Crippled European Banks Threaten a New Crisis

Only a short-covering rally on Friday saved stocks from a truly horrendous performance last week.

The Dow Jones Industrial Average lost 231 points or 1.4% to close at 15973.84 on the week while the S&P 500 dropped 15 points of 0.8% to end the week at 1864.78. The Nasdaq Composite Index fell 0.6% on the week to finish at 4337.51.

All three indexes are solidly in the red for the year with the Dow down -8.33%, the S&P 500 down -8.77% and the de-FANGed Nasdaq down -13.38%.

Investors should take little comfort from Friday's rally – Chinese stocks reopen on Monday after a break for the Lunar New Year's celebrations and Japan's markets are in free-fall, losing 11% last week.

U.S. markets will be closed on Monday for the three-day weekend but the blood sport will begin again on Tuesday…

Central Bankers Unmasked

It appears that investors are finally losing confidence in central bankers. It is about time.

Last week's Congressional testimony by Fed Chair Janet Yellen was an opportunity to study just how clueless the head of the Federal Reserve is about all things economic.

The only people more ignorant about how the economy actually works than Mrs. Yellen are the members of Congress, whose stupidity was on full display.

It is hardly surprising that investors are losing their nerve with these people in charge and Donald Trump and Bernie Sanders giving a serious run at the presidency.

In a world desperate for serious leadership and reeling from seven years of policy failures from the Obama administration and the Bernanke and Yellen-led Fed, they are wise to be dumping their stocks and junk bonds and moving into Treasuries and cash.

We Haven't Seen the End of Banks' Troubles

The selling has taken on a more disturbing tone of late by affecting more systemically sensitive sectors such as banks.

Now, U.S. banks are well capitalized and should not pose a systemic risk… unless their derivatives books blow up.

Nonetheless, their stock prices have declined by 30-40% over the last few months as the yield curve has flattened, which hurts their profitability, and credit quality has declined, which points to higher loan losses.

Difficult capital markets are also likely to hurt profitability in the quarters ahead.

Just look at these tanking shares…

Goldman Sachs Group Inc. (NYSE: GS) is down 33% from its 52-week high of $218.77; Morgan Stanley (NYSE:MS) is down 43.7% from its 52-week high of $41.04; Bank of America Corp. (NYSE: BAC) is down 35.3% from its 52-week high of $18.48; Citigroup Inc. (NYSE:C) is down 38.4% from its 52-week high of $60.96; and JPMorgan Chase & Co (NYSE:JPM) is down 18.6% from its 52-week high of $70.61.

Some of these are trading at sharp discounts to book value, in this case, it means that investors are questioning the quality of their balance sheets.

European "Gambler" Banks Could Detonate

The carnage in European banks is much worse, but then again European banks have much more serious problems than U.S. banks. They suffer from inadequate capital and enormous amounts of bad loans that could force them into insolvency without government support.

Deutsche Bank AG (USA) (NYSE: DB) stock collapsed last week before rallying on Friday after the bank announced it would repurchase its senior bonds, which are trading at a discount.

I have written extensively about DB's problems on Sure Money; the debt buyback won't solve them and the very fact that management had to publicly reassure markets indicates just how bad things have become for the bank that I believe poses a serious systemic threat.

Other European bank stocks like Credit Suisse Group AG (ADR) (NYSE: CS) also got hammered last week after announcing lousy earnings.

Europe's banks are in big trouble and that poses a serious risk to the rest of the world because these banks do business with every other financial institution in the world.

The U.S. economy and U.S. markets cannot insulate themselves from their problems. I'm going to follow this story closely in the weeks and months ahead.

High-Yield Is Still a Nightmare… And It's Getting Worse

The junk bond market continues to fall apart.

The average yield on the Barclays High Yield Index breached the 10% mark last week, which is worse than it looks since the Fed's zero interest rate policy has kept this number artificially suppressed. The average spread is now 839 basis points.

The total return for the year is already -5.16% and we are only 6 weeks into 2016. The broken energy sector is now trading at an average yield and spread of 20.75% and 1778 basis points, respectively, while the Basic Industry sector is not far behind at 14.37% and 1238 basis points, respectively. The market is nothing short of a disaster. While there are definitely specific bonds worth buying, only those with strong stomachs need apply.

At the opposite end of the credit spectrum, Treasuries have rallied strongly as yields have plunged and the yield curve has flattened. The yield on 10-year Treasuries have dropped to 1.75% (they were lower before Friday's rally) as investors seek safety.

Gold has also rallied to 1,238/oz. as investors come to realize that central bankers are not only grossly incompetent but that their incompetence is going to end up destroying the value of paper currencies around the world.

Readers should continue buying gold – and save themselves and their children and grandchildren.

After all, Janet Yellen and her idiot friends aren't going anywhere.

Europe is on the verge of a "Lehman Brothers moment" of its own, so Michael is currently recommending defensive plays and profit strategies for the crash to his Sure Money Investor readers. You can get this free service, along with his full banking crisis briefing by clicking here.

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About the Author

Prominent money manager. Has built  top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.

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  1. Dave | February 14, 2016

    The Administration and Congress don't have to be smart about the economy.
    They can still get rich off of insider information and corporate lobbyists and payouts.

  2. William McHale | February 14, 2016

    Great being here keep up the good work

  3. Robert Butt | February 14, 2016

    We have in Canada a left wing prime minister his policies are going to destroy
    Canada's ability to survive I am 64 I will probably survive but the younger millennials will pay a heavy price for voting Justin Trudeau into being Canada's
    PM. He wants to turn Canada into another Greece all I can say to americans do not compound your problems by voting Bernie Sanders or Hillary Clinton in Canada's only hope is a Donald Trump President

  4. Torreey Webb | February 14, 2016

    Great stuff.

    You and Stansberry are the only ones anyone can trust anymore!

  5. Manfred Totzauer | February 15, 2016

    I am impressed about your bank analysis in europe. I agree, that the problems at european banks are much higher than those in the USA.

  6. David D | February 16, 2016

    So far, all DB has done is rally up over $2.50 since the 2/9 low. The German government is not going to let this bank fail, propping it up by injecting billions. Calls for its demise are greatly exaggerated.

  7. conroy shields | March 2, 2016

    good analysis

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