And… now it’s crisis time.
How do you know? All you need to do is look at this…
That’s the yield on the two-year Italian bond, and its shape is scary. Anytime you see an asset change in value so violently – especially if it’s the yield on the sovereign bond of, say, the world’s ninth-largest economy – you know there’s trouble.
The Financial Times explains…
“Italy’s political crisis spooked international markets on Tuesday after its central bank chief warned that Rome was on the cusp of losing investors’ hard-won trust, sending European and US bank shares lower as traders gauged which lenders could weather a new eurozone storm.”
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Just last week, it was Argentina and Turkey. Barron’s explained last week…
“Stock markets in [Turkey and Argentina] have fallen more than 10%, and the currencies nearly 15%, over the past month. The drivers are common and familiar: high foreign debt, current account deficits, budget gaps, and inflation, against the backdrop of soaring oil-import costs and rising U.S. bond yields.”
And there’s more, of course. Bloomberg reported yesterday, “Asian equities slid Wednesday as concerns about the repercussions of Italy’s political turmoil and the renewal of trade tensions between the U.S. and China gripped financial markets.” (It shouldn’t be surprising that trade tensions haven’t faded away.)
And let’s not forget that the on-again, off-again summit between the U.S. and North Korea is one tweet away from being a full-blown crisis (again)… or any number of geopolitical risks.
Know this about financial crises… and “crises”
I’ve worked in markets in the midst of a lot of financial crises, from the so-called Tequila Crisis (Mexico, 1994) and the Asian crisis (1997), which morphed into the LCTM crisis… which triggered the Russian crisis. That crisis was known in Moscow as “the crisis” until 2008, when what a lot of people now call the global financial crisis (GFC) became “the crisis”… kind of like how the Great War later became known as World War I. Then of course there was the dot-com bubble… and the euro crisis…
And that’s just my personal history. Everyone has their own battle scars. My lessons from those, and what they mean for now…
Crises are like cockroaches… there’s never just one
Since everything is connected (see below), there’s never just one cockroach. If there’s one – one emerging market currency, one dodgy debt issuer, one market that’s collapsing – it’s not in a vacuum.
Everything is connected… EVERYTHING
When the yield on Italian bonds spikes (see graph above), it means that investors are selling Italian bonds. So they’re getting cash… and where is that cash going?
It flows into so-called safe haven assets… like the U.S. dollar, the Japanese yen, (sometimes) gold, and, above all else, U.S. Treasuries. The graph below shows the yield for U.S. 10-year Treasuries. (Just a few weeks ago markets were concerned about yields breaching the 3 percent level… and now they’re back down.)
If investors suddenly go “risk-off” – that is, they want out of assets that are perceived as higher risk – it’s like a rock tossed into a pond. The ripples reverberate through markets… what happens in Turkey or Italy makes investors nervous about their holdings in emerging markets, and junk bonds, and off-colour currencies. So they sell them. And that can have a series of unintended consequences that are more like a boulder in a puddle.
Europe is the crisis gift that will keep on giving
It was just a few years ago that Greece – an economy as big as that of the U.S. state of Kentucky, or two-thirds the size of Myanmar’s – kept world financial markets on edge. And what’s happening in Italy isn’t going to go away. A recent article in Bloomberg asked, “Is Italy the Next Greece?” (“Italy’s Nightmare Has No End In Sight,” answered a competing headline.) And as a quick Google search for the title will show you, it’s not a new question, either.
How bad could an Italian debt crisis be? Analysts at think tank Peterson Institute for International Economics – not an institution known for hyperbole – wrote that it “could be horrific.”
And it’s more than just Italy. Billionaire fund manager and social activist George Soros, in a recent speech, said, “The EU is in an existential crisis. Everything that could go wrong has gone wrong”, and that to fix it, the continent “needs to reinvent itself.”
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Look for the “tell”
In poker, a “tell” is a shift in a player’s demeanor or behaviour that can be a clue to his assessment of his hand. For example, “… players who look squarely into your eyes during a hand are conveying strength. Having a big hand often makes players more relaxed, and when they are more relaxed they are more likely to make eye contact than not. Players who are weak or bluffing are usually less comfortable about the situation, and won’t be so ready to look directly at you,” explains pokernews.com.
What’s the “tell” in markets? It’s when the price of an asset is moving in a way that doesn’t seem to fit with the rest of the market… until it does.
For example, the graph below shows the share price of Deutsche Bank.
As the rich grown-up in Europe’s room, Germany will bear the brunt of any eventual haircut or debt restructuring of Italian debt. And as the centerpiece of Germany’s financial system, Deutsche Bank will suffer mightily in this process. It was in trouble not long ago, and based on the current share price action, it’s in trouble again.
Will this be the crisis that triggers the long-awaited end of the bull market in stocks? Regardless, you should be ready… here are some ideas on how to prepare.
Publisher, Stansberry Churchouse Research