MorningWord 07/09/14: Euro Bank Weakness Notable $SX7E $VIX

by Dan July 9, 2014 9:28 am • Commentary

This morning I read a fairly interesting article from Reuters’ Mike Dolan Scoping the new subprime as watchdogs cry ‘bubble’ where he quotes the annual report of the Bank for International Settlements (BIS).  Think the Justice League for central banks.  The article hits on a few warnings that appear to have been overlooked by the investment community, but will most likely be pointed to during the next crisis as a sort of shot across the bow for the stunning gains in public equities despite well below-average global growth and well above-average economic stimulus.  Here were a few excerpts:

in its latest annual report the Bank for International Settlements, the Basel-based forum for the world’s major central banks, seemed pretty convinced global debt markets are once again in risky territory and heading for a fall.

‘Exuberant’ equity and real estate and rock-bottom financial volatility merely fed off that picture, it said. And it added that if all this was simply due to zero official rates, it could all suddenly go into reverse when they rise.

“It is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally,” the report mused.


The BIS, then, is at most just flagging the risk of higher interest rates. “The sustainability of this process will ultimately be put to the test when interest rates normalize.”

The seeming inevitability of rates rising from next year suggests investors should already be bracing for some serious turbulence, if not quite on 2007 levels.

Crawling out of the “Fear Bunker” for a second, I think we can all agree that central bankers for the most part have had a less than stellar track record over the last 20 years forecasting impending disasters.  They have clearly been much more adept at throwing everything they have at combating them after the fact in an attempt to overcome them. We know how that ends, since we’ve seen three fairly epic asset bubbles in the past 20 years.  I am not an economist, and this is all above my pay-grade, but as a trader who has observed the recent record levels of complacency, I find myself more often than not searching for the “canary in the coalmine” so to speak.  As my partner at RiskReversal, CC likes to say, “we don’t get any bonus points for degree of difficulty” for our market calls or trade ideas.  However, it’s hard not to identify divergences and unappreciated warnings from those who should be “in the know” and not attempt to extrapolate a bit.

Here is one that seems to get little attention.  The Euro Stoxx Bank Index (SX7E) appears to be rolling over, down about 12.5% from the 52 week high in April, approaching its 2014 lows from early Jan and just yesterday closing below its 200 day moving avg for the first time almost a year:

Euro Stoxx Bank Index (SX7E) 1 yr chart from Bloomberg
Euro Stoxx Bank Index (SX7E) 1 yr chart from Bloomberg

On a longer term basis, the index’s apparent failure at MASSIVE technical resistance, the level that it broke down below during the European Sovereign Debt Crisis is 2011, is notable, and could be signaling more volatile times to come:

Euro Stoxx Bank Index (SX7E) 5 yr chart from Bloomberg
Euro Stoxx Bank Index (SX7E) 5 yr chart from Bloomberg

I know, I know, ECB head Mario Draghi will do “whatever it takes” to keep the Euro Ship afloat, but with risk assets where they are (hint UP) and investor complacency where it is (hint also UP) maybe it makes sense to listen for a sec to some veiled warnings about the disconnect between fundamentals and asset prices.