Tuesday, September 13, 2011

Meanwhile, Across the Pond

A couple of months ago I wrote about something that analyst Lazaro Birinyi calls "the Cyrano effect".

Named after the fictional character Cyrano de Bergerac, the Cyrano effect simply means that when some particular piece of news is so well-known and obvious (like the nose on Cyrano's face) that the news is likely already priced into the market.

Take the European banking crisis.

On the surface, it would appear that the market is already well-aware of the problems facing some of the world' s largest banks, particularly those in France. Here, for example, is an excerpt from a piece in today's Wall Street Journal:

"We can no longer borrow dollars. U.S. money-market funds are not lending to us anymore," a bank executive for BNP Paribas, who declines to be named, told me last week. "Since we don't have access to dollars anymore, we're creating a market in euros. This is a first. . . . we hope it will work, otherwise the downward spiral will be hell. We will no longer be trusted at all and no one will lend to us anymore."


Later this morning the French government issued an official statement denying the theme of the article, but clearly there is serious concerns among finance officials in Europe.

Bank stocks throughout the world have plummeted as well. A price index published on The Economist's website shows that share prices for European banks are now back to the lows of the financial crisis in the fall of 2008.


While the author of the piece suggests that perhaps bank shares are oversold, he also notes that modern banking is largely a game of confidence. Once the market believes there is a problem, investors withdraw crucial funding from banks, thus creating a problem where one might not have existed before.

So the problem facing investors in mid-September 2011 is basically this: has the mood become sufficiently pessimistic amongst investors that the "bad news" is already priced into the market (i.e. the Cyrano effect)?

Or are the problems only beginning?

Let me give you one last thought, courtesy of one of my favorite columnists Ambrose Evans-Pritchard of the London Telegraph.

Most news reports paint the political crisis in Europe as basically a story of the Greeks refusing to do the economic "right thing": rein in spending and raise more tax revenue. Yet as Mr. Evans-Pritchard points out, the Greek reluctance may be grounded more in economic reality than has been generally portrayed:

Let us be clear, the chief reason why Greece cannot meet its deficit targets is because the EU has imposed the most violent fiscal deflation ever inflicted on a modern developed economy - 16pc of GDP of net tightening in three years - without offsetting monetary stimulus, debt relief, or devaluation.

This has sent the economy into a self-feeding downward spiral, crushing tax revenues. The policy is obscurantist, a replay of the Gold Standard in 1931. It has self-evidently failed. As the Greek parliament said, the debt dynamic is "out of control".


I continue to believe that dividend-paying, large cap US stocks make sense for most investors, but I also am watching events in Europe very closely - I've lived through too many difficult markets in past Septembers and Octobers to become complacent.