15 December 2011 – European Debt Crisis

It feels good to be out of the markets. The European situation was driving my trading batty and I consider myself extremely lucky to end the year with a tiny, infinitesimally small gain (break-even, basically). With selling done, I’m definitely at the proverbial sleeping point now.

From a technical point of view, the PSEi has been going sideways since October 24, 2011. Since then, the composite index has trended between 4,200 – 4,400. As of yesterday’s end of trading, we’re at 4,285.93 which is almost right in the middle of the channel. We’ve been hereabouts since December 1. Tsupiteros are viewing this as the “eye of the storm”, with a potential big move up or down coming.

Europe remains at an impasse. Over the years, the Euro has bequeathed its stronger economies (e.g. Germany) the gift of added competitiveness (i.e. via lower exchange rates than without the Euro). On the other hand, weaker European nations (e.g. Greece) benefited from higher capital market liquidity and lower financing costs. These are different benefits.

To this day, the politics of these varying interests are driving the European debt crisis. For Germany, it is politically unpalatable to “bail out” its weaker neighbors. Thus, we see Chancellor Merkel’s unwavering insistence on stricter budget controls as the path to fiscal union. The European Central Bank (ECB), heavily influenced by Germany’s interests, has rejected calls for large scale bond buying, issuance of Euro bonds, and quantitative easing. These, along with the option of European debt guarantees, are believed by economists to be the best solutions to the crisis. Unfortunately, condoning such actions would seem to reward the spendthrift ways of Germany’s neighbors, ensuring the political demise of the ruling party. Thus, we have the essence of the impasse – Germany vs. other European nations.

For 2 years, Europe has successfully “kicked the can down the road”, approving inadequate half-measures while delaying the politically divisive hard decisions. However, with large quantities of European debt maturing between this month-end and throughout early 2012, capital markets have complicated the situation. Unsustainably high interest rates and low volumes of financing are threatening the financial viability of more and more European countries – Greece, Spain, Italy, Ireland, Portugal.

These events have gathered a lot of momentum. I think that, as is often the case in human history, it will take a disaster to unify European leaders. Europe will continue to muddle along without solving its key issues until something pops, perhaps one or more countries suddenly default. In the meantime, credit default swaps and refinancing costs will remain stubbornly high. In the words of Kathleen Gaffney of Loomis Sayles, Natixis Asset Management, “This is Lehmans. Take two. Cubed.”

These are what I’ve gathered over the course of the past few months, and are the basis of my opinion for sitting out the markets for now. I think the European risk outweighs the rewards of a possible Santa Claus rally. Just look at how the uncertainty is pummeling the Peso, despite the seasonally high remittances supporting it. At the end of the day, we trade our opinions of the market. These are mine. But I highly encourage all of you to do your own independent research and analysis of the markets. What’s best for my trading may not be what’s best for yours.

Happy Holidays, Traders!

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