The imminent insolvency of Cyprus has been averted and most commentary concentrates on the iniquity of seizing bank deposits or the forced shrinkage of Cyprus’ over-large banking system. Malta is similarly overbanked by the way, so watch out for unpleasant developments there too. Equity markets have rallied in the usual way when an obvious cataclysm is averted, just as they did when the Euro was ‘saved’ last summer. This latest ‘relief rally’ has been small, so far at least and there are reasons to think that it won’t travel far in many countries. The unity of the Euro has once again been maintained but there has been no resolution of the deeper problems that exist within the Eurozone. The stresses caused by differing productivity from country to country are already extreme and show no real sign of easing. To remedy the inequalities that result requires either massive ‘internal devaluations’ of perhaps 30% in the Mediterranean countries or continued transfer payments from the productive North to the unproductive South. Internal devaluations are the chosen route, together with continued loan support from the North. These are loans, not redistributive grants although it seems likely that write-offs will eventually transform such loans into outright gifts.
The prospect of enough real internal devaluation to restore competitiveness in Spain and others is faint as it is too painful to achieve. The productivity gap will continue and it results in a feedback loop that shrinks prosperity in an irreversible trend in the unproductive countries but tends to increase it in those that are already competitive - Germany and its near neighbours that comprise about 40% of Eurozone output. This divergence is the real result of adopting the Euro and it is an ongoing process not just a static situation, as some seem to think.
We write often on this subject because our study of feedback as we look for forces acting on markets means that we see things that conventional academic economists may miss.
This comes at a time when we have already seen multiple weekly-scale top extensions in various stock indices around the world. Not all have extended because not all have risen and now it makes sense to look for those that will be weakest when the current up-move ends and to select them to sell short. It may well be that US indices will reverse into down-moves from hereabouts – they have been rising and these are some of the markets that show daily and weekly extensions. It may be that Japan too and Austria will stall here but if equity markets are to falter it is predictable that those that will do worst are the Southern Europeans caught in this desperate trap. There is some confirming evidence from the European Central Bank, published in the Economist earlier this month. Lending to Spanish borrowers is shrinking even faster than other countries in the Eurozone and this is an obvious precursor of further economic gloom there:
We will continue to analyse each market and global territory in our customary way for those readers who have a particular interest in say China, the US or Germany. For those who have complete freedom to act, this would seem to be a good time to sell short equities in Greece (yes, still!) Spain, Italy and very probably France. We already have an outstanding short recommendation in Spain around 3% above current levels and we would hold on to that position and even add to it. The vexed question remains France - it has been trading almost exactly level with Germany for months, even though the situation there resembles other Mediterranean countries, not those of Northern Europe. It has even more potential to drop, but when will it crack? How about right now…?