Events in Europe are following the pattern seen in the U.S. several years ago. In Europe, financial crises in small countries are now giving way to crises in large ones.
This parallels what happened here. In 2005, home-building stocks peaked, and the national housing market peaked around year-end. In 2006, mortgage lenders and brokers began going bust. In winter 2007, the stocks of large financial companies peaked. In the spring, Bear Stearns announced problems with two real estate funds it sponsored.
In July, the Russell 2000 peaked. In August, the Fed temporarily reversed its tightening bias by announcing a small emergency cut in its “discount window” interest rate.
Also that month, if memory serves me correctly, the economist Ben Stein announced that no one should worry, what was happening in sub-prime would stay in sub-prime.
In the fall, problems with bond insurers became apparent, and cracks started appearing in the auction rate securities ARS) market. The Dow and S&P 500 peaked.
A recession began in December. In January, the broad averages fell into a bear market. Notably, the ARS market suddenly froze around late January, creating the first financial panic of what was then a mild, unrecognized recession. Bear Stearns was rescued before it could fail, due to Federal Reserve activism. Fannie Mae and Freddie Mac raised money in the spring and then were taken over by the Federal government in late summer before they too could fail.
With the recognition that the two GSEs were insolvent, there was no denying that was happening in sub-prime was not staying there.
In Europe, if we call Iceland part of Europe due to financial and commercial ties, things began going downhill when its banks defaulted on their debts. After that, we started hearing a lot about the Irish property bubble that was bursting, with great damage to their banks, and Greece’s financial problems began making the news in late 2009. From little Greece and Ireland in 2010, matters morphed toward recession in 2011 just as they had in the U.S. in 2007. Now that much of Europe is in recession (severe in some countries), we are seeing that indeed Spain needs a bailout. What was happening in the periphery (“subprime” in the U.S. analogy) is now happening in the core. The over-investment in Spanish real estate was not only from northerners wanting a vacation or retirement home. It is now revealed that plenty of Spanish, reveling in their recent dramatic increased incomes, speculated in second homes, nice retirement homes, etc. The analogy now that I see is similar to what happened in the U.S. after Fannie and Freddie went down. It wasn’t just Lehman going bust that set off the Great-ness of the recession. It was the essential insolvencies of numerous large banking and financial companies. Remember Washington Mutual? Wachovia? Countrywide? These were very large players- and they were apparently insolvent, though they were acquired by other financial companies so the actual condition of these companies was not disclosed.
And, after Lehman went down, the AIG mess came to a head, and then the rout was on.
Now, Spain is supposed to be bailed out by… Italy (in part). Meanwhile, the Greek situation remains unresolved. Is Greece Europe’s equivalent of Lehman in this analogy? I well remember watching when David Einhorn, a long-short fund manager, went on CNBC when Lehman stock was in the $32 price range in 2008 and said he was short the stock due in part to what he viewed as material misrepresentations of its financial condition? Certainly that would appear to describe Greece.
When a region is in a recession, otherwise-tolerable significant problems tend to become crises. Thus, trying to pick a bottom in Europe’s recession is both engaging in difficult economic/market timing, plus hoping and speculating that nothing approaching a “Lehman moment” will occur. When taking the Space Mountain ride in Disney World, one is in the dark and never knows when the thrilling down moves are about to level out or turn up. So it is with Europe nowadays.
Valuation algos may show the Dow-type stocks to be a little cheap, but not by enough to turn me away from a focus on safety of investment principal in this year that is shaping up to be more like America’s 2008 in Europe than I had hoped.
I used to love Space Mountain, but I sure didn’t love 2008.