If You Thought August Was Bad, Just Wait Until September!

Up until August, this year had been fairly dull as the S&P 500 was in a trading range somewhere between 1250 and 1350. The selloff was due to a slew of negative economic releases which led to lowered economic growth expectations as well as renewed concerns over European sovereign debt markets and banks. Since August 8th the S&P 500 rallied just under 10% before selling off once more. The S&P 500's trading range is now between 1205 and 1120, and unfortunately I think we may have another repeat in which negative economic releases and continued worries over Europe may see the current trading range broken to the downside with the markets erasing QE2's entire rally from 2010.


"Only when the tide goes out do you discover who's been swimming naked" (Warren Buffett). The same issue we faced back in 2008 remains, too much debt. You can't solve a debt problem with more debt and while you can paper over debt with money printed out of thin air as Fed Chairman Bernanke has done, it's the lower economic end of society that feels the pain of higher commodity inflation. Rather than let bond holders and commercial banks take the pain for restructuring current debt imbalances, central banks continue their endless stream of bailouts. With the global economy slowing we are likely to see further financial stress ahead and yet an ever stream of bailouts. Expect a rough two-week period ahead as August economic data is very likely to show further slowing. Until the Fed enacts more money printing and the government more bailouts and fiscal stimulus, I would stress caution ahead as defense and capital preservation should remain the dominant investment theme.

When economic activity decelerates you begin to see who has been "swimming naked", as Buffett says, as those in the worst financial stress and those most leveraged are the first to deteriorate. While the financial crisis of 2008 that infected the world may have found its origins in the U.S. subprime fiasco, it appears this time around "ground zero" is the European banking crisis. The crisis with Greece first erupted in 2010 and it had a material affect on the U.S. and other economic regions, but stress began to fade as credit default swaps (CDS) in the U.S. declined in the back half of 2010. However, CDS levels in Europe basically moved sideways and never really came down. This second wave of European banking stress has now pushed CDS levels in Europe well above the highs seen in 2010 and now U.S. financial stress appears to be picking up as well and accelerating higher. The parabolic moves we witnessed in 2008 in CDS levels appears to be occurring once more as financial stress gathers momentum.

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