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The Mounting Case For A New Bear Market

Published 03/04/2013, 12:40 AM
Updated 07/09/2023, 06:31 AM

It is ironic that right when most Bears where capitulating, a geopolitical event in a small country far away from the US started something that may potentially lead to the next Bear Market and actually trigger a global meltdown that could make the 2008 crisis look like a small correction.

First of all, we are not part of the bears bunch, we do not have a bias in that regard. We use quantitative methods to assess the probability of long/short trend changes and we do not care about the WHYs of the market volatility, we only care about the HOW MUCH, WHERE and WHEN.

However, what is happening currently in Italy (Europe) is a fundamental curveball that is too significant to be ignored.

As we explained in some of our latest Daily commentaries, the political instability in Europe (more precisely: in Italy) may lead to potentially catastrophic events, mostly because the new emerging political force of Italy (the M5S led by former comedian Beppe Grillo) has in its political agenda the 'restructuring' of the 2 trillion euros italian sovereign debt (read: default) and a 'referendum to let italians decide if they want to stay or not in the euro currency bloc' (read: exit).

In our view, the above facts lead to a simple conclusion: instability for markets in the next few months and potentially a serious global meltdown if Italy defaults on its debt and exits the euro currency bloc.

The main issue with this curveball in our view is that most global investors at this stage do not have a clear understanding of what is happening in Italy (we do, because we have a highly privileged observation point on it).

Last week Credit Suisse published a report analyzing the Italian situation, concluding that most probably, given the local elections results, the European Central Bank will end up deeply cutting euro interest rates and flooding the euro-system with long-term liquidity, following the Bernanke model (opposite to what German hawks wanted so far), to guarantee that Italy does not go into default.

Goldman Sachs' Jim O'Neill recently expressed a similar view, saying that what is happening now in Italy is 'exciting' and hopefully will push away the European austerity measures (wanted by Germany) that so far have badly hurt the European PIIGS, sending them into a recession spiral.

What is all the above telling us?

Very simple: the global banking gotha thinks that the Italian election outcome is actually paving the way for massive liquidity injections into the European financial system and this is seen as a positive event. To let you understand better their thinking: imagine that Occupy Wall Street has now become the first political party in the US and has a very large number of senators and representatives in Congress and the Senate and it's able to gridlock everything and the global bankers think that this will force Bernanke to ease more (assuming it was even possible) to improve the country's economy.

The main concern we have with the bankers' vision is this: what if Italy votes to exit from the euro currency bloc and go back to their local currency?

The bankers seem to miss that key point in their analysis: it is a big mistake, they are failing to understand the scope of the revolution that is happening in Italy (and also they fail to understand that it may spread to other European countries). If you think about the last crisis, 2008, most bank analysts completely missed and underestimated the magnitude of what was about to happen. This time they are failing to understand that Beppe Grillo and Italy are taking the same path as Iceland: they are chasing the "bankrupt yourself to recovery" model, praised also by Nobel laureate Paul Krugman. The problem lies in the scalability of that model: Iceland defaulted on 85 billions euros. Italy will default on > 2 trillions euros.

In conclusion, based on our current reading of the Italian/European political and economical crisis, we are sure that there is currently a huge risk looming on the entire global financial system: the risk that Italy leaves the euro bloc and defaults on its sovereign debt and if that happens the whole global financial system will crash very badly.

The purpose of this post is to make a case for a possible Bear Market in 2013-2014. Be prepared for the worst. However, we must also say that it is not possible to predict for sure if and when there will be an actual crisis (Mr. Bernanke showed us that systemic crisis may be artificially postponed for a long time).

Too many factors affect these type of crisis and the 2009-2012 Bull run should have taught several big lessons to all fundamental and technical analysts when it comes to market timing.

In conclusion, we think that a long-term bearish bias from here is justified, a Bear Market is possible (not sure, but possible) in the next 2 years and it may be a devastating one if Italy leaves the euro, defaults on its debt and if other euro PIIGS countries decide to follow that model.

In the next few weeks, keep an eye on the 'Italy vs. Europe' unfolding drama: that is the telltale that will show you the direction of the wind: according to some economists Italy is expected to become insolvent (unable to pay its debt and public workers) in no later than 6 months from now. Boom!

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When, Pharaoh-Buffett declares 20% gain in 2012 is not enough..................Is he expecting lean years in 2013-2014- !?!?!?
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