Last week, after the failure by Italy's Monti government to repeal “Article 18," I worried out loud
(on the Buzz & Banter
, subscription required) when Italy’s sovereign bond spiral would begin anew. By the look of things, it did not take long at all. Let me expand a bit as to where I think we are and how we got here. Here, by the way, is Italy committing fiscal suicide virtually overnight.
Before the Greece bailout, whenever markets would get spooked by the euro debt problems, the EU / Fed / ECB would announce some pie-in-the-sky money-printing program and the markets would rip higher. The game worked for months...until it did not. Late last year investors and traders decided that “announcing programs” was a nice thing, but the time had come to actually pony up the money behind the programs. So private creditors were strong-armed into restructurings, Greece set itself on a path to a full blown depression, and Germany picked up the tab until the next Greek default.
The critical event in that drama wasn’t so much the terms of the restructuring; it was that Germany opened its wallet. That effectively reset the bar for all future bailouts: if a country runs into trouble, the markets will expect a check from the Germans to tie things over. The hope was that, on the heels of the Greek experience, other teetering countries would get their houses in order, and at least buy themselves some time. The government shuffles in Spain and Italy happened precisely so that reforms would be implemented.
Unfortunately, without an obvious catalyst, over the last couple of weeks something reawakened the notion that despite the reforms, Spain simply cannot make it. My guess is that the reality of 24% unemployment and the inability of the government to continue to borrow and spend finally hit home. There is a growing market fear/consensus that Spain has past the point of no return; it is bankrupt and no game of 3-card Monte can continue hiding that fact. On a standalone basis, Spain is already a huge predicament for Germany, but with some creativity, a merger of the ESM and ESFS might
have enough resources to ring-fence it for a while. But throw Italy into the mix and the size of the problem is way out of anyone’s league. Italy is too big to save. And that’s where the Article 18 debacle jumps to the forefront.
Judging by yesterday’s market moves, few, if anyone, expected that Italy would commit fiscal suicide almost overnight. But that is, in fact, what happened last week when -- as the newspaper Il Giornale
worded it -- Monti “Dropped Trou” to the unions and backed off from repealing Article 18. All the reforms that Monti had implemented as a non-partisan Prime Minister were a lead-in to labor reforms, and to the abolition of Article 18, which has strangled the Italian economy for decades. When that failed, everything else was effectively rendered useless. Reforming the Italian economy without reforming the labor market is tantamount to the US implementing fiscal reforms without touching entitlements and discretionary spending. It is no reforms at all.
And that takes us to where we are today: the Spanish implosion is intensifying; Italy has to refinance approximately 16 billion euros of debt by the end of the month at borderline unserviceable rates; and its government has blown up any semblance of a fiscal plan that might keep it out of its own debt spiral. The message wasn’t lost on the equity markets, which dropped 5% in one day in Italy, and are revisiting the 2009 lows in Spain.
Will the trembling spill into our markets beyond what would be an irrelevant 5-7% correction from the S&P 500
(SPX) highs? As I’ve been arguing for weeks now, a lot will depend on the US corporate bond market, and whether it will continue to throw free money at corporations. After a very quiet Monday, and despite yesterday’s stock market beating, Tuesday saw a pretty healthy day of issuance with close to $5 billion sold, including a fair amount of junk. If corporate buyers don’t disappear, it will be difficult for the bears to crack our markets. That said, credit default swaps on some US sectors are perking up and some spreads are also widening.
The DeMark charts tell a similar story. On the daily time frame, we got a “price flip” off of a completed TD Sequential Countdown, a TD Wave 5, and a Megaphone 7; follow through from a break of TD Reference Close Down tipped us off to likely downside acceleration. With TDST support broken after just 4 bars of the TDST Buy Setup, we have to see if the break is qualified, and then reassess.
On a weekly basis, we got a “price flip” off of a Megaphone 7 and TD Reference Close Down has been breached. We’ll have to wait until next week to see if we have follow through confirmation. If so, then the technicals will become a significant headwind.
So prepare for an SPX visit to the 1330 - 1350 area and keep watching the credit tells and the charts for where we might go from there.
A few bullets on specific names offering some trading setups:
Right on cue Procera Networks (PKT) prices an $80 million secondary. I’m not a buyer of the stock but I’ll be offering April / May 20 puts if the premium is right.
The no-cost Altisource Portfolio (ASPS) ratio spread (see Smart Money Will Sit Tight for Better Prices) is working out well but doesn’t look like I’ll get assigned on the short leg; the May 60-55 (1x3) is getting close to being available at no cost and I’m inclined to try it again.
Fusion-io (FIO) has pulled back pretty hard and I’m again eyeing 1x2 put spreads trying to get long stock at $17.50.
I’m gradually loading up on my favorite E&P names (see As Corporate Stocks Rock, Energy Can't Find a Bottom, Coal Gets Buried, and Techs Take Off) and hedging them off by shorting SPDR S&P Oil & Gas Exploration (XOP).
I’ve just about finished “leaning” on my Dendreon (DNDN) puts; by buying stock. Through August I’m playing with house money as all my puts are paired off with stock.
Will Germany open its wallet again, or will teetering countries actually get their houses in order?
Editor's Note: At Minyanville we often argue that markets and stocks are driven by four primary attributes: the fundamentals, the technicals, the structural, and psychology. In this weekly piece, trader Fil Zucchi will attempt to digest these four measures to come to actionable recommendations, but with a couple of twists: Rather than relying on standard technical analysis, he will examine the technicals through the lenses of “DeMark” indicators. And rather than highlighting straight entry and exit points for stocks, he will use options to gain long / short exposure, control risk, and generate cash flow. Investors should note: This column will be written 1-2 days prior to publication, so by the time it appears the prices of the securities mentioned may have changed.
Positions in SPX DNDN XOP ASPS PKT
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