Debt Bomb Explodes in Italy
The market surged yesterday. And more importantly, the bulls can claim three victories: another defense of 1250, bank stocks outperformed the market and the dollar declined. Now if only those pesky, risky, growth companies (small caps) would get some investor attention, this market could really soar.
Yesterday's move was another building block to the bullish trend that started in October. And I should be looking to add to my bullish exposure.
Two things kept me out of the market yesterday (well three, my limit order for SKUL, RJET and AVL didn't fill) But the two major reasons I stayed clear of chasing yesterday's move both involve Italy, and I didn't view either as bullish.
Yesterday the market rallied following the news that Silvio Berlusconi, current Italian prime minister, would resign. I claim to know very little about this world. But one thing I do know is that leaders and politicians don't surrender power easily. I'm not going to make today's content a psychology lesson, but people that are used to holding a position of power will become attached to their own perceived superiority. So when someone in a position of power, be it politician, lawman, or CEO, steps down, something nasty is likely going on behind the scenes.
It's an old rule of thumb in stock investing: when a CEO resigns (unexpectedly) sell the stock. Just ask investors of First Solar (Nasdaq: FSLR) how detrimental a CEO resignation can be to stock price.
While prime minister isn't the same occupation as CEO, it's essentially the politician equivalent. And if we follow the same rule, we should "sell" Italy.
In the investment world, countries really aren't readily in a position to be bought or sold. But the debt of the countries is readily available for purchase. And when a country is expected to underperform, like Italy, the cost of capital increases.
Yesterday I mentioned the biggest thing to watch this week was the price of Italian bonds: "One big number to monitor [this week] is the yield on Italian bonds. Yesterday [Monday] the yield rose to 6.6%, which is 0.4% away from the panic number. Another quick rise in yield could get the bears back into Europe, which sinks bank stocks and euro, overnight."
Initially stocks rose following the potential resignation of Prime Minister Silvio Berlusconi. But I viewed that as a negative. And today, belatedly, so did the market. Rates on Italian bonds surged to new highs. The rate on the 30 and 10 year bonds is the highest its been since the euro union formed. And the five year rate rose to over 7.5% overnight and the heavily monitored ten year rate is 7.2%.
The selling should ease over the next few days. But the increase in yield will make it hard to obtain cheap debt, which also impacts the ability to pay current bills. And bond investors, who were already gone when the news was announced yesterday because the bond market closes earlier than the equity market, are doing this morning exactly the opposite of what the market did yesterday, selling.
The euro has gotten crushed, and is down over 1% this morning. More importantly, it is below the $1.37 must hold support level, which could mean this decline will last for another week or so, and head much lower.
The price weakness will not be contained to just debt and forex either, stocks will also be crushed. The indices have pushed lower at the open. But if I see signs of equilibrium midday, get ready for a buy alert because the U.S. is not highly exposed to the catastrophes in Italy.
