Mario Draghi Keeps Playing His Monetary Fiddle While Euro-Banks Burn

Market Roundup Dow 15,882.48 (+115.74) S&P 1,868.99 (+9.66) NASDAQ 4,472.06 (+0.37) 10-YR Yield 2.02% (+0.04) Gold $1,101.60 (-$4.60) Oil $29.80 (+$1.45)

In July 2012, European Central Bank President Mario Draghi said he would do “whatever it takes” to save the euro and the European economy. That sparked a massive rally in asset markets around the world, one that persisted for a couple of years.

This morning, Draghi was at it again. He said there are “no limits” to what the ECB can or will do to recapture that asset inflation magic, strongly implying even more action will be taken at the ECB’s next policy meeting in early March.

But as this Wall Street Journal story notes, Euro-QE isn’t working. Inflation is falling worldwide and stocks and risky bond prices are plunging.

That’s because investors are finally accepting the harsh reality/inherent paradox I’ve been talking about for more than a year: If QE and negative interest rates actually worked, the global economy wouldn’t need more doses of it every few months! It would be fixed and growing like mad. The fact it isn’t tells you everything you need to know.

More talk from the ECB chief – will it work over the long run?

But while Draghi keeps playing his monetary fiddle, hoping investors will dance to his tune for more than a few hours or days, the real, underlying rot in the European banking system is going from bad to worse.

Take Italy. That “PIIGS” country’s banks are getting hammered mercilessly. Shares of the large firm Banca Monte dei Paschi di Siena plunged 22% yesterday, extending year-to-date losses to around 50%. A broader index that tracks a bundle of Italian banks has now lost a fifth of its value in 2016 — and it’s not even February!

The list of catalysts behind the losses is long indeed. Fears of depositor flight. Pressure from the ECB to increase loss provisions. News that bad loans in the Italian banking system surged to a high of 201 billion euros ($217 billion) recently.

Then there’s another of the “PIIGS” countries — Portugal. Investors are dumping debt issued by banks in that country once again. That’s because regulators are taking steps that imply bondholders will get whacked with bigger losses in the event of future bank restructurings or failures.

Even in “core” European nations, problems in the banking system are mounting. Germany’s Deutsche Bank (DB) warned late yesterday that it would lose 6.7 billion euros ($7.3 billion) for full-year 2015 as a result of legal and restructuring costs, plus lousy market conditions.

Revenue plunged 15% year-over-year in the fourth quarter alone, and analysts suggested DB may need to raise even more capital. The largest bank in Germany is already in the process of eliminating 35,000 jobs through layoffs and business divestitures. Things are so bad, the bank’s U.S.-traded American Depository Receipts (ADRs) just plunged below their bear market lows from 2009. That puts them at their lowest level since they were issued in 2001.

European banks outside the euro currency union are in bad shape, too. Switzerland’s Credit Suisse (CS) is in the midst of a massive overhaul, one that required raising more than $6 billion in new capital and worldwide restructuring actions. Its U.S.-traded shares just sank to their lowest since August 2012.

Then there’s the U.K.’s Barclays PLC (BCS), which just said it would slash 1,000 jobs and pare back operations around the world. It’s planning to close offices, exit investment banking, and jettison other businesses in countries and regions as far afield as Australia, Indonesia, Taiwan, Brazil, Thailand, Russia and North Africa. Its U.S. shares are trading at 41-month lows.

Given their massive asset bases, and their large market weightings, these European banks are a huge problem for European equity markets. They can and will put serious downward pressure on European averages, which in turn will continue to spill over into other foreign markets.

So first, make sure you don’t own any of these lousy European financial stocks. If you do, dump them on any oversold rally.

Second, stay away from diversified European ETFs until those underlying banking sector problems get fixed.

Third, consider doing what I do in my Interest Rate Speculator service — target vulnerable European and domestic stocks with investments that go up in value as equity prices fall. That strategy has led to multiple rounds of nice profits for several months now.

And above all, continue to view oversold bounces and short-term rallies in bear markets for what they are: Great opportunities to lighten exposure or buy new hedges at better prices.

So what do you think of Draghi’s latest salvo? Will his comments re-ignite animal spirits for longer than a couple hours or days? Or have investors gotten sick of all the talk, talk, talk and ineffective action? Do you own any European stocks, and if so, why? Do you think U.S. stocks are a better investment, or are stocks in general too risky here? Let me know what you’re thinking below.

