Chile's central bank is worried about the global economy. Although it decided to keep its interest rate at 5.25% for now, the bank's board said slowing growth prompted it to consider a rate cut as early as December instead of early next year. But even though Chile sees a slowdown ahead, its gross domestic product […]
The latest plan to preserve the European Union (EU) and save the global banking sector is to force European banks to increase their equity capital.
The goal, of course, is to restore confidence and stability. But if that's the case, then why are so many analysts and savvy investors still nervous?
To put it bluntly, because they know it won't work.
As it stands, the capital shortage is about 200 billion euros ($277 billion) according to the International Monetary Fund (IMF). I think it's more like 1 trillion euros ($1.4 trillion) by the time you factor in all the cross holdings and the daisy chain of exposure that makes the entire banking system there look like Swiss cheese.
Why Recapitalization Won't Work
There are three things that are especially problematic to me:
- European Union (EU) ministers apparently are going to put capital into the system without knowing how much it needs or exactly where to put it. Hard to believe, but thanks to the opaque nature of the derivatives markets, nobody can be sure exactly how much exposure any one bank or financial institution has.
- Healthy banks that do not need an infusion will get one anyway. Rainer Skierka, who is a stock analyst at Bank Sarasin & Cie AG, shares my belief that this will lead to massive dilution for shareholders.
- Any bank that is undercapitalized will effectively be the recipient of capital that has been diverted away from healthy banks and into its toxic financials. Unfortunately, this money will be placed at higher risk in an effort to earn the incremental income needed to backstop bad bets that already are on the books. That means shareholders who are led to believe things are improving will actually find their money at an even higher risk than before.
As I have noted repeatedly since this crisis began, regulators are fighting the wrong battle and have been since 2008. They are worried about liquidity when they should be worried about solvency.
Sure, a bank recapitalization can repair the banking system when it comes to keeping money moving in terms of short-term credit – but no amount of money can prepare European banks for a sovereign default or credit freeze because there literally isn't enough money on the planet to recapitalize the banking system unless you remove the risks that plague it.
The "system" is still at incredible risk.
The total worldwide notional derivatives exposure is more than $600 trillion dollars according to the Bank for International Settlements (BIS). And that's against a gross market value of merely $21.1 trillion.
In other words, banks have invested in instruments valued at $21 trillion but with a total exposure that's 28.4-times that — or $600 trillion dollars.
This is why rogue traders are such a problem; they can take disproportionately large risks with not a lot of capital, which often leads to catastrophe.
Take Nick Leeson, the former derivatives broker who worked for Barings Bank. His leveraged trading losses eventually reached $1.4 billion, or twice Baring's available trading capital. Barings went under as a result.
More recently, Kweku Adoboli, who served as director of exchange traded funds (ETFs) at UBS AG (NYSE: UBS), blew a $2 billion hole in UBS' balance sheet.
Part of the problem is that n obody knows exactly how much cash banks spend to amass such investments because derivatives and sovereign debt trading instruments are still largely unregulated and "self policed" within the industry.
So what's this have to do with our money?
To most investors, just surviving a bear market is more important than finding the next jet-fueled growth stock.
But I want to let you in on a secret: Rather than just trying to survive, investors can actually thrive in bear markets.
In fact, I make a lot more money a lot faster in bear markets than I do in bull markets.
After all, stocks and most other asset classes typically fall faster than they rise, because fear is a much stronger motivator than greed.
So if you're not making money in a market like this one – where prices are falling, even plummeting – you're missing out.
It's time to change that. And I'm going to show you how.
Bear Market Funds
The best way to profit from a bear market is to use exchange-traded funds (ETFs) in conjunction with options.
Let's first look at the ETF component.
There are plenty of inverse ETFs that go up in price when markets go down. And for even more oomph, there are "leveraged" inverse ETFs.
You can use these funds to "short" stocks and commodities, without having to open an options account, or rely on a broker.
But remember to do your homework. Make sure you understand exactly what each ETF you're interested in actually represents. Don't just go by the name. Read each prospectus to learn how the fund's investments are allocated and how it's supposed to perform under various market conditions.
