“A man who carries a cat by the tail learns something he can learn in no other way.” – Mark Twain
These PIIGS just won’t be corralled.
As has frequently been the case over the last two months, a period that has seen the Dow Jones Industrial Average (DJIA) shed a lofty 13%, the PIIGS (Portugal, Ireland, Italy, Greece and Spain) remain squarely at the center of the universe of investor concerns, weighing as heavily as the flailing U.S. economy.
This should be no surprise, as the economic health of the European Union and the U.S. is as intricately linked together as, say, bacon and eggs.
And while the recent spate of bad economic reports out of Washington have undoubtedly impacted the market in a negative fashion, it is the EU sovereign debt crisis that may be evoking a recognition among investors that a default by Greece, if not a greater danger, could certainly push things over the edge a lot further and faster.
The effect of such a default upon both the European and U.S. economy is difficult to quantify, and none of the key players, such as the European Central Bank (ECB), the International Monetary Fund (IMF), or the German and French governments, are offering clear models of what a default would actually look like. That’s likely for several reasons, including the cynical possibility that the ECB is simply trying to buy time for current bondholders to liquidate their positions before a default occurs.
Another reason is because it’s just never happened before.
In some ways, a default by Greece could be considered a Black Swan that isn’t a Black Swan.
That is, if it happens, it would not be a truly unexpected event. In fact, quite to the contrary. However, the consequences of a default could easily create elements of the unexpected, containing qualities of the sort that generate head scratching of the “should-have-seen-that-coming” variety.
A default by Greece could resemble a round of dominoes, with some, or even all, of the other PIIGS following suit. Or the event could be isolated enough that it would serve as something akin to a valve on a pressure cooker, allowing the rest of the EU to eventually stabilize and rally in a positive way.
But the likelihood is the impact on Wall Street would be hard and negative, because, once again, the relationship of the economies on either side of the Atlantic is so deep.
A substantial percentage of revenue generated by corporations that make up the S&P 500 comes from Europe, to the tune of about 25%. Should the EU experience a serious downturn as the result of one or more of the PIIGS defaulting, then Wall Street would share the pain, which would likely run fast and deep.
Last week’s market action clearly reveals the skittish sentiment that comes from the recognition that the EU sovereign debt crisis is, at best, being temporarily “handled” rather than being resolved.
The news that the ECB’s chief economist quit amidst policy disagreements apparently didn’t inspire investor confidence. Taken in tandem with a rumor that Germany was in preparations to safeguard its banks certainly reinforced the perception of disunion within the EU.
At week’s end, the Dow responded precisely the way it’s been responding to all recent negative EU news, whether rumor or fact. It finished the week in the red, losing over 2%. That made a string of seven out of nine weeks to the down side. The S&P 500 Index (SPX) faired slightly better, shedding 1.7%. The Nasdaq (COMP) dropped the least of the major indexes, off 0.5% on the week.
The drops in the major indexes certainly can’t be blamed solely on the EU crisis. Ben Bernanke added nothing new to the mix during last week’s speech, and Wall Street wanted something new, at least a solid hint of stimulus to come. That didn’t happen. And the President’s “job speech” didn’t excite investors greatly either, which was hardly a surprise. Finally, the Commerce Department reported a rise in wholesale inventories, which, while not unexpected, was depressing nonetheless.
This trifecta of uninspired noise from out of Washington did manage to entice the Bears to step even further from their caves.
So in spite of the indications that the U.S. economy may return to its recessionary status, the EU debt crisis seems to be the more potent trigger upon investors right now. Until a clear resolution of that situation emerges, news of the PIIGS will continue to dominate and, like a wild boar whose tusks are way too close for comfort, can only be ignored at one’s own peril.
What the Periscope Sees
Last week, the suggested hedged play of pairing IYH (iShares Dow Jones U.S. Healthcare Sector Index Fund) with FAS (Daily Financial Bull 3X Shares), a leveraged ETF that tracks the Russell 1000 Financial Services Index, held its own, with IYH as the long and FAS the short.
The current market conditions make this pairing worth considering for the upcoming week as well.
Full disclosure: The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”
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