Our Readers Speak

With all the turmoil out in oil, stocks and other assets, several of you were keen on sharing your thoughts about what is going on — and where we’re going next.

Reader Mike S. offered the following take on crude: “You can point the finger of decreasing oil prices at the Obama administration. They lifted sanctions on Iran, who now will start selling oil on the open market. With all this excess supply, oil has nowhere to go right now except one direction.”

Reader Henry J. had this to say about stocks: “In a bear market, buy inverse assets. This is a BEAR market! All the QE programs did was to put off the bear market that should have happened back in 2008. Too big to fail? Ha!”

Reader 151 picked up on that thread by saying: “You are absolutely right about QE delaying the carnage. It not only delays, it makes it worse by revving the economy up as high as possible prior to the inevitable fall. The economists at the Fed have never predicted a recession or a depression and their ‘fixes’ are anathema.”

One of the core problems with many of the world’s economies is a massive overhang of debt. Reader Donald L. opined on that issue by saying:

“Will someone please explain to me how all this debt, public and private, will be serviced without collapsing the entire economy? Do we have to wait until France, Puerto Rico and Illinois circle the drain before this problem is addressed? And please don’t tell me increased productivity. Even if we had a GDP growth rate equal to the Reagan years, the pain would be more than politicians could handle or the people would put up with.”

So what can you do to cope with this market environment? Reader $1,000 Gold said: “Now that the August S&P support levels have been broken, it’s obvious that the market is going to follow oil to a bottom. There are very strong support levels at $20 per barrel. Also, the supply and demand curve could reach a balance in the second quarter. So I’m holding what I bought in august and I will buy more at some point.”

Reader Chuck B. added: “Mike says buy on dips, sell on rips. In other words, trying to be an investor in this market is a losing game, since the dips are likely to be greater than the rips — always trending down until the bear market is finished.

“The only way to come out ahead is to trade. On the other hand, trading is a losing game for anyone without a beady eye and a fast draw. It is easy to get attached to a winning position until it suddenly turns into a loser.”

Thanks for all the comments. Some of the recent weakness in oil definitely stems from Iran’s re-entry into the market. Iran and Saudi Arabia are battling to see who can flood the market with the most oil, making it very hard for prices to stabilize.

As for stocks, you definitely can’t overstay your welcome in down markets. You have to use the oversold, relief rallies you get to unload vulnerable stocks and/or reload short positions before markets head even lower. Go back to 2007-09 and the bear market playbook that worked then.

Specifically, we would see periodic crescendo selloffs when some terrible economic report, or lender bankruptcy, or bank earnings disaster would strike. Then some government or central bank policymaker somewhere would announce some supposed “fix.”

That would cause a very sharp counter-trend rally, which would run out of gas fairly quickly. You could make a ton of money if you played your cards right. But you had to cast aside the bull market framework that you had been using for the half decade preceding the bursting of the housing bubble.

In other words, it’s a new market. That means you need a new way of thinking, and a new set of strategies to profit. I’ll continue to share mine with you each step of the way, so you can help protect and grow your wealth no matter what the market throws at you!

Any other pointers you’d like to share with your fellow investors? Then use the comment section below to weigh in.

Other Developments of the Day

China tried to shore up its money markets overnight, injected 400 billion yuan (about $61 billion) into the financial system. The move by the People’s Bank of China is designed to boost liquidity ahead of the annual Chinese New Year holiday, but also lower borrowing costs and shore up market confidence.

The Russian ruble was today’s emerging-market catastrophe currency, plunging more than 5% at one point to a fresh all-time low. One dollar now buys about 86 rubles, much more than the 50 or so last spring. Investors are worried that the economy’s outsized exposure to oil and gas production leaves Russia vulnerable to recession, massive budget deficits, and further future devaluation.

A massive winter storm is poised to sock the Mid-Atlantic and Eastern Seaboard states in the next two days. Cities like Washington and Baltimore are expected to get the worst of it, with up to two feet of snow. New York and Philadelphia could also see several inches of the white stuff.

Are you bundled up and ready for this winter storm? Or are you more worried about the financial storms wreaking havoc in China, Russia, and other foreign markets? What do you think of the latest round of layoffs from the banking, oil, and materials sectors? Will they put more pressure on the domestic and global economies? Speak up in the discussion section below.

Until next time,

Mike Larson