A New Worry in Europe
Volatility returns... A new worry in Europe... Italian bond yields are exploding higher... Why this crisis could be far worse than the last...
Following the long holiday weekend, most U.S. stocks closed 'in the red' again...
All three major indexes – the Dow Jones Industrial Average, the S&P 500 Index, and the tech-heavy Nasdaq Composite – closed significantly lower.
They were joined by the small-cap Russell 2000 Index, which had been a relative bright spot of late.
And most notable, the market's "fear gauge" – the CBOE Volatility Index (VIX) – surged higher for the first time in weeks. The VIX jumped nearly 40% to more than 18, its largest single-day move since February's "volatility panic."
Unlike last week's declines, today's sell-off wasn't about fears of a 'trade war' or escalating tensions with North Korea...
Instead, today's sell-off followed new worries out of Europe.
In short, for the first time since the 2011-2012 European debt crisis, markets are once again questioning the future of the euro. Only this time, rather than Greece, Italy is the big concern. As the Wall Street Journal reported this morning...
Markets globally convulsed Tuesday as investors came to terms with an Italian political crisis that some fear could morph into an existential threat to Europe's common currency…
Six years after the eurozone stepped back from the brink of a breakdown, a violent selloff in southern European debt bled into broader financial markets, as investors sought the safety of the U.S. dollar and Treasurys, both of which rallied sharply.
As the Journal noted, the sell-off in Italian government debt has been dramatic as yields have skyrocketed higher...
For example, the yield on six-month Italian debt was still negative as recently as April. Today, it is trading above 1.2%.
The yield on 10-year Italian government bonds has nearly doubled in the last month to more than 3.175%.
And as you can see in the chart below, the yield on two-year debt has exploded. It was still in negative territory just two weeks ago, but is now above 2.5%...
Likewise, the "spread" between 10-year Italian government debt and benchmark 10-year German bonds (or "bunds") has surged to its widest level in more than four years.
These are incredible moves in what are typically "boring" government bonds, and they indicate real fear on the part of investors.
Now, like Greece, Italy's debt burden is a concern...
Italy's debt is more than 130% of its gross domestic product... making it the most indebted European country behind only Greece. And unlike many of its eurozone siblings, Italy's economy remains weaker today than it was before the last crisis.
But last time, the markets worried that debt problems could lead to a country like Greece being kicked out of the eurozone. Today's worries aren't about debt... at least not directly.
Instead, these worries are political...
In short, it looks increasingly likely that a country like Italy could choose to leave before these debt issues become another crisis.
Of course, the inner workings of European politics are beyond the scope of the Digest. But in simple terms, "anti-euro" parties on both the left and right have been slowly gaining power in Italy and other European countries in recent years. And this weekend, the issue came to a head when one of these parties nominated a particularly anti-euro economist as Italy's new finance minister. As Bloomberg reported...
For the crucial job of finance minister, the populists, who won a parliamentary majority in elections in March, nominated Paolo Savona, an 81-year-old economist of very strident opinions. He has called the euro a "German cage" and once advocated that Italy should secretly prepare a plan to leave the euro.
Current President Sergio Mattarella vetoed the nomination and proposed a more centrist candidate. However, both the right- and left-wing populist parties rejected the move and have proposed sweeping new government elections instead. More from Bloomberg...
Instead of accepting [Mattarella's alternative nomination], the left-populist Five Star Movement and the right-populist League are proposing new elections in the hope of drawing increased support to their side. They're also accusing the president of exceeding his rightful authority; the Five Star Movement is even calling for his impeachment...
The Five Star Movement and the League hold a majority of seats in parliament and have said they won't support a technocratic administration. Between now and new elections, perhaps in September, the populists are threatening in effect to campaign against the country's very system of government.
This could be Italy's most important vote since 1948, when the Christian Democrats beat the Communist Party, affirming the country's place in Western Europe. This time, Italy's membership in the eurozone and of the European Union itself are at stake – questions that weren't put squarely to voters last time.
There's no way to know how the vote will go...
But if anti-euro parties gain control of Italy's government, the fallout could be far worse than anything we've seen so far. And unlike the last crisis, a European Central Bank stimulus or promises to "do whatever it takes" are unlikely to solve this one.
In the meantime, this is just one more reason to expect continued volatility in the months ahead.
