What the markets are missing about Europe’s crisis right now

Well it got pretty scary for the overinvested longs early this morning. The mainstream media is focused on the S&P downgrades of France and other Euro-zone countries but the real story is that the Greek bond “negotiations” on a “haircut” have broken down once again. The dudes in power over there are trying to put a good face on it and are sure they can get a deal done next week…but the markets appear to be running out of patience. Not the stock market just yet, but there are several worrisome signs that the stock markets are likely to get hit next.

First, take a look at this chart of the Euro vs. the US dollar. Brian Reynolds, a brilliant Wall Street sellside analyst who’s been a mentor and friend of mine over the years once told me that the most important thing to look at in the bond and currency markets is when the magnitude of the moves — not necessarily the direction of  the moves. That is, the only time the bond/currency markets should be on the radar of a stock trader is when the bond or currency markets are making crazy moves in the near-term. That can often lead to exogenous events that can then hit the stock market — sometimes to the upside, but usually a crazy bond or crazy currency move will lead to a sell off in the stock market.  I know plenty of brilliant stock traders who have lost their shirts because even as they were right about their broader economic analysis and the impact it would eventually have on their stocks, that they never waited for and then missed when the catalyst finally came. And such a broader economic stock market catalyst usually comes from a major move in the bond or currency markets.

So here’s the chart of the Euro vs. the Dollar:

Normally a currency move of several percent in a month would be pretty aggressive. The Euro’s down another 1.1% today alone.

The second worrisome development is the negative yield at which the German government sold their bonds earlier this week. In other words, investors in Europe are so worried about SIMPLY GETTING THEIR MONEY RETURNED to them that they are willing to lend the government of Germany 1 dollar for the promise of getting paid back, say, 99 cents, in a year. Negative interest rates — not from the government, but from investors who are so spooked that they’re willing to get less money back in the future than they are lending out today.  That’s not normal. And I don’t see that reflected in any media discussions or from any traders I know, despite their incessant focus on all things Euro-zone. They’re missing the biggest story of the week in that regard.

I’m relatively hedged in my stock portfolios with both longs and shorts and calls and puts. I’ve got both short-term trades like the VIX calls I bought last week along with long-term investments like Google and Apple that I’ve owned for so many years and long-term shorts like LPS which is still my biggest short position. So I’m not making any changes to the portfolio based on this analysis, but I am looking at buying some shorter-term market puts today and into next week, depending on the news flow and how these currency and bond markets in Europe act from here.