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Is the “You Know What” Hitting the Fan?

 -- Published: Thursday, 9 July 2015 | Print  | Disqus 



Charts and commentary by David Chapman

26 Wellington Street East, Suite 900, Toronto, Ontario, M5E 1S2

Phone (416) 604-0533 or (toll free) 1-866-269-7773 , fax (416) 604-0557




The world it seems can no longer escape Greece. The newspapers and the internet are abuzz with comments and analysis about Greece. Greece appears poised to continue to dominate the headlines for at least the foreseeable future.  What happens in Greece could turn out to be an historical moment depending on how this ends. The reality is most likely there are no good endings, only bad choices. Negotiations between Greece and its creditors (known as the Troika – the EU, the ECB and the IMF) have sometimes degenerated into name-calling with the Greeks calling the Troika terrorists and some officials from the Troika calling the Greeks “tax evaders”. Others have referred to the Greeks as profligate and lazy. None of it is helpful in resolving the problem.


Trying to make sense of all of this is difficult for even the best of analysts. In 2008 the Greek government debt to GDP was estimated to be around 108%. Today it is estimated to be 177% and possibly higher. Greek government debt is estimated to be anywhere from €300 billion to €380 billion (that compares to the US and its $18.3 trillion debt; the interest alone on the debt at 2% is estimated at $366 billion). What happened in between was that the Troika loaned money to Greece to help them through the problems that in some respects stemmed from the financial collapse of 2008 but the funds rather than going to actually help Greece pull out of its deep recession was largely recycled to bail out primarily German and French banks. A severe austerity program was also implemented as it was in other indebted countries collectively known as the PIGS (Portugal, Italy, Greece and Spain) although other countries particularly in Eastern Europe also needed loan assistance and also saw austerity programs implemented.


Today Greece is facing at least 25% official unemployment and over 50% unemployment amongst the young 16-25 age group. Many young people and others who can are leaving Greece as they see little future there. The crisis has seen upwards of 5,000 suicides. Greece has been most likely in an economic depression for years given its economy has contracted by an estimated 25% since the financial crisis of 2008.


Greece has historically been a serial defaulter with defaults in 1826, 1843, 1860, 1893 and 1932. The demands of the Troika in order to receive more loans is to cut pensions further and implement further austerity measures in a country that has already been under severe austerity measures for years. The tax evasion problem is primarily due to Greece’s highly self-employed population that operates in the cash underground economy, and an oligarchy, particularly in shipping that have an entrenched tax advantage.


What is one to make of all of this? The “No” vote on July 5, 2015 seems to have tied the hands of the Greek government. They cannot accept the steep austerity program proposed by the Troika without possibly facing considerable civil unrest at home. The Troika, led by Germany, cannot give in as several other EU countries such as Italy and Spain could demand a similar deal. Italy’s debt is estimated at €2.7 trillion and Spain at €1.1 trillion. Irrespective the EU has prepared a plan in the event of a Grexit. German politicians have already noted that there is no question of writing off Greek debt, as it would not be accepted by the German pubic nor other Euro states who would demand equal treatment.  


If the Grexit does happen, it could be the equivalent of a financial earthquake. It is unknown as to what derivatives are attached to Greek debt nor what cross default clauses could be triggered in the event of a Greek default. Concern has been expressed about the German banks particularly Deutsche Bank one of the world’s largest derivative banks. Official statistics indicate there are about $700 trillion of derivatives outstanding but other statistics indicate it could be as high as $1.4 quadrillion. With Greek debt estimated at €300 to €380 billion, the ECB, the IMF, the EU and some banks could absorb a significant write-down. It is estimated that losses for a number of Euro countries could be the equivalent of 3-4% of GDP. Germany apparently holds roughly €95 billion of Greek debt.


The Greek banks are also on the verge of collapse but here it may be the deposit holders who pay – the bail-in as it is known. By comparison, the Lehman Brothers collapse of 2008 was considerably smaller despite the $700 billion “TARP” program from the Fed to bail out the financial system. If Greece were to move back to the drachma the currency could most likely face at least a 50% devaluation to the Euro. That would make imports more expensive and could unleash a wave of inflation. As well, Greece could face considerable civil unrest. Given Greece’s history with military juntas, some have speculated it could happen again although that would be unheard of in supposedly democratic Europe.  


The real fear is contagion as a Grexit could encourage other anti-EU parties that are rising to prominence in a number of countries. Great Britain is facing a referendum on its membership in the EU although Britain does not use the Euro. In Spain, an anti-EU party could win upcoming elections. In France, an anti-EU party is leading the polls. The same is true in Austria and in other countries as well. Many believe that contagion is the real danger as opposed to the collapse of the Greek economy itself. Greece only represents about 2% of the Euro economy. But Italy as an example represents roughly 11% of the Euro economy. Already Spain, Italy and others have seen yields on their bonds rise sharply because of the uncertainty surrounding Greece. That is not a positive sign.


The chart of the Global FTSE Greece 20 ETF (GREK-NASDAQ) is not encouraging. GREK recently gapped down on huge volume, not a positive sign. GREK is down 55% in the past year and appears poised to fall further to potential objectives down to $6.75. Indicators are pointed down and have considerable room to move lower. The chart of GREK seems to be suggesting that the pain is not over for Greece just yet.