Stay long, but keep a close eye on your trailing stops.
New 52-week highs (as of 5/25/18): Automatic Data Processing (ADP), Amazon (AMZN), Intel (INTC), Lindsay (LNN), Monsanto (MON), Okta (OKTA), Ralph Lauren (RL), Sysco (SYY), and Verisign (VRSN).
The mailbag is overflowing with feedback on Porter's latest Friday Digest on GM. Send your notes to feedback@stansberryresearch.com. As always, we can't provide individual investment advice, but we read every e-mail.
"Porter, you couldn't be more spot on about GM. As a 30 year veteran of the Auto Industry (retail side) I can assure your readers that what is happening at GM (and Tesla) is exactly as your calling it. I'm amazed anyone would own stock in a domestic automobile manufacturer. Between management robbing the company blind, the unions driving production costs through the roof, and market saturation levels with product and debt, GM doesn't stand a chance." – Paid-up subscriber John H.
"I offer possible further evidence in support of your GM analysis. For several years prior to the GM bankruptcy, and up until 2016, I owned a small manufacturing company that supplied metal stamped parts to both GM Tier-I suppliers, and to GM Service directly.
"I like to measure a company by the attitude and competency of its day-to-day employees (not the big shots). I have told people for several years since GM emerged from bankruptcy that my experience suggests nothing has changed – the same inefficient procedures, employee incompetence, and 'passing the buck' attitude remain firmly entrenched. This suggests to me that top management never 'got it,' and is once again on the road to ruin. Just my opinion." – Paid-up subscriber Gary W.
"Porter, I'm a CPA and a CVA and am the founding partner of my firm which presently has 30 employees.
All of my clients are closely held businesses. So often I see valuations that are not supported by historical cash flow or even realistic projected cash flow, have highly risky leverage ratios and just seem to lack due prudence, that I'm left shaking my head and thinking 'maybe they know something That I don't.'
"Your letter today reinforced the fact that fundamentals matter, always, regardless of company size! Thank you and I appreciate your dedication to helping your readers learn (there is no such thing as teaching, only learning)." – Paid-up subscriber Bryan M.
"I absolutely love when you tell us we're allowed to share the Digest with family and/or a friend. Everybody loved it and agrees... except for one dumb***! Keep up the good work. Thank you for all you do." – Paid-up Stansberry Alliance member Matt E.
"Your 'Groundhog Day' Digest is a reminder and wake-up call to all investors. It is the kind of thinking and advice we pay you for. I knew the markets were going to crash in 2009, and I still lost a lot of money in stocks because I didn't follow-through on my suspicions. I did, however, make it all back and more buying real estate in 2010. So if positioned correctly with enough cash to take advantage, one can make money when the markets decline dramatically. When markets crash this time, with your help, I plan to make money with both sides of my portfolio. We need to hear this stuff! Keep up the great work!" – Paid-up subscriber Tony J.
"Déjà vu all over again for GM, but it will be a long Chinese water torture watching it unfold and considering the machinations of DC and Wall Street to paper over it. Damn the torpedoes, Porter. You the Man. In 2007 and '08, I was on my own dealing with the financial collapse, though I had a big investment bank for a broker. Fortunately, I found Stansberry soon thereafter and my moat is now filled with the gators of SR for financial knowledge and protection. Can't thank you enough for the opportunity to learn and prepare for the Reckoning on the horizon." – Paid-up subscriber Dave E.
"I really enjoyed the GM story in the latest Digest. I have always avoided ANYTHING GM. I worked on many of their cars and trucks that friends and/or relatives owned over the years, and in my opinion, they were all poorly designed cheap crap. I would tell the owners this, but they were always GM to the core, almost cult-like. I never understood this undeserved loyalty!
"From your story, I see their financials are apparently poorly managed cheap crap too. They should be rolling in cash, because they sure don't put much into their products! When the government bailed them out, I was shocked. I thought let this disaster DIE, but no, let's throw taxpayer money away on saving them. What a shame, and you know what NOT learning from past mistakes is... Keep up the good work, believe me I KNOW it is hard delivering messages people DO NOT want to hear or believe!" – Paid-up subscriber John B.
Regards,
Justin Brill
Baltimore, Maryland
May 29, 2018