The energy sector plunged again on Monday but it was falling in conjunction with the entire market. The declines we are seeing in energy are completely market related and caused by the uncertainty in Europe.
WTI prices collapsed to $76 intraday and Brent broke below $101 as the global markets sold off on worries over Greece. Late Sunday a Greek official warned that Greece would miss its deficit targets for 2011 and 2012 because of a sharper than expected recession in Greece. Hitting the targets was a prerequisite for receiving future bailout payments.
The group of 17 euro zone finance ministers meeting in Luxembourg said as a result of the Greek announcement they would hold off on the 8 billion euro payment until November. They were also going to review the conditions for the second 109 billion euro package still under discussion. Lastly they are also going to review the haircut provisions agreed to by private creditors in an effort to do a soft restructure of Greek debt. Those private creditors had agreed to take a 21% haircut on their existing debt in hopes of giving Greece time to recover and repay the balances.
What these events of today likely mean is a full blown default and debt restructuring forced on Greece by the EU, ECB and IMF. They are already so deep in debt there is no mathematical way for them to ever pay back what they owe today. All of this drama by the euro zone ministers is equivalent of rearranging the deck chairs on the Titanic. Greece will eventually default. The only question is whether Europe will let Greece collapse the entire European banking system or the EU will come up with a method to isolate Greece from the rest of the euro zone.
Since the results of letting Greece self implode would be so damaging the euro zone must come up with a way to manage the default and to protect the European banks. The U.S. isolated all the U.S. banks from disaster after Lehman by guaranteeing all bank deposits and debt. This stopped the run on the banks and prevented a global disaster. Europe must do the same thing for Greece. The euro zone, ECB and IMF must announce they are guaranteeing all deposits in European banks and all bank debt. Once they do the potential ramifications of a Greek default will be limited.
Greece has 357 billion euros of debt. Relatively speaking that is a small amount for all of Europe. The euro zone, ECB and IMF could restructure that debt at 50% or even 75% off the principal and it would still be a manageable number. Those holding the debt would be burned but they knew when they bought it that Greece was a very weak credit. Greece has been a bankruptcy looking for a place to happen for most of the last decade. The euro zone has already bumped their European Financial Stability Fund (EFSF) to 440 billion euros. By allowing leverage on that fund they could easily extend it to two trillion in buying power for loan guarantees and bond purchases.
Eventually the euro zone will realize they have to bite the bullet and take the hit. The quicker they do it the smaller the amount of damage. If they had accepted the problem a year ago when the first bailout was created they could have solved it then and there would be no headlines today.
The problem with the lack of action is one of management by committee. The euro zone common currency group consists of 17 nations. The bylaws require 100% agreement by all nations to make any material change. Getting any three nations to always agree on anything is a challenge much less 17.
This will pass. Eventually Europe will realize the longer they wait the worse it is going to get. If your foot is infected and the antibiotic is not working there is only one option. You have to amputate the foot. The longer you wait the farther up your leg the infection spreads and you could end up losing your entire leg or even your life. The choices are unpleasant but the EFSF antibiotic has not worked and the contagion is spreading globally because investors expect European banks to be amputated as well.
When Europe eventually takes concrete action and puts a shield around their banks the global markets will rally. Because hedge funds and institutions can't short European banks they are shorting banks in America and around the world because they need to hedge against their risk in European banks. That shorting will end and the global financial sector should rally strongly. Today nobody knows for sure how much exposure any bank outside Europe has to Europe. Once that risk is eliminated by the EU the entire problem will go away.
In the U.S. the banking sector closed at a new post recession low with a decline of nearly -5% on Monday. The S&P declined by almost -3% despite good economic news in the USA. The ISM for September rose unexpectedly to 51.6 from 50.6 and the highest level since June. Analysts were expecting a decline.
The vehicle sales for September rose sharply to an annual rate of 13.1 million units compared to the August rate of 12.1 million. September was the strongest vehicle sales since April. Sales of SUVs and pickups were especially strong. Dealers reported pent up demand with expectations for continued strong sales through year-end.
Construction Spending for August rose unexpectedly by +1.4% compared to a -1.3% decline in July. Analysts were expecting another decline. Overall spending rose +0.9% over its 2010 level and the first time in three years it has been positive year over year.
The U.S. is NOT heading into a recession. Europe is going to get resolved. This 357 billion euro problem is being blown way out of proportion. The global equity markets are going to rally strongly when Europe is resolved and the U.S. is going to lead the pack.
This is a buying opportunity for equities. This is an especially strong buying opportunity for energy equities. The U.S. economic data above would have provided a strong spike in oil prices in a normal market. "Sales were especially strong in SUVs and pickups." Those are models that consume the most fuel. Instead of a rally we saw WTI and Brent sag as a result of investors being forced to raise cash to cover margin calls and due to fears about a total global collapse. Nobody knows where the bottom will be so raising cash to A) protect yourself from further losses and B) prepare yourself for the buying opportunity to come is always a good plan.
I believe long term investors should be leveraging into energy positions and especially those with rising oil production and rapidly rising reserves. If we wait for the European problem to be solved it will be too late. The markets could spike 5-7% in a week or less. The time to buy is now. If equities decline another 5% then add to your position.
The S&P closed below 1100 at 1098. Technically it is not yet a break of that support level but a further decline could target as low as 1050. That would be another 5% decline. Unless Europe decides to prolong the pain I would be surprised to see that level but if we did I am very convinced today that it will hold. Ideally we could just wait until 1050 and back up the truck. Unfortunately thousands of funds will have the same idea and they will start buying before we get there. At our current oversold levels any rebound could be explosive. That means they have to be prepared to jump in on a hair trigger notice if the market direction changes.
Everyone has a different mindset about investing and buying dips. We are definitely looking at a falling knife here but it is really close to the floor. You can wait and try to pick a bottom only to find the S&P futures 30-40 points one morning and the Dow gapping up +400 points in another missed opportunity. I prefer to buy something today and something else tomorrow so when that blowout open occurs I am already in the game. Energy stocks remain the only sector with a guarantee of long term upside performance.
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