Also be sure to check the bid -and -ask spread to make sure it isn't too wide, and the average daily volume to make sure it isn't too thin. I don't trade any ETFs that trade less than 1 million shares a day, on average.
Another thing to keep in mind is that many ETFs make good short-term trading vehicles, but are bad long-term investments. That's because many ETFs don't track their benchmarks precisely. And if they are leveraged, the tracking error widens considerably over time.
Still, these are very versatile instruments. You can buy them in retirement accounts, they are margined the same way stocks are, they are liquid and tradable all day, and you can put in stop-loss and profit -target orders.
Exploring Your Options
The second way to profit from a bear market is through short selling.
I say that all the time and I'm surprised how many people think it's wrong to short stocks.
Trading to make money in a bear market has nothing to do with what's good for the U.S. economy or for America. It's simply a matter of what's good for your net worth.
The old notion that it's un-American to short stocks comes from Wall Street's institutional elite. They don't want the public shorting stocks. In fact, they don't want the public even selling stocks. Why? Because Wall Street wants buyers lined up to pay for the stocks that it is selling short.
Money Morning global investing guru Martin Hutchinson has identified the one global region that he's focusing on as the world's next big profit play.
You'll be stunned to see what he's discovered.
But you'll also be wise to listen.
Start the conversation
In lowering its growth forecast for the United States and Europe, the International Monetary Fund (IMF) warned of "severe repercussions" unless drastic measures are taken soon.
But don't expect the warning to spawn any real action.
"The global economy has entered a dangerous new phase," Olivier Blanchard, the IMF's chief economist said in the report released yesterday (Tuesday). "The recovery has weakened considerably. Strong policies are needed to improve the outlook and reduce the risks."
The IMF slashed its 2011 growth forecast for the U.S. economy from the 2.5% estimate it offered in June all the way down to 1.5%. Next year won't be any better: The 2.7% 2012 projection the IMF offered in June was cut all the way to 1.8%.
"Bold political commitment to put in place a medium-term debt reduction plan is imperative to avoid a sudden collapse in market confidence that could seriously disrupt global stability," the IMF said.
But with governments in Europe moving slowly to contain the sovereign debt crisis afflicting the PIIGS (Portugal, Ireland, Italy, Greece and Spain) and the United States suffering from political gridlock, the IMF's call to action will likely go unheeded.
In recent weeks, U.S. President Barack Obama has proposed a jobs plan, as well as a deficit reduction plan. But with congressional Republicans opposed to elements of those plans – primarily increases in spending and taxes – the swift policy action the IMF sees as critical will likely be stillborn .
In Europe, the IMF is calling for bold action to contain the debt crisis. It is particularly worried that a Greek default could cause many large banks – which own much of the Greek debt – to take large losses.
That U.S. banks are intertwined with European banks heightens the risk.
According to Money Morning C apital W ave S trategist Shah Gilani, "U.S. banks are widely believed to have $41 billion of direct exposure to Greece" and have loaned heavily to their European counterparts.
More sobering, Gilani says, is that "U.S. money-market funds have a hefty European exposure, too." He noted that 12% of the loans made by our biggest money-market funds were made to three big European banks – two of which, Societe Generale SA (PINK ADR: SCGLY) and Credit Agricole SA, were downgraded by Moody's Corp. (NYSE: MCO) just last week.
The third, BNP Paribas SA, remains under review.
The extremely volatile markets of late stem in part from news suggesting Greece's debt issues have made a default imminent – creating a global black hole that's sucking in a growing number of other economies with it.
Default fears intensified last Friday when European finance ministers announced they would delay a decision on whether or not Greece was eligible for its sixth tranche of bailout funds. Greece was scheduled to get the next $11 billion (8 billion euros) installment of its $152.6 billion (110 billion euros) aid package by the end of September, but now must wait at least until October.
European Union (EU) and International Monetary Fund (IMF) inspectors met with Greek Finance Minister Evangelos Venizelos last night to evaluate the country's progress with austerity measures. Greece agreed to reduce its deficit to 7.5% of gross domestic product (GDP) this year, and below 3% by 2014 in order to receive bailouts from the IMF and other euro nations.
