Markets are initially soothed this week as bulls rejoice after Cyprus found a solution to its recent problems. Larger depositors will have to take a bigger hit than smaller ones and the smaller ones will get the guarantee they had been promised.
By Bill Fleckenstein
March 29, 2013
Markets were initially soothed this week as bulls rejoiced over Cyprus finding a "solution" to its recent problems.
I suppose in a way that's true, but the differences between this week and the previous one are simply the institution of capital controls and the fact that larger depositors will take a big hit and smaller ones will get the guarantee they had been promised.
Thus, there was a bit of good news (along with the bad) in this decision, even if the consequences are liable to lead to plenty of trouble.
In fact, there is a lot we just don't know about what may occur, as my anonymous friend, whom I refer to as the Lord of the Dark Matter, pointed out about a week ago:
"How does the monetary transmission mechanism work across the eurozone in an environment of capital controls?" he asked. "How can any eurozone policymaker now claim, with a straight face, that a euro in one part of the eurozone is worth the same as a euro in a different part of the eurozone? (Or) going forward, why should there not be a tremendous risk premium in senior unsecured bank debt across the eurozone?"
Those are just a few of the more obvious questions.
Many details and knock-on effects will need to be sorted out, but because there haven't yet been meaningful perturbations in world equity or bond markets, nearly everyone has assumed that all is well.
Today's undervalued pick: Risk analysis
In rebuttal to that (non)thought, the LODM really hit the nail on the head -- about the nature of the market's response to both Cyprus and other negative events in general -- with his comments on how they are essentially forced to conclude everything will work out, thanks to the flood of money-printing by the world's central banks.
In his words, "You assume everything will be fine, right up until it is not."
He also pointed out that when Lehman Brothers defaulted in 2008, the Standard & Poor's 500 Index ($INX -0.59%) closed out the week marginally higher, because it took a while for the market to realize the consequences of the default, as well as other cascading problems.
The moral of the story is that -- in an era when assets are levitated by central banks printing absurd amounts of money, monetizing government debts and spewing out liquidity -- markets don't discount much or analyze events very well (which is a point I have made often, but never summed it up as succinctly as I believe he did).
As this week wore on, however, it became clear that Cyprus is starting to matter. European markets lost around 1% midweek and, more importantly, debt markets in Italy, Spain and Portugal began leaking, and bank stocks in Europe were put under pressure.
You don't have to be much of a student of the European Union's financial plumbing to understand that the potential for a decent amount of chaos is quite high.
Still room for improvement
Of course, the platitudes being mouthed by U.S. stock market bulls that Cyprus was "contained" and/or immaterial were laughable from the outset, and those comments only demonstrated the bulls' complete lack of understanding of how the financial system, economies, markets and psychology are intertwined.
This is why they don't realize that this year’ sstock market rally has had nothing to do with things getting better and everything to do with people's willingness to believe all is well (or about to be), thanks to money-printing levitating the markets.
I would not be surprised to see the market get considerably weaker as we head into and through earnings season. I can't imagine that's going to be very pretty. And given the amount of "hope-ium" that has been consumed by so many, the potential for momentum building on the downside is quite high.
I haven't done anything on the short side, but I am debating with myself if and when I should test those waters.
Waiting on a trend
I know that for some time now gold and silver have been unresponsive to what has been a very positive set of fundamentals. But I don't think you could have designed an environment more conducive to precious metals, with all the world's central banks, save for the European Central Bank, printing at warp speed. And now that confidence about the banking system, at least in Europe, has been broken, ECB President Mario Draghi almost certainly will unleash his printing press.
A combination of the loss of confidence, potential bank/government debt problems and worldwide money-printing is the perfect recipe for a wild ride in the metals. I don't know when that will start, but it will.
To conclude on the subject of Cyprus and Europe, the LODM this week sent a short and sweet follow-up email that brilliantly summed up the situation:
"From this week onwards, investment committees and risk managers at many of the world's largest pools of capital and let's not forget corporate treasurers will be convening to carefully reconsider their exposure. . . . In other words, there is a non-negligible risk that what has thus far been a steady drip of repositioning and reconsideration of exposure above the deposit insurance limit turns into a torrent."
On the air
My latest interview with Eric King of King World News is now available. In it I cover the situation in Cyprus and Europe, and the prospective implications for the psychology variables of trust and confidence.
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