European Government's Panic Triggers Stock Market Crash

By: Nadeem_Walayat

Black Monday ended with European stock markets down by between 7% and 9%, wiping out more than $2 trillion from global market capitalisation as markets collapsed in response to the disunified panic moves by individual european governments to guarantee all deposits at 100% which is contrary to the outcome of the weekend crisis meeting of European leaders that's only significant result was for a £12billion package of loans for small businesses.

Ireland started the ball rolling last week with its 100% guarantee to prevent a collapse of its financial system. This prompted the weekend European ministers meeting which failed to deliver on expectations which prompted unilateral actions by individual governments. The scene was set by news of Germanies apparent $2 trillion, 100% guarantee to all depositors which came in the wake of the collapse of attempts to rescue Germanies second largest commercial lender Hypo Real Estate. Germanies move was closely followed by Spain, Denmark and Greece (earlier), with suggestions a French guarantee was also imminent.

Iceland the Northern Rock Country

We had the first signs during the morning of the first european country fast on the road to bankruptcy, Iceland which is outside of the Euro currency block experienced a collapse in its currency the Icelandic Krona following its governments panic moves to prevent a collapse of its big banks as the following article suggested could lead to a bankruptcy of the country- Iceland Going Bankrupt?

The latest news on the Iceland front is that the Government is seeking to take immediate control of all of the Icelandic banks which includes nationalisation of Landsbanki and Glitner and force the other banks to take state loans. UK customers of the Icelandic subsidiary bank, Icesave found that they were unable to withdraw funds during the day which I warned as strong possibility in my earlier article. However the funds are protected both by Iceland's own guarantees and the UK FSCS picking up the balance, therefore any account freezures 'should' be temporary, and neither will savers be hit by the collapse of the Krona as savings tend to be in sterling or euro's. However savers should at the first opportunity seek to repatriate their savings to a 100% UK bank as the consequences of a country going bankrupt could render guarantees meaningless.

Euro Collapsing?

The Euro suffered a sharp fall which is not unexpected given the disunity exhibited by individual member countries, which has prompted many credible commentators such as Wolfgang Munchau of the Financial Times to suggest that this could result in a collapse of the Euro as the following article illustrates Credit Crisis Actions Risk Collapse of European Monetary Union.

For Europe, this is more than just a banking crisis. Unlike in the US, it could develop into a monetary regime crisis. A systemic banking crisis is one of those few conceivable shocks with the potential to destroy Europe's monetary union. The enthusiasm for creating a single currency was unfortunately never matched by an equal enthusiasm to provide the correspondingly effective institutions to handle financial crises. Most of the time, it does not matter. But it matters now. For that reason alone, the case for a European rescue plan is overwhelming.

However I do not agree with this and similar conclusions elsewhere, my view remains that the EURO is a currency that looks set to one day become the worlds number one reserve currency in the coming decades, especially as Europe seeks to further expands its frontiers. Clearly that point is still some distance away given the flight of frightened capital to the US Dollar and Japanese Yen. The European finance ministers clearly have to get their act together in the short-term and speak with a single voice, it remains to be seen whether they are able to do this or not. However panics tend to garner reforms which break through political resistance against more centralised control of the Euro block banking system, therefore there are many actions that can be taken to further pool individual countries sovereignty to strengthen the EURO and therefore will prove strongly supportive of the Euro in the long-run as control is further taken out of the hands of individual countries that results in confusion and panic as we have witnessed today.

Stock Markets Crashing

Asian markets started the ball rolling following Fridays about face by the US Stock markets following the passage of the bill in the House of Representatives, with the Nikkei down more than 4%, India down 4% and Hong Kong and Shanghai also down 5% each, which set the scene for similar falls amongst European stock exchanges during the day.

By Europe's close, the London FTSE 100 Index had its worst points drop on record of 391 points, ending the day down 9% which is its worst performance since the October 1987 crash., during my weekend article / newsletter I warned that the current situation was worse than either of those that I have traded through namely 1987 and the dot com crash / bear market of 2000, where investors will be subjected to many crashette's along the way rather than a big one day crash, as western governments seem to have measures in place to prevent an out and out single one day crash along the lines of the 1987 22% drop on the Dow Jones. London's 9% was joined by Frances CAC 40 which also ended down 9% which is its worst on record, and the German Dax was off 7%.

The United States witnessed a 800 point crash on the Dow Jones which followed an opening free fall before the "specialists" stepped in as part of their duties under the direction of the Plunge Protection team (PPT) to support the market when it is in a full crash mode, this enabled a trend to form during the day which contributed to a late day change of short-term trend and sentiment which saw a sharp reversal and the Dow Jones to end the day down 370 from an earlier low of 9,500. Other indices such as the Nasdaq followed a similar intra-day pattern.

