Why the Smart Money Is Running for Cover!

Dear #field8#,

Earlier this year, I wrote a Money and Markets piece titled “Social Unrest Setting the Stage for Sovereign Defaults.” We had already seen overthrows in Tunisia and Egypt, Libya was underway and other Middle East/North Africa flare ups were in the early stages.

In that February 26 column I laid out why a global movement could just be getting underway.

I said,

“… every step of the way through this global economic crisis the shocks have been thought to be contained. But they’ve proven time after time to be just the opposite: Contagious!”

That’s been the case with sovereign debt problems in Europe — once said to be contained and now known to be systemic. And it’s proving to be the case with public uprisings, too. It started in the Middle East, and now it continues to spread through Europe … as I said it would!

In Greece, protestors have turned violent, fighting to pressure parliament to reject more austerity demands from its euro-zone counterparts.

Spanish protestors have been in a month-long standoff, occupying a square in the capital of Madrid in what’s been called the Spanish Revolution. Last week, politicians in northeastern Spain were forced to enter parliament by helicopter or under police escort as protests grew against heavy cuts needed to slash its deficit.

The head of the biggest public sector union in the UK has announced it will be staging the biggest coordinated “action” in the history of the country, which could last months, to fight the job losses, tax hikes and benefit cuts.

As I’ve referenced many times here in Money and Markets, the most extensive study on historical global financial crises (by Harvard professor Kenneth Rogoff and University of Maryland professor Carmen Reinhart) shows us that fallout of widespread financial crises goes in four stages:

1. Surge in fiscal deficits,
2. Larger deficits turn into more debt,
3. Bloated debts = downgrades, and
4. Downgrades lead to sovereign debt defaults.

We’ve seen deficits grow in response to the financial crisis. We’ve seen debt levels explode. We’ve seen downgrades come one after another.

Anti-austerity protests across Europe could trigger the euro’s downfall.

The next step: Sovereign debt defaults.

And despite global politicians’ best efforts, it starts in Greece.

It’s become increasingly clear that the trigger of a sovereign debt default in Greece won’t be from a “line in the sand” drawn by European politicians. To the contrary, they have proven that they will continue to do anything and everything to put off the day of impact.

I believe the end game in this crisis will be when the PEOPLE fully exert their power and say “no more.”

That’s when they say to their rich euro-zone neighbors …

“Keep Your Money, Keep Your Austerity
Demands and Keep Your Euro!”

When that happens, the Greeks, the Irish, and the Portuguese can free themselves from the rule of their euro-zone constituents, regain their sovereignty, re-instate their own currency and begin to rebuild.

Expect this public uprising to be the case, not just for Greece, but for people around the world who have continued to suffer while politicians bailout institutions and dig deeper and deeper holes.

While such a scenario may, at least, serve as pieces to put the world on a path of sustainable recovery, the near-term consequences would likely be:

  A possible complete break-up of the euro, the second most widely held currency in the world,

  Another global financial crisis where banks fail and credit freezes (again),

  Return to recessions for many countries,

  And another round of chaotic activity in financial markets.

Consider this …

Since early May the key markets that have been most closely linked to global risk appetite have definitively changed directions. The S&P 500, crude oil, silver, the euro and the Australian dollar all posted major long-term reversal signals in May. So did the U.S. dollar. The signal: An “outside range” … a pattern consistent with predicting major turning points.

Meanwhile, yields on U.S. Treasuries have plunged.

Despite all of the efforts by world central banks to add money in the system to stimulate recovery, little of it has actually reached the real economy.

With global economies slowing, risks rising and government intervention exhausted, all of the above market activities indicate that the smart-money is broadly preparing for another global storm.

In fact …

They’re Running for Cover!

The chart below shows the relationship between the velocity of money — the frequency with which money changes hands — and the performance of global stocks. You can see the plunge in the global velocity of money (in red) and the corresponding effect it tends to have on global stocks historically (in gray).

From this chart, the next three-month change in global stocks, as measured by the gray line, is likely down — in the neighborhood of 10 percent or more.

The last few times money velocity plunged at this rate were episodes of peak uncertainty surrounding the financial crisis of 2007-2008, and the European sovereign debt crisis of 2010.

I can’t guarantee what will happen from here. But if we use history as our guide, expect extreme volatility around the corner.

Regards,

Bryan

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