Europe - The World Is Revolving Around It

I got upteen emails or had conversations on why the market was down today. Following our my opinions. Maybe I am wrong but I am going to get on my soapbox because I have been writing about this and investors seem clueless. Everything below is as I see it so this is my qualifier versus the normal qualifiers I would throw in throughout my written dialogue.

There are two big dangers in the market. The biggest and most important is Europe. I don't care how you slice or dice it, this is big!!!! I did a post on Sunday talking about the lack of anything coming from the emergency summit in Brussels. I said because I do not know how politics work in Europe it was unclear to me what really came from the summit but it looked bad. I said you could get up at 2:00 a.m. and you would know how the U.S. markets would trade. If you would have gotten up at 2:00 a.m. you would have seen Europe was down about 2%, at 4:00 am 3%, 6:00 am 4%, and by 10:00 am about 5%. During this whole time the European currencies picked up speed selling off against the dollar. This is the most important thing driving the U.S. and I would argue the world markets. 95 out of 100 years (making the number up but making a point) currencies, and a macro issues with another continent doesn't matter. Now it does. Europe is 30% of world GDP. Without Europe the world economy doesn't go around. There is massive pressure in Eastern Europe as the Eastern Europe currencies collapse. Western Europe lent to Eastern Europe tons of money in the Euro and Swiss Francs not local currencies. As the currencies collapse in Eastern Europe the debts skyrocket in currencies terms because they are priced in foreign currencies greatly increasing the likelihood of default. On top of that, economic activity collapses also increasing the likelihood of default. Western Europe is primarily the nations on the hook which increases the likelihood of a EURO collapse as Western European countries decide if it is every country for themselves (why should Germany bail out Poland?). This creates huge stress on the currencies in relation to the U.S. dollar which creates huge problems for U.S. companies who do business in Europe. I have used this example before. Why is Microsoft going down further? It is cheap on every metric and has a massive cash hoard. I would argue because over 20% of their business comes from Europe and the market is starting to value their European business close to 0 or maybe even less than 0. Why would you value that less than 0? Simply because companies are not going to pull out of Europe but to keep the business going (especially if things really collapse) will cost alot of money. Now extrapolate that across thousands of companies. Checkpoint (CKP) which is cheap cheap but was down 14% today. They do 40% of their business in Europe. Or KSWS which is close to selling for cash but does 50% of their business in Europe. I was listening to a conference call today of an America company who has maybe 20% of their business in Europe and because of currency issues revenue in U.S. dollars was about 4% less than it otherwise would have been because of the EURO and the British Pound. This was at the end of the 4th quarter!!! Look at what the EURO has done since January and February. This is big and I keep preaching it on my blog and I keep getting the question of, well i don't understand, what was the news. The news was Sunday in Brussels. Seeing how the market reacted to interpret the news was all you needed to know!!!! Add on top of that the potential civil unrest and you have a powder keg. Latvia's governing coalition collapsed last week (may been the week before). The country is on the verge of bankruptcy. How many of you know that? My guess is if you said you didn't know that, you are an American. How many of you invest who didn't know that? Normally who gives a jack squat but you have to realize what is important now and all of a sudden it is important not only on its own but because of the warning bells that should go off extrapolating what it means to the rest of Eastern Europe. Sweden has $25 billion U.S. dollars lent to Latvia individuals. Swedbank, SEB, and Nordea (all Swedish banks) are the ones primarily on the hook. Germany has $5 billion lent to Latvia.

This is a link with a short video and write up on Latvia

http://www.euronews.net/en/article/01/03/2009/latvia-on-the-brink-of-collapse/

This is a link that shows which Western European company has exposure to which Eastern European Country.

http://www.ft.com/cms/s/0/ea19fec8-028e-11de-b58b-000077b07658.html

This article sums up Europe's problems. (Thanks goes to Pete for originally giving me the article several days ago). There is also a little video on the left hand side that is decent.

http://finance.yahoo.com/tech-ticker/article/195065/Europe's-Crisis-Much-Bigger-Than-Subprime-Worse-Than-U.S.?tickers=ubs,cs,db,hbc

In relation to this last link I was asked what % of GDP do our banks run. I do not know but the reason it is not relevant is because you have to look at the biggest banks in relation to GDP, not the entire banking sector. Not every US bank is in trouble. Iberia bank was the first bank who paid back the TARP money. Many banks never took TARP money. There are solvent banks. The question is the biggest bank in relation to the country. This is what happened to Iceland. The biggest banks were to big for the country to save. The U.S. also has the advantage (probably unfairly) for being the world reserve currency. This gives us much greater flexibility than Switzerland whose two biggest banks UBS and Credit Suisse could swamp the nation. I was also asked why there is such an emphasis for the statistics of loans, losses, as a percentage of GDP. The reason is because GDP is like a country's income stream. Look at Iceland. When a bank fails and the government takes it over, the balance sheet is essentially merged with the country's balance sheet. If you have total assets of 10 after taking over a massive bank and total GDP of 2 you have all of a sudden created potential massive leverage for the country if the assets go bad. There is a limit to claims on tax revenue to pay back this debt. When it passes the tipping point the trust in the currency becomes broken and it collapses.

I was also asked why this isn't getting coverage. The answer is it is. IT IS EVERYWHERE except in the U.S. Americans are self centered, myopic, narrow brained people. We have years of being mentally conditioned that we determine what will happen. 99% of time that is true. 2008 the U.S. was ground zero. 2009 Europe is ground zero. I said this two months ago in my letter, on this blog, and in conversations. I watched CNBC World last night. Every 10 minutes the conversation was on Europe. CNBC America it was barely mentioned. Asian papers, European papers, it is making headlines. In the U.S maybe the third page. Somewhere in December I realized where the story was shifting towards Europe. My daily routine changed. I no longer started my morning reading U.S. blogs and the WSJ. I now start the morning reading the Guardian business section, UK Times, European blogs, and recently a few free Central European Online articles. If I get to the WSJ, it is after dinner because frankly, there news is not really that important currently.

If you watched CNBC today, all you heard was AIG. CNBC is horrific in identifying cause and affect. If you watch CNBC realize this. AIG means jack squat in its own right. This does lead to the second big danger and that is the implosion in the U.S. insurance industry. Like Europe, this is a real danger. Insurance companies receive premiums for policies and then invest them. As stocks collapse along with other asset classes, the insurance companies who eventually have to pay claims have less and less money to pay those claims. This could be deadly. The only way AIG means jack squat is if you can glean any information for what is happening to the rest of the industry.

One last tidbit. As the day wore on you could see that the selling I think eventually came because of margin calls. You could see this in gold. I got an email from a friend that said Dennis Gartman (who is a trader) said he was selling gold because margin calls in other assets would force funds to liquidate gold holdings. Gold was up all last night and most of the morning until big selling pressure took over. I believe any dips in gold should be looked at as opportunity though margin selling could accelerate and you could see gold down 10% or $100. This doesn't change the fundamental story.

Okay, done with my soapbox. Have a good evening.