Russia faired far worse, which took a real battering by plunging 19%, its worst ever one day drop which prompted a halt in trading during the market freefall. Clearly the Russian's have yet to develop their own circuit breaks and PPT.

Are Bailouts the Answer ?

NO, Bailouts are not the answer as we have witnessed following the US $700 billion blank check which was supposed to be bullish for the stock market has clearly had ZERO positive impact on the stock market, what the markets demand is liquidity and capital injections for the banking sectors. Therefore we may witness over the coming days the mother of all liquidity injections, and perhaps capital stakes in banks or part nationalisations along the lines of what Iceland is proposing, that coupled with deep interest rate cuts would influence market sentiment.

Stock Market Where Next ?

The stock markets are exhibiting extreme short-term volatility which means it is basically a Reactive traders market than a forward looking forecasters market, nevertheless the market is oversold on many measures, especially the VIX volatility indicator which exploded to a new all time high of above 50, this shows EXTREME FEAR as market participants scrambled to hedge against further declines and possibly a crash by buying mainly PUT options. This extreme level is usually associated with imminent significant stock market bottoms. However the VIX has been elevated at a level of above 40 for several weeks which illustrates that we are living through historic events the likes of which have not been seen since the 1987 crash.

Therefore whilst the stocks bear market is a long way from a bottom as corporate earnings continue to contract in the face of economic recession, the current stock market panic bottom may be imminent in terms of TIME, which on a seasonal basis implies a rally into the November US presidential election, though barring any further screw-ups in disunity amongst European governments.

The expectations are for a bounce on European exchanges on Tuesday of approx 50% of Monday crash declines, therefore expect strong rallies during the day from the opening onwards which follows on from Monday's late session Dow Jones bounce.

What can Savers and Investors do ?

Savers - To reiterate what I have been saying over the last 6 months, savers still have a a golden opportunity to lock in high fixed savings rates which in the UK are above 7% . These rates won't stay around for much longer, were talking perhaps in the days rather than weeks or months. So the time for action is now ! - Yes, banks can go bankrupt but savings are protected which includes accumulated interest. In the UK the protection is for the first £50k per group. I will be bringing forward my interest rate forecast for 2009 to tomorrow in light of the fast changing pace of events.

Stock Market Investors - Financial panics tend to present opportunities, but for the ordinary small investor this is not the time to contemplate stock market exposure as the likely hood is that as with many of the banks going bankrupt or being taken over for mere peanuts, so will many companies during the recession, this means attempting to pick stocks now to ride out the recession is very difficult and could result in the destruction of much shareholder capital even if the indices do not reflect this on the other side of the crisis. Therefore stock market investors should avoid equities as corporate earnings are expected to contract and therefore elevate price / earnings ratios which makes today's valuations for many companies meaningless.

Gold - My analysis of 2 weeks ago conclusion was that gold looks set to exhibit a bullish trend into early 2009 to above $1200, the trend to date is inline with the forecast which called for a downtrend into early October before the next up leg began, which appears to have now started following yesterdays sharp rally, however the reaction below $850 was a sign of weakness, therefore any reaction during the coming days from Tuesdays peak needs to be muted so as to set the scene for a continuation of up trend.

More recent analysis of the credit crisis.

• 05 Oct 2008 - Keyser Soze Heists Main Street Out of $700 Billion
• 02 Oct 2008 - Countries Can go Bankrupt Too!
• 29 Sep 2008 - Dow Jones Stock Market 777 Point 7% Crash
• 27 Sep 2008 - Bradford & Bingley Nationalised Another UK Bank Wiped Out by Tulip Backed Securities
• 25 Sep 2008 - Bailout Plan Talks Collapse Overnight as Congress Rebels
• 23 Sep 2008 - Gold Bull Market Trend Forecast
• 21 Sep 2008 - Historic Week: US Government Avoids Financial Armageddon
• 17 Sep 2008 - Hedge Funds Crash Halifax, HBOS Rescued by Lloyds TSB
• 14 Sep 2008 - No Bailout for Lehman as Fed Awakens to Bond Market Crash Risk
• 09 Sep 2008 - BANKRUPT Banks Wiped Out by Tulip Backed Securities, Is China Cheap?
• 06 Sep 2008 - Credit Crisis Phase II - The Economic Crunch

Your analyst expecting a Tuesday bounce.

By Nadeem Walayat
http://www.marketoracle.co.uk

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Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analysing the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

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