MorningWord 7/1/13: Ok, enough with all the summer swoon fear-mongering stuff. It is summer, and yes, global equity markets sold off from all time highs in the last few weeks. And it’s a slow news cycle so hings tend to get played up a bit. I think it is fair to say that no matter what the global economy faced since the bottom of the financial crisis back in early 2009, equity markets have climbed a wall of worry. Naysayers have tried to point out why this leg of the rally will fail and why that was the top, but for the most part, equities in developed markets just kept chugging along to higher highs until indices like the SPX made new all-time highs.
The bell that was wrung at the “all-time highs” sounded a tad different than the one heard at previous intermediate highs like new 52 week, new 2 year etc etc, partially because market participants think back to where they were the last time the SPX closes above 1575 in late 2007, and then what came next. The irony this time around with the SPX back at levels not seen since Nov 2007 and early 2000 is that in those past highs it appeared that bubbles in the U.S. were the potential cause for a corrective phase. This time around it appears that concerns of a global economic slowdown have the potential to stall the U.S. recovery. Fears of a hard landing in China/general weakness in BRIC nations, flare ups of Arab Spring in the Middle East (Turkey/Egypt of late) and a stagnant Europe are all well known macro concerns.
For instance, last fall prior to the massive global equity market rally, there was constant concern that the Shanghai Composite was breaking the magic number of 2000 on the downside, and was quickly approaching the lows from 2008. After its monster bounce, it did break again, just recently, and has closed below 2000 every day for the last 10 trading days and all hell hasn’t broken loose. I guess a sort of hard sloppy landing is starting to get priced into stocks in the west.
So if emerging market weakness is becoming a “known” and possibly adequately “priced in” to U.S. equities where could a “lesser known” or an unexpected surprise come? If I were to suggest the potential for some sort of surprise out of the European banking sector, your response would be “that is soooo 2011/2012” and you’d probably right to dismiss it, but there is one chart that I think deserves a little attention as it is probably one of the worst that I see on a daily basis of late, EuroStoxx Bank Index (SX7E).
The above chart is a bit of a train-wreck in my opinion and I am hard pressed to think that a meaningful break and close below long term support would not have ramifications outside just European banks. The head and shoulders formation at least has to get your antennae up and possibly suggest that there is something fishy in Denmark, literally. A couple weeks back I highlighted some comments from U.S. FDIC Vice Chairman Hoenig (here) regarding one of the largest European banks,
“Deutsche Bank’s capital levels are “horrible” and said it is the worst on a list of global banks based on one measurement of leverage ratios. Specifically, he suggests that ”It’s horrible, I mean they’re horribly undercapitalized,”….. “They have no margin of error.”
So there are a few good questions to ask. Do European bank investors see something that the rest of us are missing? Why is a U.S. bank regulator sound so concerned about a Euro Bank? And why did the commentary get so little attention? The SX7E’s underperformance (down ~9% ytd) vs the XLF’s nearly 20% ytd gains is fairly dramatic, and I would say that the likelihood of a narrowing of the performance gap between these 2 banking benchmarks could be the next “tell” for global equities, one way or the other.