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Daily Archives: February 16, 2010

Market has changed direction

David Rosenberg looks at the market direction from its 120-day change.

It clearly shows the market peaked in last August, then went sideway until last December; from last December, the market has been trending down.

This bear market rally was so long that surprised every professional investor. Now it’s the time to reckon.

(click to enlarge)

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Europe’s shakiest to safest

Following my previous post on Ring of Fire, here is a chart from Economist Magazine that gives you an idea of which countries stand as the riskiest in Europe,  if debt crisis were to hit.

Why did Europe blink?

WSJ's analysis on Greece bailout:

Why did Europe blink?

The decision by European leaders to offer Greece support, albeit unspecified, likely owed more to fears for the weakened European banking system and its ability to supply credit to a fragile recovery than fraternal concern for a struggling neighbor.

Shares in euro-zone banks slumped as the sovereign-debt crisis unfolded, with Greek banks tumbling more than 50%. Aside from the political imperative for leaders to make a statement, the fear of contagion to the wider euro-zone economy was real.

Falling government-bond prices themselves aren't the biggest problem. Most European banks hold government bonds as available for sale assets, which means mark-to-market losses are recognized through the profit-and-loss account only when they become impaired. And although mark-to-market losses are recorded on the balance sheet as a reserve, it doesn't count under current Basel rules as a deduction against regulatory capital. If governments continue to pay their coupons and the bonds remain eligible for central-bank facilities, then bank capital or liquidity positions should be unaffected.

But there are several channels through which contagion can operate. Rising government-bond yields could push up yields on other assets, triggering mark-to-market losses on trading books. They also could lead to higher bank-funding costs, because bank credit-default swaps tend to track sovereign swaps. At the same time, fiscal tightening could tip economies back into recession, leading to higher bad-debt charges. If gross domestic product fell 1%, loan volumes fell 2%, nonperforming loans increased 5% and bond spreads widened, Credit Suisse estimates the European bank sector's 2010 earnings and return on equity would be nearly halved.

But European leaders likely also had their eye on an even bigger tail risk: That sovereign-debt fears could lead to a collapse in lending to vulnerable countries. The exposure of French banks to Portugal, Ireland, Italy, Greece and Spain is equivalent to 30% of GDP, according to Stephen Jen of Bluegold Capital Management. Irish and Portuguese banks also are heavily exposed to those countries. Austrian banks' exposure to Eastern Europe is equivalent to 54% of GDP. These linkages between banking systems are a potentially potent transmission mechanism, making it hard to put a fence around the Greek sovereign crisis.

No wonder European leaders felt unable to leave Greece to the mercy of the markets. But in offering support, they are merely following a familiar pattern established during the crisis of shifting responsibility for funding the global debt pile from credit markets to the banks, from banks to sovereigns and now from weak sovereigns to stronger ones. Once this transfer is complete, the debt pile really will have nowhere else to go.