How to Spot the Foreign Market "Contagion" About to Go Viral

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Europe has always played a huge role in the U.S. markets. The U.S. Treasury reported that European investors and central banks held $1.6 trillion of U.S. Treasury securities in June. More importantly, they had purchased $114 billion of that over the past year, including $32 billion from April to June.

And although there's no breakdown of U.S. stock and corporate bond holdings by country, Treasury holdings are about one third of total foreign securities holdings. Assuming that ratio applies to European holders, then they hold a total of roughly $4.8 trillion in U.S. assets and added nearly $100 billion of that over the April-June period.

There's little doubt that this has helped drive the stock market blowoff.

That cash flows into the U.S. markets. When European investors buy Treasuries, most of those purchases are from U.S. Primary Dealers, even if they are not direct purchases of U.S. stocks. The dealers use some of the cash they get in those sales to Europeans to buy stocks. When European investors, or U.S. corporations in Europe, buy U.S. assets, that adds liquidity to the U.S. system and fuel for the inflation of the U.S. stock market bubble.

So I have always found it important to track the monthly data on the European banking system for you. Its growth, or lack thereof, matters to the U.S. market – whether that growth is intrinsic, or smoke and mirrors.

To find out whether European banking is really obscuring the truth about the U.S. market, we must take a deep dive into the data. That's what I'm doing here for you today. Unfortunately, what we find might not lead to the most heartwarming reassurance about the U.S. stock market's current trajectory.

That's because a looming, so far unseen contagion is currently buried in the heap of it.

The Contagion Is Hiding Amid Misleading European Lending

Lo and behold, smoke and mirrors continue to drive lending and deposit growth in the European banking system. The inflation of a European housing bubble, with increases in mortgage balances outstanding, plays a huge role.

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Then there's interbank fun and games with the European Central Bank's Targeted Long-Term Lending Operation (TLTRO). These have been the sources of all of the apparent growth in the assets of European banks.

In reality, while loans and deposits have grown, total assets have not grown at all. Apparent asset growth in some national banking systems in Europe has been offset by the ongoing collapses or lack of growth in others.

Meanwhile, the forces driving the apparent growth of loans and deposits are unsustainable. The ECB is in the process of cutting its quantitative easing (QE) to zero. Under QE, the ECB buys bonds to add to its balance sheet. That forces cash into the European banking system. But when QE goes to zero in December, liquidity will shrink and so will the flow of European money into U.S. markets.

European banks have already taken baby steps toward repaying the ECB's massive phony loan program, the TLTRO. The TLTRO loans were supposed to stimulate lending. But the only lending they stimulated was interbank lending designed to take advantage of the interest bonus the ECB would pay based on the increase in loans.