eurozone debt crisis
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Latest Eurozone Debt Crisis Plan "Another Grand Illusion"
As European leaders celebrated a tentative agreement to accept tougher budgetary rules among its members, critics expressed doubts the plan would cure the two-year-old Eurozone debt crisis.
Last week's highly anticipated two-day summit resulted in 26 of the 27 European Union (EU) nations - the United Kingdom objected - agreeing to create a new treaty that would require members to keep budget deficits to within 0.5% of gross domestic product (GDP) in good economic times and within 3% of GDP in bad times.
EU governments would need to submit their budgets to a central fiscal authority, and violations would carry automatic penalties. The nations agreed to hammer out the details by March of next year.
World stock markets reacted positively, but many experts remain unconvinced that the EU has finally delivered the silver bullet needed to slay its monstrous debt crisis.
"They needed to create grand plan that's really workable and not another grand illusion," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "I'm afraid what we're getting is just another grand illusion."
In fact, last week's meeting was the fifth summit called to deal with the European debt crisis since 2009. Each has produced its share of optimistic rhetoric, but no concrete solutions.
European leaders from France, Germany, the European Central Bank (ECB) and the International Monetary Fund all hailed the summit agreement as a major step toward getting the debt crisis under control.
"This is the breakthrough to the stability union," said German Chancellor Angela Merkel at the end of the summit. "We are using the crisis as an opportunity for a renewal."
"It's a very good outcome for the euro area, very good," added ECB President Mario Draghi "It is going to be the basis for much more disciplined economic policy for euro-area members."
Fitz-Gerald said Europe's leaders mean what they say, but ultimately the latest summit will do little more than spark a brief rally in the markets.
"These government officials still don't get it," Fitz-Gerald said. "They're still not addressing the underlying problems. We'll be having this conversation again next year."
A Tough Sell
Although enforcing budgetary austerity would help prevent current debt problems from getting worse, it's unlikely the citizenry of most EU member nations will allow it to happen.
"Their proposal is preposterous," writes Brett Arends of MarketWatch, likening the EU plan to the United States allowing its largest creditors, Japan and China, control over the federal budget.
"How would you feel if you opened the paper to be told that the new Sino-Japanese "Fiscal Stability Commission' in Washington had just slashed your grandma's Social Security checks by one-third, scaled back federal highway repairs, and that it would impose a 10% national sales tax?," Arends said. "That is, after all, effectively what is being offered to the people of Greece, Italy, Spain, Portugal and Ireland."
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S&P to Eurozone: Fix It or Else…
By timing its downgrade threat to the same week as a key European Union (EU) summit on the debt crisis, Standard & Poor's is essentially telling Europe's leaders to "Fix it or else."
The ratings agency said late Monday that it had put the credit of 15 Eurozone countries, including AAA-rated Germany, on a 90-day watch. The move means each affected country has 50% chance of a downgrade.
European leaders are scheduled to meet in Brussels Dec. 8 and 9 to discuss EU treaty changes that would mitigate the debt crisis, such as restrictions on budget deficits. German Chancellor Angela Merkel and French President Nicolas Sarkozy unveiled an outline of the plan Monday.
The timing of the S&P warning "could hold leaders' feet to the fire and force them to go through with a comprehensive solution," Peter Jankovskis, co-chief investment officer at OakBrook Investments, told Reuters.
Reaction of the world's stock and bond markets was muted, with investors apparently looking ahead to the summit.
Money Morning Capital Waves Strategist Shah Gilani said it was "about time" the ratings agencies started to get serious about credit ratings in the Eurozone, saying they were behind the curve on such problems as mortgage-backed securities.
"Now they're pushing their new "ahead of the tsunami' PR campaign," he said. "Their PR agenda aside, they're right to be knocking these credits down to reality."
They Had it Coming
S&P listed several reasons for its warning.
"After a good two years of trying to manage the crisis, the political efforts have not been able to arrest matters," Moritz Kraemer, head of European sovereign ratings at S&P, told the Financial Times. "It is our view that this is a systemic stress, a confidence crisis that affects the Eurozone as a whole."
Those "stresses" include tightening credit, rising government bond yields, squabbling among Eurozone leaders about how to cope with the crisis and the rising risk of a Eurozone recession next year.
