Stock markets are set for a roller coaster ride this
week. Strong 1st quarter profits were reported and the US
economy grew 3.2% in the first quarter, slightly short of
economists' forecast but still a third consecutive quarter
of growth. However, investors were spooked by lingering
doubts on the viability of Greece's financial rescue.
Two months of wrangling on the terms of financial aid
was brought to bear as Greece received a bailout of €110bn
over 3 years, sponsored by the EU-IMF. The olive branch was
expected after Greece's close brush with bankruptcy last
week. All hell broke loose after European Union revised
upwards Greece's 2009 deficit to 13.6% of GDP and rating
agencies downgraded its credit to junk status, limiting
access to fresh funds.
The first disbursement of bailout money will be made
before May 19 to avert a default, but there is no guarantee
financial stability will prevail in the eurozone. If Greece
bites the bullet and succeeds in putting its finances in
order, they will face a recession and deflationary
pressures which will cripple their economy for years.
However, given Greece's abysmal record in fiscal
discipline, it is doubtful if the austerity measures will
be implemented fully. Greece promises to cut its budget
deficit to 3% of its GDP by 2014, but reining in spending
is a tough call, with mounting political pressure from
rioting workers and pensioners. From the initial response,
a deadlock may ensue and hold the economy to ransom which
essentially defeats the purpose of a bailout.
A Dangerous Precedent
It is ironic that with this bailout, bond vigilantes
have shifted their scrutiny to other debt laden nations in
the eurozone. Greece is but the tip of the iceberg, they
came first to the party with hat in hand and are now safe,
at least for a year. A dangerous precedent has been set,
though. How can Europe not save Portugal or Spain after
handing Greece a lifeline?
Besides the PIGS (Portugal, Spain, Italy, Greece), you
can count Austria, Belgium, Hungary, Ireland, and UK in the
soverign default risk category. The US and Japan have
worrisome debt-to-GDP ratios, too, but because the former
possess a reserve currency (licensed printing press), while
the latter has a wellspring of domestic savings to tap into
for cheap government loans, their financial woes are not
expected to blow up any time soon.
And since we are talking about irony, it is worth
mentioning that the sovereign debt crisis is set to
boomerang back to the banks which started the financial
crisis with their reckless and greedy behavior. To prevent
a total collapse during the darkest hours of the mayhem,
European banks transferred toxic assets from their balance
sheets onto the states, which were deemed better able to
absorb such risks. Countries also adopted loose monetary
policies to jumpstart their moribund economies. Add in
lower tax revenues to these Keynesian efforts, the result
is astronomical budget deficits.
The fact that European banks hold a lot of Greek,
Portugese, Italian and Spanish debt is not lost on
investors, especially the 'shorts.' If these countries
default, the banks will definietly require another round of
capital raising to bolster their balance sheets. But what
if capital markets froze again and unlike 2008, you can't
bank on another shot of taxpayer rescue money as fiscal
budgets are already maxed out?
I hate to say this but financial Armageddon awaits
Europe. As a monetary union, you have to sink or swim
together. If more countries start asking for bailouts, the
entire eurozone will face a higher interest spread, and the
euro could be non-existent if the political limitations of
the eurozone are not fixed.
Asian Fiscal Crisis Redux?
Seeing how Europe struggles brought back memories of the
Asian financial crisis in 1998. Not surprisingly, "Sell in
May and go away" strikes a chord with many investors. The
cliche does not always apply but it is a good rule of
thumb. Historically, stock investing during the period from
May-November is fraught with danger or at best rewarded
with meager returns. Moreover, with a remarkable gain in
the stock market (S&P having risen 75% since bottoming
out in March 2009), it is time for a considerable
To be sure, a lot of positive news had been priced in
amid the stock market rally. The V-shaped recovery and
optimistic valuations appear realistic to many investors
despite unfavorable aspects like high unemployment, rising
debts, higher taxes, etc. While not exactly in a stock
market mania, investors have cast aside their fear.
Thankfully, the recent stock market decline may keep our
feet firmly on the ground. This is a time when investors
should review their portfolios and make adjustments by
offloading deadweight, shifting into defensive sectors and
putting stop losses into place.
Usually, when investors shun stocks, they head for the
bond markets which are considered safer investments. You
get a fixed income annually and if you hold it to maturity,
you get back your principal. But bonds suffer from interest
In the past, bond prices had plunged by 20-30% when
interest rates double. As the US bond market is much larger
than the stock market, many "risk averse" investors are
going to feel poorer due to the losses from their fixed
When Ben Bernanke will raise interest rates is unclear
but if futures on Federal funds are any indication, the
zero-rate policy is likely to be abandoned in November or
December. Indeed, with the economy is on the mend, Ben
Bernanke has little excuse to delay raising interest rates
and combat inflation. We may even see hyperinflation by
2012, thanks to energy/commodities which are in a secular
bull market and the Fed's misjudgment.
If you still favor bonds, you should go for short term
Treasuries (3-6 months) because the longer the maturity
date of your bonds, the higher your losses if rates surge.
Right now, anything more than 2 years is a dangerous
In the stock market, rising rates which translates to a
higher cost of capital, will be detrimental to businesses
but especially so for financial, property and construction
counters. With higher installments, investors will think
twice about purchasing houses. The effect of fewer buyers
coupled with desperate sellers who are on floating rate
mortgages and about to reset higher will not be kind to the
property sector. REITs, if they happen to have excessive
debts and require refinancing, will also be tested once
interest rates increase.
As for China, it is losing its luster as a
get-rich-quick destination right now. The government has
clamped down hard on property speculators, restricted hot
money inflows and outflows and it may yet raise banks'
reserve ratio requirement for the nation's banks to
All these measures are calibrated to burst the bubble
and yield benefits in the long term, but in the short run,
nobody knows if the pendulum will swing too far and result
in a second dip. Thus, parking cash in yuan, hoping there
will be an appreciation, is not a sure bet if the Chinese
economy cools down drastically.
Under such circumstances, gold remains the favorite
asset for investors who love a safe haven. Even if gold
achieved a year high of $1169, there is more upside to go.
The frenzy which ensues from a European collapse will only
add to gold's appeal. And with the ongoing debasement of US
dollar, gold has no direct competitor when it comes to
preserving our purchasing power.
You can print out trillions of dollars to pick up the
slack in the private sector or distort market machinations
but you cannot change the primary trend which shows that
stocks are in a secular bear market. The stock market can
go up higher or lower but it has to come back to its
equilibrium, say Dow Jones Index of 10,000, which is why
some astute pundits have pointed out that this round figure
is nothing to crow about and we will see more of it before
the whole episode is over.
As I mentioned in my last post, this is not a year to
attempt speculative activities and buying stocks
aggressively is a dangerous approach. However, I do
encourage buying on the dips, say after 10-15% correction.
We have not seen the worst of the carnage which will
probably gain momentum in June but if it is any
consolation, there could be a rebound in early 2011.
Bearish Pattern Active on Oil Chart