A tough week ended on May 7th. After Thursday’s wild ride, we couldn’t get a bounce on Friday, and the markets closed with the following notable weekly losses (figures courtesy of US Global Investors):
S&P 500 Index, -6.4%
NASDAQ Composite, -8%
Crude Oil Futures, -12.7%
The “C” word – contagion – is driving a lot of the fear in the markets. The European situation is, as we have been reporting, dire and getting progressively worse, risking the banking crisis we feared. Inter-bank money markets in Europe have tightened greatly as default swaps have soared. We cannot overemphasize how dangerous this is for financial markets. Policy makers, including the ECB, have been chasing this problem from behind all along, and seem unable to get out in front of it. Markets are pricing in a policy failure. Chinese markets have also posted losses after credit tightening measures intended to slow runaway real estate inflation.
At this point, any rally in risk assets should be seen as an exit opportunity for trading accounts, but longer term holdings should also be reviewed. Keep an eye on events and monitor positions closely, especially in foreign assets and commodities. Credit default events and a return to recession in Europe are now high probability in the forecastable future. With a collective GDP larger than the US, a European Union recession will not likely be confined to Europe, even though the US economy is growing much more vigorously. Markets always price in recessions ahead of the event.
Nota Bene: in a recent post we discussed energy company stocks not being the same as energy commodities, and trading more like stocks. In similar fashion, while gold prices ralled in the market rout, shares of gold miners (as represented by the XAU) lost 4% last week. For those who are inclined to hold gold in their portfolio (not something I do myself), be aware that gold mining shares are not a near substitute for the metal itself.