So yesterday’s Italian elections came in utterly inconclusive, and as we slowly discovered that the center-left couldn’t beat out in any meaningful fashion Silvio Berlusconi or a comedian (some would argue that’s redundant), everyone categorically asserted that “Indecision 2013 – Italian Style” (thank you John Stewart) was the reason for the market slide on this side of the pond.
One of the most difficult aspects of this business lies in distinguishing between causation and coincidence, because choosing between the two can lead one to clairvoyant positioning or a car-wreck whiplash. The European crisis that is supposedly re-awakening and shaking our markets is at its core a debt/credit and credit derivative issue, which is why the financial markets have grown obsessed with Credit Default Swap (CDS) spreads and sovereign bond spreads vs. the German bund. (Corporate Bonds, Derivatives, and How They Wag the Equity Markets
is my take on how various credit instruments that serve as the equity markets' whisperers.) Unless we are entering a new phase of Euro problems, nothing that has defined the Euro crisis so far is showing up in the credit markets:
Italian CDS and bond spreads are a multi-year lows.
Ditto for US CDS and 2-year swaps.
CDS of large US financials are at or near post US crisis lows.
Morgan Stanley (NYSE:MS) tapped the bond market for $4.5 billion last week; yesterday $11 billion of new corporate bonds were sold, including $1.3 billion by Fifth Third Bank (NASDAQ:FITB); and to erase any doubt on the tone of corporate credit, France BNP Paribas (FRA:BNP) sold $1 billion of 10y-year bonds at 3.25%.
If that’s what a re-emerging credit crisis looks like, I’ll take two of those and I’m pretty sure I’ll feel good in the morning.
(More from Minyanville: Bernanke's Date With Deflationary Destiny.)
The only arguable reason I can find to explain the “shocking” 2.8% drop in equities since last week, is simply that the markets look exhausted on DeMark counts (see Interpreting DeMark Indicators: All Trends Must End, But the When Is Key
), and to these tired tape-reading eyes, they feel tired too. I’m not minimizing the aggravation of sticking through a 3%, 5%, or 10% drop, nor am I oblivious to the fact that corrections that cannot be connected to specific reasons tend to be even scarier because they give the feeling of flying blind. But nothing that has characterized the waves of crises of recent years is in play right now. With one possible exception, that is.
Yesterday the Dollar/Yen (USDJPY) traded in a four, big-figure range, something I can’t recall happening in the last five years without Bank of Japan intervention or in the aftermath of the Japanese earthquake. The yen has had a very large and very fast down move this year, and shows a compelling DeMark Buy Combo 13 on the weekly charts, which could explain in part yesterday’s reversal. However, what one must always worry about with violent moves in currencies is the spillover effect they may have in other asset classes. I have no keen insight on how or why a turn in the yen might explain a pullback in US equities, but it’s at least worth noting the freakish similarity (not necessarily correlation or causation) between the JPY/USD chart and the S&P 500
Just don’t tell me that stocks are falling because of the Italian elections.
Author's note: The above was written Monday evening, and this morning Italian CDS and bond spreads are meaningfully wider. Be that as it may, I’m sticking with my view that the Italian elections may serve as a catalyst for a market pullback, but not as the underlying reason for it, let alone the basis for a protracted swoon. Again, it doesn’t mean the market can’t tank, but there are lots of structural explanations right here at home that can explain that better than some attribution to Italian clowns. . . I mean politics.
Speaking of which, as I caught up with yesterday’s reading, John Hilsenrath’s piece in the Wall Street Journal
was an eye-opener. First, he suggests that the Fed may be warming up to the idea of tapering off asset purchases; no big news there. But his second scoop is indeed newsworthy in my humble opinion: The Fed may be rethinking the sequencing of its exit strategy and may hold on to securities longer than planned. At the risk of sounding tabloidish, that is as close as I have seen anyone (especially someone with a near-direct leaks-line into the Fed) begin to concede that the Fed may indeed be trapped. By some estimates, the DV01 of the Fed’s balance sheet, i.e. how much the value of the Fed’s assets rises/falls for each basis point change in interest rates, is up to some $4.5 billion. This means that should the Fed want/need to sell assets to push up rates, it (and by extension we) could incur very large losses. That’s of course something that so far Ben Bernanke categorically denied was ever possible, with the same near-certain confidence he had when he proclaimed that the subprime crisis was contained.
If I had to correlate yesterday’s market drop to any one piece of news, Mr. Hilsenrath has just handed me my pick.
By the way, Bill Gross is out on Twitter suggesting that the new driver of risk-on/off will be the ups and down of the yen.
Position in SPX.
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