By MoneyMorning.com.au
“U.S. stocks slumped, driving the Standard & Poor’s 500 Index to its biggest decline since August, amid concern that European leaders may be unable to keep the euro zone intact as Italian yields surged to a record.” – Bloomberg News
Clearly the investors who sold down the U.S. market 3.67% overnight aren’t Money Morning readers.
Because if they were, Europe’s problems wouldn’t be a surprise.
The same goes for most Aussie investors who are running for the exit this morning… pushing the S&P/ASX 200 down 3% at the open.
But the big news overnight was the Italian 10-year bonds. Yields reached the highest level since the creation of the euro currency in 1999. The cost for Italy to issue debt is now 7.25%.
The chart below shows the six-month progress of the Italian 10-year bond. The red square is where the yield stands after last night’s move:
But don’t panic. European leaders are still trying to come up with a plan… oh, hang on, maybe you should panic.
Let’s show you why…
So you can see why Italy’s yield action could be just the beginning of its problems. Take a look at the chart below of Greek 10-year bonds:
Those bond yields hit 7% in April 2010.
A few weeks later, after bond yields had soared above 10%, the market cheered. The Independent newspaper reported:
“Global markets surged in relief yesterday at the €720bn (£616bn) Eurozone stabilisation package put together to allay fears of contagion from the Greek sovereign debt crisis…
“Greek 10-year bond yields fell by 499 basis points [4.99 percentage points] and two-year yields fell by a record 1,327 basis points [13.27 percentage points] as panic about the restructuring deal receded.”
The joy didn’t last long. Nineteen months later and the Greek 10-year bond yield hit 30%… and two-year bond yields are now 107%! So much for the “Eurozone stabilisation package”.
Which brings us back to yesterday’s Money Morning:
“The markets love the latest non-event from Italy. But the excitement will soon wear off and the market will fall. Then we’ll get another non-event… which the market will love… until that wears off too.”
We’ll repeat: the market is so volatile you can’t just pin your flag to the bullish or bearish side of the market…
You’ve got to play both sides.
Let’s get something straight. Of course Italy will need a bailout…
The only thing that’s not certain is how they’ll do it…
Will it be a Greek-style default? Or will it be U.S.-style money printing? It’s the difference between being honest (default) or deceitful (money printing)…
Put another way, will they stab investors in the chest or in the back?
Neither is pleasant. But at least you’ve got a better chance of defending yourself if you know what’s coming.
It’s also important to remember the real criminals in this – governments, central banks, bankers and progressives – will look for a scapegoat to shift the blame.
Rather than admit the European debt problem is due to failed economic, financial and political systems, they’ll pin the blame on so-called bond vigilantes.
This is a term for investors who look to profit from falling bond prices. They’ll claim nations are being punished by bond traders who unfairly push bond yields too high by selling or short selling bonds.
(When bond prices go up, bond yields go down and vice versa.)
In reality, bond traders are just taking a position in the market. And don’t forget, for every seller, there’s a buyer.
What’s more, short-sellers provide a useful service to the market. They warn other investors of potential problems. Using Greece as an example again, in early 2010 commentators and investors pinned Greece’s debt problem on bond vigilantes.
At the time, Greek finance minister, George Papaconstantinou told a press conference:
“A number of people have been betting in certain ways [on a Greek default and debt restructuring]. All I can say is they will lose their shirts. I want to categorically restate that any notion of restructuring is off the table for the Greek government.”
He was right. Some short-term traders probably did lose their shirts. Business Insider noted at the time, “Greece’s ten year bond yield has collapsed a remarkable 47% to 6.6% from 12.4% (as bonds surged) just before Europe’s new bailout fund was announced…”
But the traders who kept short-selling Greek debt gained a whole new wardrobe. As the chart before shows it didn’t take long for yields to climb. And short sellers could have pocketed a 354% plus gain as Greek bond prices collapsed.
Could the same happen to Italy?
It’s possible. The consensus is Italy’s debt is too big to be bailed out… and it’s probably too big for a Greek-style restructuring.
That tells us you’re more likely to see something underhanded (a stab in the back for investors). But, as always, we’re not saying Italian bond yields will keep climbing in a straight line from here.
As with Greece, we’re sure European leaders will give investors plenty of false hope. Just make sure you don’t fall for the spin.
Because, if you only buy stocks because you think they look cheap, you’re taking a much bigger risk than investors who supplement their buying by selling and short selling stocks.
The market rallied recently because investors foolishly thought European politicians and bureaucrats could solve the problem. As we’ve said all along, the very involvement of politicians and bureaucrats is a sure sign the problem won’t be solved…
In fact, it’s only likely to get worse.
Cheers.
Kris.
P.S. If you didn’t watch it yesterday, don’t forget to check out Slipstream Trader, Murray Dawes’ latest free weekly video update. You can click here to get the Slipstream Trader YouTube channel now.
In the latest episode Murray talks about the market’s key levels of price support and resistance. And how what’s happening now has a familiar ring to it.