch to english
TPC Reply:
February 5th, 2010 at 1:06 PM
Ah, great. Thanks JT. Looks like a great video. An expert panel moderated by Faber – doesn’t get too much better than that!
chris Reply:
February 5th, 2010 at 11:41 AM
the EU situation is unprecedented in a way given the monetary but not political union, i think, and it should be interesting.
none of the PIIGS can print euros so they can’t do a bernancke and turn on the printing presses. if they can’t borrow at reasonable rates, then the ECB will have to provide some relief…by printing euros no doubt and providing emergency loans. merkle will have a cow, since it was bad enough for the west germans to bail out their east german kin.
net net, isn’t there a silver lining in all of this for the dollar? no one is going to be talking about replacing the dollar as the reserve currency much anymore. as soros says, the dollar is a bad currency, until you compare it to all of the others.
I think we get one more flush down monday or Tuesday then it is gonna be a rip your heart out rally. EU problems will be “contained” in similar manner to LEH’s aftermath. The CBs have learned their lessons from LEH and will not let things fall out of hand again…SPX to 1250 anyone?
im just enjoying this best show ever, its been great so far, every body’s writing books, they all knew, now, thanks, ON THE BRINK thank you too… are we back in the credit crunch movie all over again ? lol. this greece episode will be contained, but unfortunately the ones that will write the checks are the same ones that owens them correlation desks that are driving the cost of credit higher, vicious game… thinking of visiting greece, to see about gov’ bonds and check how other assets are doing in this “melt down”. in less then ten sessions S&Ps traded 180+- handles, trading’s siiiiiiiick… can’t wait to hear who’s next going greek lol, what did portugal ever do ? “I’m working on it, I’m working on it” great line De niro… global expansion ha ? lol, ten days they’re all in defaults ? lol. this 2010 is going to be some year in finances, IT IS LAWLESS.
I hope all are enjoying this show.
hey Mike, 1250S&Ps, 875S&Ps, its all the same if you trade them, lets see after getting minibulish again today how high cats can bounce, but still thinking that most stocks should be “better” priced…
The Greek default was just a trigger for a market that was too hasty to declare an end to the global over-leveraging problem. If Greece with a 3 percent contribution to the EU is a bigger problem than bankrupt California’s 20 percent contribution to the US, then something is not quite right with the market’s perception of risk. In truth, the Greek issue was probably started by Germany who was looking for a cheaper euro. The US treasury probably concurred that attention should temporarily be deflected from the US’s problems over to Europe. The media did their usual thing of inflaming the Greek default story, and the prop desks took it from there. Eventually however, the US’s huge indebtedness will return to centre stage.
TPC,
You have been fairly consistent for the year I have read your blog about there being no “free” lunch. Shrek, Chris and everyone needs to go to Steve Keen’s website debtdeflation.com and read debtwatch No. 34. It is about the Great Depression and right now we are almost exactly where they were two years after the first big drop. At that time in 1931 everyone thought they were coming out of a recession just like what the MSNBC talking heads are saying now. Then they started the next leg down and it was a slow grind, not a quick fast drop, until they were down 80% more. TPC has put some of Keen’s ideas on this site. It is all about the debt, and it does not matter much which country goes down first because the cascade effect will end up entangling all countries. Rightr now China is in a massive bubble, does anyone believe that they can go down without having serious side effects on everyone else?
I fix my drinking problem with a case of Jack Danils
it was ok till I woke up
This is my first time i visit here. I found so many entertaining stuff in your blog, especially its discussion. From the tons of comments on your articles, I guess I am not the only one having all the enjoyment here! Keep up the excellent work.
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