Last week’s action by the Bank of Japan to (apparently) steepen the yield curve had a major positive impact on global banking stocks. I remember watching the European open on Thursday evening; all the financials were sharply higher.
A few days later, and the greed has turned to fear.
Worries about the financial health of German behemoth Deutsche Bank rattled markets overnight. The Euro Stoxx 50 index fell nearly 2%. The Dow fell 166 points, or 0.91%, while the S&P 500 declined by 0.86%.
Bonds rallied on a rush into ‘safe haven’ assets, with the US 10-year yield down three basis points, to 1.58%. Oil reversed yesterday’s losses, and gold was up slightly.
But it’s not as if Deutsche Bank’s woes are new. The stock has been in trouble for some time. After peaking at over $50 per share at the start of 2014, the stock has been in free fall. Overnight, it broke down to new lows, falling another 7%, to $11.85, on the New York Stock Exchange.
The reason for the fall? Speculation the bank will need to raise capital. That’s what the headlines say, anyway. But anyone who knows Deutsche Bank knows that it has needed to raise capital for a while.
With each share price decline, however, this task seems harder and harder. Who is going to tip more money into an institution that is clearly on the precipice?
A bank doesn’t suffer that large a share price decline unless it is in real trouble. For example, the bank has shareholder equity of around €68 billion, yet its market cap is only €14.5 billion.
Does that mean it’s cheap because you’re buying the equity value for around 20 cents on the euro? Or does it mean the balance sheet equity is way overvalued? Looking at the ugly downtrend in the share price, I’d say it’s the latter.
The only good news is that Angela Merkel admitted over the weekend that the bank would have to be bailed out. Her admission wasn’t as overt as this, though. It came in the form of an official denial that Deutsche Bank would receive a bailout. But you know the rule. Don’t believe anything until you get an official denial.
Still, if Deutsche Bank is even suspected of teetering on the edge of bankruptcy, fear will spread throughout the rest of the banking system. It was this fear that brought the market down overnight.
But don’t get carried away and think this is another ‘Lehman Moment’. Deutsche has been the sick man of Europe for some time. It’s not as if this is fresh news. Sure, if the bank did have to be rescued, it would cause a fair amount of pain. But would it trigger another global credit crisis?
I doubt it.
But do I think it (or anything else) could cause a short term panic, and up to a 20% global market decline, in the next few months? Absolutely. I think the risks of such an event are high, especially if the Fed reiterates its tightening view in the weeks ahead, and if Trump continues to improve in the polls.
I’m keeping a close eye on the S&P 500, as shown in the chart below. It’s a little hard to see, but the index has all but given up the gains that followed last week’s Fed meeting. That rally was short, sharp, and ultimately feeble.
[Click to enlarge]
The important thing to watch for now is a break of the support lines, which I have drawn in green. If the lower support line gives way, that would suggest we could be in for some nasty downside action.
That could well coincide with some nasty presidential action. The debate between Clinton and Trump will probably be over by the time you read this. Apparently, it’s a big deal, and a strong showing by either candidate will give them a big boost in the lead up to the election.
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Trump is looking surprisingly good in the polls. Should he take office, it would be bad for Wall Street…and bad for stocks in general. If Clinton got in, on the other hand, it would be business as usual.
I could be completely wrong, but I have a nasty feeling that Trump could win this election. If this is what the polls show in the lead up to the November vote, the market will sell off sharply.
Currency markets are already moving ahead of today’s debate. From Bloomberg:
‘Traders have been piling up bearish positions as polls showed Democrat Hillary Clinton’s lead narrowing in recent weeks over Republican nominee Donald Trump, who has pledged to renegotiate the two-decade-old Nafta trade accord that turned Mexico into an export powerhouse. The currency is the worst performing in emerging markets over the past month, and Citigroup warned in a note to clients that it will fall further if voter surveys show Trump gaining more ground after tonight’s debate.’
So it’s shaping up as a potentially nasty time in the markets. Trump, the anti-establishment megalomaniac, is gaining momentum just as the Fed looks like it will finally pull the trigger on another interest rate rise.
That’s not a good combo for stocks. It’s time to be wary.
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