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business newsWinners and Losers in the European Crisis
By
James Kostohryz
May 05, 2010 4:10 pm
The situation in Europe will certainly have a number of casualties.
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Observations
I would like to offer two observations regarding what's going on in Europe.
1. Things can quickly reach a point of no return. I think Greece is already past that point. If European officials are not able to reverse market psychology within the next month and restore confidence to sovereign debt markets, I think Portugal and Spain will go down. At that point, all bets are off for Europe and the global economy.
2. The present situation in which events in financial markets are driving the crisis is one that doesn't bode well for the future of the financial industry worldwide. Europeans have a propensity to blame all of this on “speculators” and therefore the cries for “global financial reform” will be deafening. Obama is sympathetic to these cries, so the scenario of some sort of global financial regulatory project is made all the more plausible. A regulatory boondoggle is certain to emerge if such a project materializes. Thus, this is not a good environment to be investing in investment banks. The sort of free-wheeling financial capitalism that has made these institutions profitable, will be severely curtailed. This also has implications for future long-term growth.
The first casualties of a European meltdown will be commodities. Some have already corrected. If Europe lapses into recession, they have much further to go. Oil seems particularly vulnerable to me here as it's still near highs, and sentiment toward black gold on the Street has been very bullish in recent weeks.
Europe is China’s main export client. If Europe goes down, it could be the catalyst that bursts the bubble in China.
A final observation. It won't be easy to short the downside if and when things develop negatively, as sharp rallies caused by government action will tend to cause big short squeezes. Risk management and a strategy of taking profits along the way must be key to any short-side strategy.
I am 100% cash.
How to Handle It
As we work through this, we can't forget that the 800-pound gorilla in the room is the US economy, and right now this gorilla is driving a million ton super-tanker that is headed in the opposite direction as Europe. So as we analyze Europe and its global effects, let’s not forget that the short-term picture in the US (at least in my opinion) is quite bullish. US economic momentum is quite strong and picking up steam. It's highly unlikely that the US market will drop too far in the next three months in the context of a continually improving economy. So let's be mindful of that.
Everybody and their mother (including me and mine) seems too weary of shorting Europe or markets in general because they expect that European governments will come up with some sort of plan or another that will cause some major short-covering rallies. But this raises the question: If nobody is shorting because they are afraid of bailouts, then who will be covering shorts? Furthermore, if nobody thinks that the bailouts will work, who will buy the news when bailouts are announced? The recent Greek mega-deal could be a big tell for what's in store for packages put together for Portugal, Spain etc.
I remember when I was trading Argentine sovereign debt before their default almost a decade ago, the same situation arose. Once the crisis reached its terminal stage, each bailout-related announcement produced a reaction of about a day. And each time the reaction was shorter in duration and more muted. It feels much the same now.
Bottom line: The focus probably needs to be on finding good Europe-leveraged shorts and possibly doing some hedging with select US longs.
No positions in stocks mentioned.
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