But investors are afraid the country will run out of cash before a bailout decision is reached.
Greece may not be going down to a Trojan-level defeat in the next few days, or even weeks, but there is little doubt that the country cannot afford to remain harnessed to the euro. It faces almost certain default at this point, sad to say, which means that some big banks, shareholders and bondholders are going to suffer.
Perhaps those Eurozone critics who said that a currency union not backed by taxation or bond-issuing authority was a bad idea should have been heeded. Then countries like Greece would not have been encouraged into a currency union that's an ill-suited match for its unique economy, history and ambition.
Now the critics are being proven largely right, unfortunately.
The most dangerous thing is new evidence that the debt crisis continues to spread.
Looks like France is headed down the same path as Italy and Spain. According to a Bloomberg News story last week, France may need new austerity measures to avoid a bond sell-off and credit rating downgrade.
It seems that Nicolas Sarkozy is the new Silvio Berlusconi.
At this point a Greek debt default is virtually unavoidable, and it could happen in a matter of weeks.
The ensuing chain reaction will upend markets around the world and will almost surely lead to more defaults among the European Union's (EU) other debt-plagued nations, collectively known as the PIIGS (Portugal, Ireland, Italy, Greece and Spain).
The bond markets have already passed sentence, with the yield on two-year Greek bonds spiking to an astronomical 76% yesterday (Tuesday). Yields on 10-year Greek bonds rose to 24%.
By comparison, the 10-year bond yields of another PIIGS nation, Italy, rose to 5.74%. Meanwhile, bond yields for the EU's strongest economy, Germany, have dropped below 2%.
The credit default swap (CDS) markets, where investors can insure their bond purchases against default, agree with the bond markets' verdict. As of Monday it cost $5.8 million and $100,000 annually to insure $10 million worth of Greek debt for five years, which means the CDS market now considers default a 98% probability.
Most European stock markets have been hammered over the past several weeks, with some dropping as much as 25%.
"Default is inevitable," said Money Morning Global Investment Strategist Martin Hutchinson. "Greeks are paid about twice as much as they should be, and that gap can't be solved by austerity."
How Soon is Now
In recent weeks Germany has shown more reluctance to dig deeper into its own pockets to bail out Greece and the other PIIGS. At the same time, Greece has struggled to implement the austerity measures that are required if it is to continue receiving aid from the European Central Bank (ECB) and the International Monetary Fund (IMF).
Greece's budget deficit has increased 22% this year, while its economy is projected to shrink more than 5%.
Every new development appears to bring Greece closer to the brink of default – and some see that happening in the very near future.
"My guess is there will be a Greek debt default by the end of this fiscal quarter – yeah, that means very soon," said Money Morning Capital Waves Strategist Shah Gilani.
It's often difficult to comprehend – much less internalize – the risks posed by the European sovereign debt crisis.
But understand this: If Europe's problems aren't resolved in an orderly fashion, the stock market drops we saw last month will be small potatoes compared to the steep declines that lie ahead.
So here's the solution: Let the Eurozone break up right now on its own terms. And let a new, stronger euro currency come as a result.
At this point, that is the only viable solution to the problems Europe faces.
So far, everything the European Union (EU) has done to try to subdue this outbreak has come up short. In spite of all the group's efforts, the European sovereign debt crisis continues to snowball, drawing more and more countries into the fold as it gathers momentum.
The trendy solution is to simply expel the weaker members of the Eurozone. That would work if Greece was the only problem, but it's not.
That's why a better solution would actually be the opposite – for the stronger countries to abandon the euro and create their own currency.
European countries with strong economies – Germany, the Netherlands, Finland and Sweden – should simply walk out.
I'd like to take credit for breaking new ground with this idea, but I can't. Former head of the Federation of German Industries, Hans-Olaf Henkel, writing in the Financial Times recently proposed this alternative solution as well.
Still, it's worth subscribing to for a number of reasons.
To begin with, it would absolve the strong countries of their liability to prop up their weak Mediterranean sisters.
