Shells and Contagions


With stock markets worldwide resting on important support, all eyes are on Greece in a bid to gauge whether those supports will hold.

The ECB continues to run around giving new meaning to the phrase “rearranging deck chairs on the Titanic”.

The eternal political game of kicking the can down the road will not end until the market eventually kicks back. And when it does it will be a mighty wallop.

I think nearly everyone, bar European Central Bank (ECB) president Jean-Claude Trichet, is resigned to the fact that Greece is going to default. The only question is what form that default will take.

The fact is that this ‘Vienna’ solution of coaxing investors to roll over their Greek debt ‘voluntarily’ may still be seen by S&P as a default.

According to a Reuters article, S&P’s Moritz Kraemer told Die Welt that ‘past experience show that restructuring the debt of a country, whose creditworthiness is rated at CCC like Greece is currently, tend not to be voluntary and investors must sustain losses. What’s decisive is how does it compare to what was promised to creditors when they first invested their money’.

Therefore we may be staring down the barrel of a default event regardless of the tricks used by the ECB to avoid a default.

The more pressing concern is tonight’s confidence vote for Papandreou, the Greek prime minister. There is a far higher likelihood that things could unravel quite quickly if he is booted out of office.

There are reports from Bloomberg that European governments are considering withholding half of Greece’s next 12 billion-euro aid payment. The reduced six billion euro loan would be enough to cover bond redemptions in July. If you follow the money trail you can see that European governments are giving Greece taxpayer money that will in turn be given to European banks.

This whole shell game is based on the fear that a spreading contagion started by a defaulting Greece will render the European banking system more insolvent than it already is.

A quick look at the PIIGS bond markets will show you that the contagion has already begun. Portuguese and Irish 10-year bonds are over 11%.

Italian and Spanish 10-year yields have been treading water for most of this year but we are now seeing signs that their yields may be close to breaking out to the upside.

Moody’s downgraded Italy’s credit rating last week. It must be remembered that Italy has a debt to GDP of 119%! Pretty scary for a $2 trillion economy that is struggling to grow. If investors get spooked and Italy’s bond market implodes our current concerns about Greece are going to look like a tiptoe through the tulips.

This is where you should keep your eyes focused going forward. Spanish and Italian bond yields. If you see them break out of their current ranges to the upside then you should start battening down the hatches.

UK banks have already been lowering their exposure to Europe over the past few months. The Telegraph in the UK is reporting:

That leading banks, including Barclays and Standard Chartered, have radically reduced the amount of unsecured lending they are prepared to make available to Eurozone banks, raising the prospect of a new credit crunch for the European banking system’.

‘Standard Chartered is understood to have withdrawn tens of billions of pounds from the Eurozone inter-bank lending market in recent months and cut its overall exposure by two- thirds in the past few weeks as it has become increasingly worried about the finances of other European banks.

‘Moves by stronger banks to cut back their lending to weaker banks is reminiscent of the build-up to the financial crisis in 2008, when the refusal of banks to lend to one another led to a seizing-up of the markets that eventually led to the collapse of several major banks and taxpayer bail-outs of many more.

‘While the funding position of UK banks is far stronger now than it was back in 2008, the banking systems of several other major European countries, including Spain, Germany and Italy, are showing increasing signs of weakness.

‘Analysts at UBS have warned that Eurozone banks are “particularly exposed” having not done enough since the crisis to cut their reliance on the wholesale funding markets and remain acutely sensitive to the withdrawal of liquidity from the inter-bank market.’

News such as this is not to be ignored. A quick look at the European effective overnight index average (Eonia) lending rate shows that it has been creeping up over the past few months.

Effective Overnight Index Average (EONIA) daily chart

One-Year Chart for Effective Overnight Index Average Eonia (EONIA:IND)

It is not at crisis levels yet but it is certainly another indicator to keep your eyes on.

Australian Equities

Our stock market has been selling off steadily for over two months and there would be many traders keen to take advantage of an expected rally in the indexes. I would not be surprised to see a rally from 4500 in the ASX 200 in the short term (depending on the outcome of the confidence vote in Greece tonight). But any rally will find stiff resistance in the 4650-4700 region.

If 4500 in the ASX 200 can’t hold in the short term then we are staring down the barrel of a quick 300-point fall in the market to 4200.

The close in the ASX 200 today is actually quite important. If we can manage to rally and close above yesterday’s high of 4520.6 then we will have created a daily buy pivot and a false break of the March lows of 4477. This would be a short-term buy signal and you could expect to see a quick rally towards overhead resistance at 4650-4700, but I would be inclined to take profit at this level due to the fact that we are in intermediate and long-term downtrend.

A failure to close above 4520.6 today would mean that we should remain neutral to bearish on the immediate prospects for the market. Any more bad news out of Europe could see the rubber band snap and the fall to 4200 could be on the cards.

If you were interested in seeing a more detailed explanation of my current technical view on the markets you can view my most recent market update from the 17th of June here.

Basically my view is that the risk remains to the downside. Any rally should be seen as an opportunity to offload bad positions or if trading from the long side then profit should be taken quickly. Europe is really teetering on the brink. The can continues to get heavier by the day so each kick has less of an effect. At some point the ECB is going to stub its toe.

Murray Dawes
Slipstream Trader

Publisher’s note: regular readers will know that Murray helms the Slipstream Trader service – which gives specific trading recommendations based on where Murray believes the market is headed next and which stocks may benefit or suffer as a result. To find out more about Slipstream Trader, go here

Murray Dawes
Murray began his career on the Sydney Futures Exchange trading floor in 1993 with Swiss Banking Corporation (SBC). He spent a couple of years in the 3 and 10 year bond and option pits before moving on to the Share Price Index (SPI) futures and options pit. From there he became a broker with SBC specialising in SPI futures and options to institutional clients. After leaving SBC Murray continued his career in broking at Bankers Trust Australia. Then in 2001 Murray moved to Melbourne to work as a hedge fund trader for one of Australia’s wealthiest families. In 2003 he was ready to set up his own firm providing the same proprietary technical trading system to some of Australia’s boutique hedge funds. The success of Murray’s system led to him trading a $10 million account for a high net worth individual. This involved trading Australian and US futures and Australian stocks. Now Murray heads up the technical analysis desk for us passing on to readers some of his experience from 16 years of trading.
Murray Dawes

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