"We are approaching a very important moment where the crisis could take a very significant turning point for the worse and we want to warn investors," Kraemer told The FT. "Considering how the crisis has deepened and the challenges that they are facing, [the summit] is the last good opportunity that policymakers have."
Although the S&P said it would take the results of this week's summit into consideration, no one should doubt the agency's resolve. This past summer S&P followed through on a similar threat to cut the credit rating of the United States to AA+ from AAA following the debt ceiling crisis debacle.
"S&P's view is that the political outcome will also drive creditworthiness, and I don't think anyone in their right mind would dispute this point," Ashok Parameswaran, an emerging-markets analyst at Invesco Advisers Inc., told Bloomberg News.
More Turmoil Ahead
Should this week's Eurozone summit fail to go far enough to please the S&P, the real fireworks will begin.
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Europe Headed for a 'Lehman Moment'
With credit drying up across Europe we may finally see the Eurozone experience its "Lehman moment" - a replay investment banking collapse that triggered the 2008 financial crisis.
Indeed, European banks are having a harder time getting money - part of the fallout from the Eurozone debt crisis - and the resulting credit crunch could freeze business activity, cause bank runs and plunge Europe into a deep recession that would badly damage the global economy.
"The Continent is headed towards deflation if there's not enough money circulating throughout their financing and banking systems," said Money Morning Capital Waves Strategist Shah Gilani. "This all becomes self-fulfilling at some point. It's a very dangerous situation, not just for Europe, but for the whole world."
A global financial crisis would derail the struggling U.S. recovery and pinch the profits of many multinational corporations.
Fresh data this week from the European Central Bank (ECB) showed the M3 Eurozone money supply actually shrank in October by 0.6%, its steepest drop since January 2009 - the height of the Lehman Brothers crisis.
A shrinking money supply is one of the early warning signals that credit availability is drying up, making it difficult or impossible for banks, businesses, and consumers to obtain loans.
"This is very worrying," Tim Congdon from International Monetary Research told The Telegraph. "What it shows is that the implosion of the banking system on the periphery is now outweighing any growth left in the core. We are seeing the destruction of money and it is a clear warning of serious trouble over the next six months."
Signs of capital draining from European banks abound.
The bank bond market is already frozen. European banks in the third quarter were only able to sell bonds worth 15% of what they sold in the same period in the previous two years, according to Citigroup Inc. (NYSE: C).
In the past six months, U.S. money market funds have withdrawn 42% of their money from European banks. And loans to French banks have fallen 69% since the end of May, according to Fitch Ratings.
Even retail customers have started to pull their money out.
"We are starting to witness signs that corporates are withdrawing deposits from banks in Spain, Italy, France and Belgium," an analyst at Citigroup wrote in a recent report. "This is a worrying development."
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Rising Government Bond Rates Push Eurozone Debt Crisis to the Precipice of Collapse
Rising government bond rates are making it increasingly costly for several key Eurozone nations to borrow money, stoking fears that the sovereign debt crisis has reached a critical stage.
Yields on 10-year Spanish Treasury bonds rose to 6.8% during yesterday's (Thursday's) auction - uncomfortably close to the 7% level at which many experts feel is unsustainable. When the 10-year bond yields of Portugal, Ireland, and Greece passed 7%, each was forced to seek a bailout.
Just last week the 10-year bond yields of Italy crossed the 7% threshold. Though yields dropped back below 7% after Italian Prime Minister Silvio Berlusconi stepped down, the respite proved short-lived. The Italian 10-year bond yield fell back to 6.84% yesterday but is expected to stay in the danger zone for the foreseeable future.
Perhaps more worrisome is the rise in French bond yields. While France is not one of the troubled PIIGS (Portugal, Ireland, Italy Greece and Spain), it has deep financial ties to those nations. French 10-year bonds now yield 3.64%, twice that of equivalent German bunds despite both nations having a top-tier AAA credit rating.
The cost of borrowing is rising even for nations that until now had been outside of the fray, like the Netherlands, Finland, and Austria.
"Momentum is building," Louise Cooper, market strategist at BGC Partners, told MarketWatch. "Ten-year French borrowing costs are now around [two percentage points] greater than Germany, Spanish borrowing costs are rocketing and 10-year Italian debt is yielding over 7%. The hurricane is approaching. Time to batten down the hatches."
