Four weeks ago I discussed the quickly deteriorating macroeconomic picture, both in the U.S. and internationally. Since then the outlook has corroded more.
Especially noteworthy: Interest-rate spreads for the European PIIGS countries are widening and consequently credit-default swap spreads for major U.S. banks are on the rise.
This can further hurt struggling U.S. financial institutions that have sold credit default swaps on roughly half of the PIIGS-threatened debt. So if the PIIGS default, these U.S. banks are on the hook for 50 percent of the resulting losses.
What’s more, during the past few weeks there has been a broad-based change for the worse in nearly all forward looking U.S. economic indicators. They haven’t reached levels clearly indicating another recession, but they aren’t far off. A relatively minor tick to the downside would generate a clear recession warning.
And with the housing market slipping again, the job market getting weaker, and the U.S. consumer in a funk it’s certainly not farfetched to expect this follow through.
Historically every recession has been accompanied by a severe bear market in stocks. But not every bear market was associated with a recession. There have been vicious bears without a shrinking economy. The 1987 stock market crash is certainly an impressive example.
So even if the economy avoided another full blown recession, which I doubt, the stock market could still face some serious trouble — which I expect.
Two weeks ago I discussed the technical deterioration of the stock market, which leads the economy both on the way up and down. I mentioned the failed breakout attempt of late April, the broken uptrend line, and the outstanding weakness of the banking sector.
And now there are …
More Signs of Weakness!
Most remarkably, the current correction is very broad based. We have seen ominous breakdowns in risk-sensitive sectors like small cap stocks, emerging markets, and commodities.
Despite oversold readings of short-term momentum indicators the market did not muster the strength for at least a short-term rally. This was especially noticeable when the S&P 500 cut through the 1,300 support level.
This behavior is a typical sign of weakness. When short-term support suddenly fails to act as a springboard to launch a rally, the market’s character has clearly changed. The bullish forces have weakened, and the bears have gathered strength.
Plus …
NYSE Margin Debt
near Record Highs
Historically, margin debt has been a clear contrarian indicator. It has been very helpful in spotting major tops, when speculation using credit was widespread. The most famous example being the 1929 stock market bubble top, when buying stock on 10 percent margin had become a national pastime.
But modern stock market tops have also been accompanied by spikes in margin debt:
- The 1987 market crash was heralded by margin debt reaching a very high 1.8 percent of total market cap.
- The 2000 bubble high also saw a spike in margin debt to 1.6 percent.
- Then came the 2007 top with margin debt all the way up to 2.3 percent. During the ensuing bear market margin debt declined, but not by much.
Here we are today with margin debt again at 2.3 percent of stock market cap, back to where it was at the 2007 high!
This development is a strong indication for another major market top in the making. Its message fits perfectly with another historically very successful contrarian indicator — mutual fund cash levels.
Yes, there are very successful mutual fund managers. But as a group they are as prone to herding as anyone. And their track record is clear: When they were mostly fully invested it was a bad time to be in stocks.
Most recent readings show they’ve been holding record low cash levels of 3.4 percent for two consecutive months. That indeed tells me that this is not a good time to be invested in stocks.
And if you’re looking to profit from falling stock prices, you might consider inverse ETFs, like ProShares Short S&P500 (symbol SH), that are designed rise as the market falls. For SH, stick to a price range of $41.50-$42.50.
Best wishes,
Claus
P.S. If you want to learn more about how to protect your investments and profit, watch our special presentation.
{ 6 comments }
So, our friends in the banking world, the insurance world, and Wall Street STILL have not learned their leson, and continue to indulge in the lucrative and utterly nonsensensical pseudo-product called credit default swaps.
If this is indeed the case, the economies that have not prohibited this sort of Vegas Keno play masquerading as a hedge deserve everythng they get, or lose.
Since these financial tar pits are still legal and available everywhere, we ALL get what they deserve, not just the buyers and sellers of these White Elephants.
Markets are designed to raise capital and distribute commodities. Whenever the players lose sight of these two primary functions, and focus on squeezing the lifeblood, in the form of profit-taking, out of the marketplace, every real investor, as opposed to the Traders, suffers, and, eventually, all the Golden Geese stop laying. There never where any Golden Eggs to begin with, and that’s why they are so prone to evaporation. There are only slow and steady returns from profitable companies who serve their economies with vital goods and services.
Unfortunately, investment banking and insurance seem to be less and less vital, and more and more part of the Too Big to Fail, Too Small to be Regulated problem.
MBB
Why are US banks on the hook for debt lent to Greece. Then the ordinary taxpayers in the US are on the hook for the US banks to bail out the too big to fails. No one will spend any money or have any confidence in the US until these nitwit bankers are brought to justice. Why are they not lending the money instead to small business. The system is just corrupt.
Who are the U.S. financial institutions that have sold credit default swaps on roughly half of the PIIGS-threatened debt and are on the hook for 50 percent of the resulting losses .
How much is each on the hook for?
I find WEISS to be very knowledgeable and realistic as to finance and economic analysis. I believe they are overflowing with subscribers.
Claus, great article and always look forward to your wisdom. Would appreciate if you would answer my question from June 15 on who the US banks are & how much could each lose.
Thank you.
Miss your market thoughts and observations, hope your absence is not due to health reason. Hope you will return to the Weiss Group with your market thoughts