I’m not Nostradamus, but one possibility that I am keeping on my radar in 2010 is a sovereign debt crisis. Handicapping the importance of news is difficult. What stories are pure fear mongering and what stories should we take seriously?
We’ve been reading about a debt crisis in Greece, Spain and Portugal for months. I wrote about it previously on December 9, 2009.
While I’m not an expert on handicapping the impact a sovereign default by Greece, Spain, Portugal or any combination thereof, I will say that the repetitive nature of the story gives me cause for concern. Many people tend to think that economic crisis occurs overnight, but the truth is it usually takes a long time to unravel (see “Discounting One Day Market Crashes”).
This sovereign debt story is starting to get my attention because it is becoming repetitive and it is showing up in the charts.
Note that EURUSD bottomed out at the March 2009 bottom and topped out in December 2009 when we first started hearing about the sovereign debt crisis. As I mentioned previously, the EURUSD pair is in bear mode which is not good for stocks.
We have to look no farther than August 2007 to illustrate an example of a story that jilted the market for a few days, hid itself for a while, but kept coming back like a bad cancer. This story was written pre-Lehman in August of 2008.
On August 9, 2007, it became clear that fear had paralyzed the world’s credit markets. The question was no longer only about the quality of assets or the availability of cash. Everything was suspect and no one was willing to take any chances.
Early that August morning in Paris, BNP Paribas announced that it was stopping investors from withdrawing money from three funds because it could not determine the market for their holdings.
"The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating," the bank said in a statement.Source: Portfolio by Jeffrey Cane, The Great Panic, August 8, 2008
So how do I evaluate this story? Well, back in December all of our US indexes were technically sound. Objective indicators such as moving averages were pointing up and the market was trading above its 50, 200 and 300 DMAs. In many cases, it was even trading above shorter term MAs. I’m not going to get spooked by a story when the technicals are solid.
It is now two months later, and the story is starting to repeat itself. The major US indexes have broken below their 50 DMAs and are clinging onto their 100 DMAs. Meanwhile, China stocks, which were the engine driving the market higher, are arguably in bear mode already. And I don’t think any technician could disagree that if it is not in bear mode, that it is on the precipice of falling into bear mode.
(A complex head and shoulders top with a throwback to the 200 DMA. Note the volume on the breakdown)
So as I try to figure out the themes in 2010, the potential for an event originating from Greece, Spain and Portugal (and perhaps Italy too) seems like a real possibility. Let’s watch and see if the story continues to repeat like the credit crisis story did after August 2007. Let’s watch EURUSD and other cues that might confirm the story.