VWM: Sharing the Wealth

Periodically, Villafranco Wealth Management produces a commentary on various topics in the world of finance, capital markets, politics and general interest. Content is meant to be informative, thought-provoking and sometimes uses elements from major publications or other respected sources. It is our pleasure to present to you:

Easy Come, Easy Go

Last week's excess of optimism in the European leaders' ability to sort things out vanished this week. The euro, bank stocks, government bond yields and equities are all back to where they were before the rally - or worse.

The scale of the meltdown is as unusual as last week's melt-up. During this week, shares of French bank Societe Generale had their largest one day fall since it listed in 1987, plunging 16 percent. The big U.S. banks like JPMorgan Chase and Citigroup lost 13% of their value in two trading sessions this week.

Italy too suffered horribly from the political chaos in Greece. Its bond yields hit all time records across all maturities, while the spread of its 10 year bond yield over Germany passed 450 basis points for the first time ever, a sensitive level. Italy cannot sustain itself at these levels. Spain's yields are not far behind.

The rush to safety of German Bonds saw their 10-year yield drop 40 basis points in two days, the largest drop dating back to 1989. The U.S. 10-year Treasury bond, which traded as high as 2.37% last week when investors thought the Eurocrisis had been at least temporarily solved, traded back down to near 2.0% after the Greek referendum threw the solution into doubt.

It is tempting to believe that after such enormous moves the market is bound to rally, and it may. But really, this week's moves were just the elimination across pretty much all risk assets of the gains they made last week. The market has given back about 4-5% of October's gains, but there is little reason for the market to rise further unless Greece reverses course. That is unlikely to happen, so now is not a bad time to take some risk off the table.

The Euro has seen a dramatic drop since the announcement of the plan. From a high of 1.4189 on October 27, it dropped to a 1.3791 on November 2. The strength of the Euro against the US dollar has been puzzling and should not continue. The fate of the Euro is highly uncertain. The Greek referendum will address not just the bailout plan but whether Greece will remain a member of the EU (it should not but probably will decide to stay). The EU will be loath to allow larger members such as Italy and Spain to depart, but keeping them in the union will be extremely expensive for Germany and France. Accordingly, the credit ratings of both countries are likely to be downgraded in the future. German's bond yields have dropped to record lows in a flight to safety but ultimately Germany may not seem so safe after it loses its AAA rating (its debt-to-GDP ratio is already 85%). The bottom line is that the economic future of Europe is bleak - lower growth, higher debt, weaker sovereigns. Right now much of the EU is in recession and will remain in that position through 2012.

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