Is the end near?

Do two consecutive good days in the markets mean the danger of a meltdown is past? Unfortunately, not. Stock prices in the US and Mexico are reacting to the 4-5% drops of last week (in dollars, the IPC lost 8.3%) and to the hope that the very real possibility of collapse will be the spur European leaders need to allow the European Central Bank to buy government debt. 


A report issued November 25 by Japan's Nomura Bank underlines just how dire the situation is. Analysts warned that “(T)he euro zone financial crisis has entered a far more dangerous phase.... a euro breakup now appears probable rather than possible" unless the European Central Bank comes to the rescue.

So, who cares?

The "Super Committee" that was supposed to deliver a deal to reduce the US deficit failed to reach agreement. Judging by level of interest rates on the 10 year US Treasury bill, not all investors are concerned: today's yield is 1.94%, even lower than when there was still hope that the Super Committee could fulfill its mission. Stocks took a beating, however.

What are investors concerned about? Europe and growth prospects.

When a liquidity problem becomes one of solvency...

Events in Europe are moving faster than imagined. On October 27, European leaders announced the breakthrough that had eluded them for so many months. They agreed on a loss-sharing formula with Greece's bankers and to two critical preventative measures, enlarging the rescue fund and raising capital standards for banks.

Just over two weeks later, the Greek and Italian leaders resigned in response to market pressure, spreads on French debt (over the equivalent German bonds) have widened to their highest level since the adoption of the Euro in 1999, and the fate of the Euro and the European Union are being seriously discussed.

Investors have seemingly become hyper-sensitive to risk, at least in Europe. A run on any country can abruptly convert a sustainable situation into one that is not. A self-fulfilling prophecy can turn a liquidity problem into one of solvency. That is the danger Italy and European banks are facing today.

Sovereign debts aren't European banks' only problem...

European banks have been much slower than US banks to write down the value of their US mortgage-related loan portfolios. Here's an interesting table from the Wall Street Journal:

Activos sospechosos

	Activos mercado de crédito	Deuda soberana
RBS	79.600 mill. de euros de euros	10.400 mill. de euros
HSBC	54.300	14.600
Deutsche Bank	51.900	12.800
ING	36.000	11.200
CRÉDIT AGRICOLE	28.200	16.700
SOCIETE GENERALE	27.500	18.300
COMMERZBANK	23.800	19.800
BARCLAYS	20.700	20.300
BNP PARIBAS	12.500	41.100
NATIXIS	9.300	8.500*
UniCredit	7.200	51.800

*Incluye Grecia, Irlanda, Italia, Portugal y España

Exposición soberana se refiere a la matriz de Natixis, Groupe EPCE
http://www.elnorte.com/WSJAmericas/articulo/657/1313701/default.asp?plazaconsulta=reforma&EsCobertura=true&DirCobertura=Suplementos/wsjamericas&TipoCob=2

The euphoria didn't last long...

Italy is under attack just twelve days after the announcement that European leaders had agreed on a new plan which included a 50% haircut on Greek sovereign bonds. Yields on Italian debt are heading towards 7%, the highest Italy has paid since adopting the Euro. 7% seems to be a magic line: once they crossed it, Portugal, Greece and Ireland found themselves forced into adjustment programs designed by the "troika" (European Commission, ECB, and IMF).

The ECB cut the European reference rate by 25 basis points (1/4%), to 1.25%, two days after Mario Draghi assumed the bank's presidency. The reduction is a major change in ECB policy and an implicit recognition of the fragility of Europe's economic situation. The ECB's decision raises the odds that Banxico will reduce the Mexican reference rate in the first half of next year.

Volatility will continue to be the defining characteristic of Mexican exchange and equity markets.

Surprised that the market for luxury goods is growing?

After seeing this graph based on US data, you won't be. It would be fascinating to see the breakdown for Mexico....

Source: http://krugman.blogs.nytimes.com/2011/11/03/inequality-trends-in-one-picture/?nl=opinion&emc=tyb2

The deal behind stocks' latest roller coaster ride

Europe’s leaders finalized a deal in the wee hours of October 27. It avoids a default by Greece, addresses banks’ capitalization and “ring fences” Italy and Spain against contagion. At least, that’s what it’s supposed to do.

Markets reacted with euphoria. Stock markets in the U.S. and Mexico staged strong rallies on the 27^th. The Dow soared 2.9% and the IPC, 8.1% in dollars. That day the cost of a dollar fell to its cheapest price in five weeks, a 2.2% appreciation.

Of what does the deal that awakened such hopes consist? First, investors holding Greek government bonds accepted a 50% reduction in the value of the bonds. Second, European authorities agreed that the core capital requirement for banks will be raised to 9%. Third, using leverage, governments will increase the size of the European Financial Stability Facility (ESFS) from the pre-agreement 440 billion Euros to 1.0 trillion. That should backstop Italy and Spain’s borrowing needs, preventing a run on those two countries. 

The “sugar high” didn’t last. Stocks pretty much held their own on the 28^th then, on the next and final trading day of the month, the 31^st, gave around 2 percentage points. 

Even so, October was a very good month in markets that hadn’t really seen a good month since the first quarter. In fact, October was one of Wall Street’s best months in years. The Dow’s 9.5% gain was its largest in nine years; the S&P 500’s 10.8% climb was its biggest since December 1991; the Nasdaq’s 11.1% jump was larger still, its best in thirteen months. The IPC did best, posting a hefty 13.0% gain in dollars in October.