Stock Market to Become More Volatile Because of Europe

This week was a good one for stocks. The Dow was up almost 300 points on Wednesday and markets in Europe had powerful rallies as well. The action was technical in nature, being an oversold bounce. The problems in Europe that have been weighing on the market haven’t gone away and more selling will follow.

The major indices in the U.S. — the Dow Industrials, the S&P 500, the Nasdaq and the Russell 2000 — all hit and even fell below their 200-day moving averages on Monday after many days of selling. A bounce from this level should be expected. It is a common place traders view as a support level where they should start buying. After such a bounce, they usually start selling when prices get near the 50-day moving average.

Problems in Europe haven’t gone away. There is still an emerging credit crisis taking place there and it is only a matter of time before it boils over into global markets. Greece has its next election on June 17th and the anti-bailout parties are likely to gain further strength. Unemployment is 21.9% there and the GDP shrank 6.5% in the first quarter after falling 7.5% last year. Greece is in its fifth year of recession and there is no respite in sight. If it leaves the euro, it would be a major blow to German and French banks and the stability of the entire eurozone.

Spain is now potentially an even bigger problem. Its unemployment rate is 24.4% and its banking system is in serious trouble. Bankia, which was formed in 2010 by the merger of seven regional banks, claimed it had a 300 million euro profit in 2011, but it turned out that it actually had a 3 billion euro loss. Now the results of other Spanish banks are being questioned. Money is leaving Spain and on Tuesday the Treasury Minister stated that “at current rates, financial markets are off limits to Spain”. The 10-year bond auction went well on the 7th however with Spain paying a yield of 6.06% (rates were as high as 6.65% in late May). It is quite obvious that the ECB was behind the buying in one way or the other. The IMF has said that Spanish banks need an immediate cash injection of $50 billion.

Some bailout of Spanish banks should be expected soon. While the market may rally on this news, don’t assume that it will keep things stable for too long. Spain, which had the worst real estate bubble in the world, is still building empty houses and the debt for these non-productive assets is still piling up in its banks. Like Greece, Spain needs to restructure its economy. Bailouts will only work if this is done and so far there hasn’t been any movement in this direction. Consequently, investors should expect the markets will start to increasingly trade like they did during the last Credit Crisis in 2008.

Daryl Montgomery
Author: “Inflation Investing – A Guide for the 2010s”
Organizer, New York Investing meetup

http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.