Economic Damage
As the Eurozone debt crisis deepens, many analysts worry that the rising government bond rates could put the brakes on lending and lead to a credit crunch such as the one experienced during the 2008 financial crisis.
In the short term, however, the steady stream of scary news is taking a toll on the stock markets. The British FTSE 100 was down 1.58% and the French CAC 40 was down 1.78% yesterday, while the Dow Jones Industrial Average fell 134.79 points, or 1.13%.
"Investors keep thinking that the powers that be in Europe are getting in front of this - only to be disappointed when additional bad news emerges," observed Money Morning Capital Waves Strategist Shah Gilani. "That's why we're seeing these whipsaw trading patterns that are so frustrating to retail investors who've been schooled to buy and hold. The reality is that this will get much worse before it gets better."
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Five Companies to Avoid Until the Eurozone Debt Crisis is Over
U.S. companies with significant exposure to Europe will take a profit hit regardless of how the Eurozone debt crisis shakes out.
The financial strain of Europe's efforts to avert default among its troubled members - Portugal, Italy, Ireland, Greece and Spain (PIIGS) - has set the Eurozone on course for a recession even if its efforts succeed.
Yesterday (Thursday) the European Commission dropped its forecast for growth in the Eurozone to just 0.5% from its previous estimate of 1.8% in May. The commission blamed austerity measures, which were aimed at lowering budget deficits, but ended up eroding investment and consumer confidence.
"The probability of a more protracted period of stagnation is high," said Marco Buti, head of the commission's economics division. "And, given the unusually high uncertainty around key policy decisions, a deep and prolonged recession complemented by continued market turmoil cannot be excluded."
Falling consumer demand has already begun to affect the bottom lines of many U.S. companies that derive large portions of their revenue from the Eurozone bloc.
"In light of cutbacks in government spending, tax increases and waning business confidence, there already has been some [company] commentary on slipping appliances, bearings and heavy-duty trucks demand," Citigroup equities analyst Tobias Levkovich told MarketWatch. "In many respects, these early remarks are a worrisome sign."
For example, General Motors Co. (NYSE: GM) on Wednesday said the debt crisis would prevent it from breaking even in Europe this year. And Rockwell Automation Inc. (NYSE: ROK) on Tuesday warned of declining capital spending in Europe next year.
Although sales to Europe account for only 10% of revenue for the Standard & Poor's 500 as a group, several sectors have far more exposure to the Eurozone.
The auto sector derives 27.6% of its sales from Europe, followed by the food, beverage and tobacco sector at 22%, the materials sector at 19.8%, the consumer durables and apparel sector at 16.2% and capital goods at 16.4%.
"Europe is a major component to the U.S. economic engine and it is a concern," Howard Silverblatt, an analyst with S&P Indices, told MarketWatch. Silverblatt noted that while a European recession may not necessarily take down the U.S. economy, "it has an impact that will move stocks."
Here are five U.S. stocks that have significant exposure to Europe and leveraged balance sheets high - making them risky investments until Europe gets back on its feet:
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Too-Big-To-Save: Italy Totters on Debt Crisis Cliff
With its 10-year bond yields nearing 7%, Italy's debt is becoming a burden it will no longer be able to handle as it follows the same path as Portugal, Ireland and Greece.
However, Italy's economy - seven times larger than Greece's, nine times larger than Portugal's and 10 times larger than Ireland's - is too big for the Eurozone to rescue.
And because Italy's economy is so large - the third-largest in the Eurozone and the eighth-largest in the world - a default on its sovereign debt would be that much more calamitous.
Yesterday (Tuesday), yields on Italy's 10-year bonds hit 6.77%, a record for Italy in the era of the European Union (EU).
"Now we are really reaching very dangerous levels...We are above yield levels in the 10-year where Portugal and Greece andIrelandissued their last bonds," Alessandro Giansanti, a rate strategist at ING Groep N.V. (NYSE ADR: ING), told Reuters.
The spike in yields reflects rising investor concern that besieged Prime Minister Silvio Berlusconi doesn't have the political muscle to push through the tough budget measures Italy needs, such as pension cuts, to get its debt issues under control.
