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US-Europe Decoupling At All Time Record As SovX - Implied Correlation Spread Indicates Historic Domestic Complacency
In last night daily report by BofA's Jeffrey Rosenberg, one chart stands out: the spread between the 12 month S&P 500 top 50 Implied Correlation (generically a proxy of broad US equity risk) and the Sov X, or the blended sovereign risk as indicated by CDS, which recently hit an all time high. In a nutshell: the spread has never been bigger, confirming that US domestic complacency over all things European (and the continuing levitation in stocks) has reached unprecedented levels, as absolutely no fundamentals can stand in the path of the hedge fund levered beta year end rally. In other words the China-US fatally flawed "decoupling" of 2007 has been replaced with a decoupling between the US and Europe. This will also end in tears. And this is happening even as European markets are unraveling, and as the EURUSD is tumbling, guaranteeing a drop in both US exports and the top line for US MNCs. But why worry: as 58 year old Valerie Whelan yesterday summarized it best: "It's capitalism gone mad." Every move in risk assets higher is merely a bet that central bankers can kick the can down the road for one more day. Nothing else. That it is unsustainable is guaranteed. Willem Buiter makes the case all too clearly that Europe will go bankrupt soon. We expect someone to make the same argument about the US very soon, especially if China does in fact commence tightening, leaving the chairman no other choice than to open the liquidity floodgates in one last attempt to preserve the dying economic system, however, this time without the benefit of being able to export inflation to China.
The chart in question:
Rosenberg's comment:
Figure 1 shows that while sovereign credit risk in Europe earlier this year was associated with greater systemic risk (as judged by the implied correlation of S&P 500 top 50 constituent returns), the latest expansion in sovereign risk since mid-October has seen generally stable indications of systemic risk (albeit with some increases in recent days).
And while the US may pretend it can decouple from China and Europe, things in Europe, especially in the Sr-Sub Fin relationship continue to deteriorate (we will have more to say on this soon).
Longer than expected maturities for the Irish (and Greek) financing packages (7.5 years) were designed to alleviate restructuring concerns in the market - but both Irish and Greek sovereign CDS spreads actually widened on the day, as shown above in Figure 2. That suggests doubts in the market that the two countries have sufficient political willingness to make the required fiscal adjustments over a long period of time. The remaining peripheral countries (including now Belgium) underperformed while there was some spillover to the core as bailouts imply a transfer of credit risk from weak to strong economies. European senior bank CDS widened significantly led by Portuguese banks - despite the absence of haircuts for senior debt in the Irish bailout. Subordinated bank CDS underperformed as substantial haircuts will be taken by subordinated debt in the Irish bank bailout.
Also, as Zero Hedge pointed out recently, the IG-iTraxx spread has hit all time highs. BofA noticed. But ignore that, and note the ridicuous decoupling between the S&P and the Stoxx 50! (right chart)
And some last observations on why if the stock market falls now, it will likely result in the collapse of part or whole of Europe:
During the earlier episode of the sovereign crisis in April-June the Euro was in freefall and increasing dollar LIBOR rates indicated strains in the funding markets. This time Europe has funding mechanisms - such as the EFSM and the EFSF - in place to help contain the sovereign crisis within Europe. While the Euro has also declined in response to the sovereign crisis this time, the magnitude of declines so far is smaller, and additional factors such as geopolitical issues and stronger than expected US economic data have helped strengthen the USD against the EUR. For example, while the Euro has declined nearly 8% against the dollar since November 4th, the currency has declined only 3-4% against the JPY and GBP. Also, the recent widening in forward LIBOR-OIS spreads appears related more to increases in bank credit risk than expected renewed funding strains.
Decoupling was the big thesis in 2007. It worked... for a while... then it all came crashing down. The same thing is happening with Europe right now. And again, it will definitely end in tears when decoupling in an intimately interconnected world is once again proven to be a myth.
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They cant have it both ways- Tightly interconnected Global economy, and insulation from things global. Either one or the other, but cant have both.
Who says? With the Ben Bernank, all things are possible.
What are you talking about, Dog? This is the criminal syndicate known as Wall Street...and they can have it any way they like it. That is...just until ONE fund buys the street's daily move of naked short selling VIX futures into oblivion. And then...presto...you are suddenly correct.
But what are the odds of that happening?
Euro debt collapsing, "cloud" selling off, PEs on favorite algo stocks officially reaching RIDICULOUS, the fake oil move yesterday almost repealed...already....gold an absolute stud into dollar strength...Wall Street bonus orgy while it is rice and beans for Average Joe [with his home value in free fall again]...winter coming on.
What could go wrong?
Gold and lovely Silver just ripped
I beg to differ. If I hear one more time about the f$#%^@ing royal wedding I am going to vomit blood!
hey life goes on...there are people who like to hear about it...not everyone is interested on financial stuff - besides they dont have any money even if they wanted to...just my take.
You are too laid back for a Tuesday Arius! :)
I was just pointing out the mistake in the statement. With extreme prejudice!!
At least the UK fascination with the British Royals have more taste than our public fascinations .. see my comment below.
True, but the one thing I have noticed about TV story lines is the British probably produced it first. Where American TV just tends to regurgitate with 'flash and bang' old ideas.
"Footballers' Wives" comes to mind.
EFSF as an LLC to act as counter-party to ECB sovereign funding through its bond purchases. Oh ya, and extend the facility by another tril to handle Spain. Lovely! (making the whole idea of a 6bn lifeline from Foundation X laughable)
At least the fallacy of an implied zero risk weights such as those that are attributed to sovereign debt under Basil II or III are no longer appropriate, if the ever were, gets a passing nod. Thanks Wilem for striking the nail on the head. Tragic that a major underpinning of the current structure is predicated upon this very presumption. I wonder how Wilem will approach the conflict between solvency of the AE's and this major support for the structure, besides adding additional trillions to funding schemes and creating LLC's to aid the extend & pretend. Back to clipping the coin for sure.
Meanwhile Desperate Housewives of the Hampton's (DHoH) starts filming next week. Thank goodness since all of this other crap has become supremely boring.
This should put an end to the trustworthiness of business media headlines once and for all.
Bloomberg
European Stocks Advance as U.S. Confidence Gains 20 min ago
U.S. Stocks Fall on European Debt Concern 41 min ago
As much as I love Peter Schiff & I am making a generalized comment here, investing in Europe does not seem terribly appealing anymore. Not that Amerika is so much better, but you have to admit, his bet was that the first domino would be us, not Europa. He makes mistakes too.
If the Chi-Comms want to destroy western civilization, they need only jack their rates and save their missiles
OT: Google bans Alex Jones
http://www.infowars.com/google-blacklists-prison-planet-com/
Wouldn't a better comparison be between the DAX, off only 3.5% from its 2010 high, and the EURUSD off over 9%, indicating the export-focused Germans, the principal economic driver of the EU sector, are loving the euro sell off, without speding precious foreign reserves to dollar couple the post QE2 weakness? Perhaps that discorrelation is what is holding up US equities on a relative basis.
The Ted spread is shockingly calm considering the bond carnage that is going on in Europe. I think a Dec 7th vote by Ireland could wake up the funding markets.
http://www.bloomberg.com/apps/quote?ticker=.TEDSP:IND
In general, it appears people expect that bailouts will simply continue and markets will go up. The moment the word "default" gets reintroduced we will get some action.
"Ahhhh! You cursed brat! Look what you've done! I'm melting, melting! Ohhh, what a world! What a world! Who would have thought that some little girl like you could destroy my beautiful wickedness." -- Wicked Witch of the West
This quote just seems hauntingly appropriate right now.