While Greece is dominating the headlines, the real story may be China. The Chinese stock market appears now to be in full panic mode. The Shanghai Stock Exchange (SSEC) has fallen 32% in the past month. This was a market built on leverage and the participants are primarily small players using margin to pursue dreams that appear to be busting. It is expected that few participants have the capacity to meet margin calls.


The Chinese have intervened in the market but except for a bounce the market turned and plunged to new lows. Intervention has manifested itself by the cutting of reserve requirements, interest rate cuts, easing regulations on margin financing (not a particularly wise idea) and providing liquidity to the financial system. As well, the Chinese halted many names or placed restrictions on selling just to try to contain the collapse. Using artificial means to try to halt a stock market collapse is most likely to end in failure although it could result in some temporary strong short-term rebounds.


If government intervention were a panacea then one would expect the economies of the US, Japan and the EU to be booming. Instead, they are muddling along at best. Japan never seems to be able to get out of its rolling recessions. Greece and numerous other countries that are overburdened with debt bedevil the Euro zone. Six years after the financial crisis of 2008, the Canadian economy appears to be sliding back into recession despite the positive pronouncements of the Finance Minister. The US appears to be improving but job growth has mostly been part-time positions and the headline unemployment rate has been falling because of fewer people in the labour force not because more people are working. Capital inflows into the US$ have helped the US stock market.


The Chinese economy has been slowing. Statistics are suggesting that the real rate of growth of the Chinese economy could be down to 3.5%. China’s economic growth since the financial crisis of 2008 has been created on leverage as the Chinese Shadow Banking system has seen growth of $17 trillion in loans while the economy as a whole has grown by only $4 trillion. That is a difficult number to square given it has taken $4 of debt to create $1 of GDP. Growth built on a mountain is ultimately unsustainable as eventually there are limits to how much one can borrow.


Here is the SSEC in meltdown form. There is still support down to 3,280 but below that, it is a long drop to the four-year MA near 2,500. Weekly indicators still have further to fall before becoming oversold. Indicators are not displaying any positive divergences that indicate that a bottom is forming. However, at the recent highs there were a number of negative divergences in the indicators. A rebound could occur at any time but the suspicion here is that the meltdown is far from finished especially given the high level of leverage that was propping up the market.


(Chart is on the next page)




If there is anything that might be signalling a global slowdown it is copper. Copper is one of the key barometers for global economic growth. Copper has fallen from a high of $2.95 back in May 2015 (coinciding with stock market tops) and has since fallen about 16%. But a note of encouragement. On July 8, 2015, copper made a new low for its move then reversed and closed higher. The breakout point is near $2.60. Copper may be forming a descending wedge triangle, which if correct is bullish once copper turns up. Reality, however, might be that copper needs more work before a final bottom is found. The current low is at $2.38.





The events of July 8, 2015 when the NYSE was shut down due to a software glitch maybe the worst sign of all. Seems that the NYSE was not the only one shutdown as United Airlines (UAL-NYSE) was grounded worldwide for hours and apparently, the Wall Street Journal experienced considerable problems with its website. No word that a hacker caused the problems but the ability to conduct financial warfare by shutting down financial systems is possible. That didn’t stop the stock markets from falling and the Dow Jones Industrials (DJI) closed down 261 points on the day. The S&P 500 closed under its first critical support zone of 2,050. The 200-day MA was at 2,055 and the S&P 500 closed under that level. The next critical support is at 1,980 to 2,000 although the 200-day MA could provide some ongoing short term support. 


The pattern of a drop followed by feeble attempts to regain the upside followed once again by a sharp drop suggests that the S&P 500 could be entering a bear market. The S&P 500 is still only down about 4% so it is a long way from officially entering a bear market. However, the ascending wedge triangle that formed between October 2014 and the highs of May 2015 suggests a possible return to the October 2014 low near 1,820. That would be a drop of about 15%.




So far the stock markets are demonstrating classic bear market action. Following drops there is considerable buying, which suggests that a “buy the dip” mentality might be prevailing. But a break of 1,980- 2,000 could crack the market and given the high level of margin debt holding up the NYSE the market could quickly become unravelled just like China.


Greece will remain in the headlines. More deadlines are due this weekend. But Greece is not the only country moving into default. Puerto Rico appears to be on the verge of default and Ukraine could default this month as well. There could be others if any domino effect got underway. As the saying goes, the “stuff” is just beginning to hit the fan. Maybe it is not surprising then that I am seeing stories of “don’t worry” the market will rebound. Denial is often prevalent in the early stages of the “stuff”  hitting the fan.  


Copyright 2015 All rights reserved David Chapman


General Disclosures

The information and opinions contained in this report were prepared by Industrial Alliance Securities Inc. (‘IA Securities’). IA Securities is subsidiary of Industrial Alliance Insurance and Financial Services Inc. (‘Industrial Alliance’). Industrial Alliance is a TSX Exchange listed company and as such, IA Securities is an affiliate of Industrial Alliance. The opinions, estimates and projections contained in this report are those of IA Securities as of the date of this report and are subject to change without notice. IA Securities endeavours to ensure that the contents have been compiled or derived from sources that we believe to be reliable and contain information and opinions that are accurate and complete. However, IA Securities makes no representations or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this report or its contents. Information may be available to IA Securities that is not reflected in this report. This report is not to be construed as an offer or solicitation to buy or sell any security. The reader should not rely solely on this report in evaluating whether or not to buy or sell securities of the subject company.



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