Those fears were further stoked yesterday when Berlusconi was unable to win a majority on a routine vote on a budget report, but eased when Berlusconi agreed to resign. Yields dipped slightly on Monday in response to rumors that Berlusconi might step down.
"The market's bias is fairly clear. The question is; what comes afterward, assuming he falls?"Peter Schaffrik, head of European rates strategy atRBC Capital Marketsin London, told Bloomberg News.
Unsustainable
If Italy's bond yields don't fall significantly, it won't matter who's running the country. The high yields are making Italy's ability to cope with its debt increasingly infeasible.
At 120% of gross domestic product (GDP), Italy's debt load is second only to Greece's among Eurozone nations. Its total debt of $2.7 trillion is the eighth-highest in the world.
As bond yields go up, the cost of rolling over this massive amount of debt increases as well, and is nearing unsustainable levels.
Italy needs to auction $41.5 billion (30 billion euros) of debt less than a week from now, Nov. 14, and another $31.13 billion (22.5 billion euros) in December. Next year Italy will need to borrow $415 billion (300 billion euros).
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MF Global Bankruptcy Exposes Vulnerability of U.S. Banks to Eurozone Debt Crisis
The bankruptcy of MF Global Holdings (NYSE: MF) was a distressing signal to investors that it is possible for U.S. financial institutions to fall victim to the Eurozone debt crisis.
MF Global filed for Chapter 11 bankruptcy Monday after credit downgrades led to margin calls on some of the $6.3 billion in Eurozone sovereign debt the bank held. The position was five-times MF Global's equity.
Although the major U.S. banks have less exposure relative to available capital, their many tendrils in Europe - particularly to European banks - will inevitably drag them into any financial meltdown in the Eurozone.
Even the U.S. banks' estimated direct exposure to the troubled European nations of Portugal, Ireland, Italy, Greece and Spain (PIIGS) is disturbingly high - equal to nearly 5% of total U.S. banking assets, according to the Congressional Research Service (CRS).
And according to the Bank for International Settlements (BIS), U.S. banks actually increased their exposure to PIIGS debt by 20% over the first six months of 2011.
But the greatest risk is the multiple links most large U.S. banks have to their European counterparts - many of which hold a great deal of PIIGS debt.
"Given that U.S. banks have an estimated loan exposure to German and Frenchbanks in excess of $1.2 trillion and direct exposure to the PIIGS valued at $641billion, a collapse of a major European bank could produce similar problems inU.S. institutions," a CRS research report said earlier this month.
Of course, the major banks say their exposure to the Eurozone debt crisis is much lower because they've bought credit-default swaps (CDS) to hedge their positions. Credit-default swaps are essentially insurance policies that pay off in the event of a default.
Unfortunately, this same strategy was one of the root causes of the 2008 financial crisis involving American International Group (NYSE: AIG) and Lehman Bros.
"Risk isn't going to evaporate through these trades," Frederick Cannon, director of research at investment bank Keefe, Bruyette & Woods Inc., told Bloomberg News. "The big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who's ultimately going to pay for the losses?"
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Does the Eurozone Have Its Own Lehman Bros?
Does the Eurozone have its own American International Group Inc. (NYSE: AIG), or worse, its own Lehman Bros. when it comes to Greece?
I believe it does.
Why else would the European Union have bent over backwards to "save" a member nation that: A) Accounts for 2.01% of the EU by trade volume; and B) Would essentially be like letting Montana go out of business - no offense to Montanans or Montana!
More to the point, if things really were under control, why would European Central Bank President Jean-Claude Trichet say that risk signals for financial stability in the euro area are flashing "red" as he did following a meeting of the European Systemic Risk Board in Frankfurt?
The short answer: Because he knows what the European banks are desperately trying to hide from the rest of the world - that there are still enormous risks and they're even more concentrated now than they were in 2008 at the start of the financial crisis.
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European Debt Crisis: How to Profit No Matter What Happens
Since the European debt crisis first emerged in early 2010, it has dominated headlines, roiled the world financial markets, and has kept investors in a perpetual state of alert as they wait for the next shoe to drop.
But let me share with you a little-known secret: Investors who understand where the "fault lines" are forming in this Eurozone debacle can transform the biggest sovereign-debt crisis in years into a major profit opportunity.
Let me explain...
For the one investment that will let you profit from the EU debt crisis, please read on...