It was one thing when only small countries, such as Greece, Ireland and Portugal needed propping up. But now Spain, with a collapsed housing bubble and eight years of bad management, and Italy, with the most debt of any country in the EU, are at risk. Both of those countries' economies are large enough to put a sizeable dent in even Germany's vast wealth.
Even more ominous, storm clouds have started swirling around France, which is still rated AAA but does not deserve to be. The country has not balanced its budget since the early 1970s, and public spending has soared on the back of hopelessly uneconomic schemes such as the 35-hour workweek.
Now the French government has come up with a supposed solution – one that consists entirely of tax increases.
So it's clear now that something must be done. And the solution I support has benefits for both strong and weak Eurozone countries.
The Benefits of Breaking Up
For the stronger countries, leaving the Eurozone voluntarily and forming a new, stronger euro currency would…
The clock may be ticking on the future of the European Union (EU).
After being shaken to its core by the sovereign debt crisis, the entire Eurozone now runs the risk of blowing up within a week.
Germany's highest court, the German Federal Constitutional Court, on Sept. 7 rules on the legality of German participation in the euro rescue fund that was established to bail out Greece.
If the court rules that Berlin's commitment to the European Financial Stability Facility (EFSF) goes against EU law, or worse, against the German constitution, the entire Eurozone could collapse.
Think of the Eurozone as a minefield full of bombs that have long lay dormant, but are all still very active. Now, Germany's court ruling – itself a single bomb timed to go off next Wednesday – could ignite a massive chain reaction.
Germany: The Eurozone's Bomb Squad
Peripheral Eurozone countries like Portugal, Ireland, Greece, Spain, and Italy (the PIIGS) are in serious trouble and European banks face monumental liquidity and balance sheet issues.
So far, only Germany's singular fiscal conservativism and economic strength have kept the EU from self-destructing. But now the Eurozone's only legitimate bomb squad may be hanging up its lead-suits, pliers, and contagion containers.
What's at issue for the Constitutional Court is whether Berlin broke the EU's Maastricht Treaty, which unequivocally stipulates that member states cannot assume each other's debts. And, more germane to German citizens and the center-right coalition government, will be the Court's ruling on whether German Chancellor Angela Merkel's decision to fund the bailout facility circumvented constitutional requirements to put such fiscal matters before the German parliament.
And while the court isn't ruling directly on the EU's currency – or Merkel's support of it – the decisions rendered will have consequences for the euro's future and by extension, the EU as a whole.
Start the conversation
With fresh sources of oil becoming increasingly scarce, Exxon Mobil Corp. (NYSE: XOM) scored a major coup on Tuesday by making a deal for access to the vast reserves of Russian Arctic oil.
Many companies were in the hunt for the Russian Arctic oil, including BP PLC (NYSE ADR: BP), Royal Dutch Shell PLC (NYSE ADR: RDS.A), Chevron Corp. (NYSE: CVX), Total SA (NYSE ADR: TOT) and Statoil ASA (NYSE ADR: STO), but it was Exxon that walked away with the prize.
The arrangement with state-controlled Rosneft (PINK: RNFTF) gives Exxon a significant advantage over its major rivals — all of which have struggled in recent years to replace the oil they're extracting with new sources.
Rosneft, in which the Russian government has a 75% stake, estimates the three Kara Sea blocks where Exxon will be exploring contain about 36 billion barrels of recoverable oil.
"If that figure is correct and Exxon is able to produce the fields, we are talking about one of the world's largest oil discoveries in the last 50 years," Fadel Gheit, an energy analyst at Oppenheimer & Co., told MarketWatch. "But it remains to be seen how much of that oil is economically recoverable."
Rosneft estimates total reserves in the area at about 110 billion barrels of oil equivalent – an amount four times the size of Exxon's proven global reserves.
Quid Pro Quo
Having access to reserves of that size will help Exxon rectify its replacement ratio for oil. Earlier this year Exxon reported that for every 100 barrels of oil it produced, it found just 95 barrels of new oil.
Exxon has been more successful in replacing natural gas resources – it finds 158 cubic feet of gas for every 100 it extracts. But with natural gas prices slumping, the company would much rather find more oil.