The mess in Italian politics has helped to push the markets down in a big way on Tuesday with the Dow down -392 points or -1.6%. And it brought the tenuous nature of the European Union’s alliance back to the fore.
Eight years and three months ago, I wrote an article about the European debt problems. It took almost 14 more months to come to full crisis mode. Greece was the central problem and it remains a sovereign state in debt trouble to this day (though it’s largely been swept under the proverbial rug by a series of “loans” from the European Union).
But that country was not alone. Back then (wow – was it really more than eight years ago?), the acronym PIIGS was all the rage. It was used to talk about the government debt problems of Portugal, Italy, Ireland, Greece and Spain.
Fast forward to today and many of those same countries are in the center of the populist movement against the European Union – notably Italy and Spain.
The populist movement has already struck in England during the Brexit vote. In Italy, anti-EU parties won enough of the popular vote to form a majority coalition of roughly aligned populist parties.
But it didn’t happen, as the Wall Street Journal reports:
“Italian President Sergio Mattarella on Sunday blocked the formation of a euroskeptic coalition government, raising the prospect of new elections that could strengthen the hand of anti-eurozone forces.”
First of all, let’s realize that trotting out a new government in Italy is fairly ho-hum news. In fact, this is the 63rd different government coalition in Italy in the 73 years since the end of World War II.
Balancing out the “Italy’s changing coalitions again” ho-hum feeling is the fact that the country is the EU’s third largest economy behind Germany and France (or fourth, if you count the departing UK) – so this is a much bigger deal with larger implications than when the 16th largest EU economy (Greece) was grabbing headlines.
This has brought heightened uncertainty back into the markets. But strangely, it has not affected all markets or indexes in the same – setting up some very interesting anomalies. Let’s take a quick look that will help to paint this unusual picture and then draw some conclusions.
The Ital-Leave Fallout in Charts
Let’s start with a few charts where we’d expect geopolitical mayhem to have a big impact.
First, the directly affected region – Euro Stocks – should take a hit, and they did as we see in the FEZ which is the European analog to the U.S. Dow Jones Index of blue chip stocks:
Next, we’d expect the country at the center of the storm, Italy, to take an even bigger hit and it did not disappoint:
“Flight to quality” assets should have the opposite happen – a big up day – and indeed they did. We saw a huge jump in U.S. Treasuries, represented here by the ETF TLT:
The flight to quality in currencies also happened with the Japanese Yen and Swiss Franc jumping up along with the U.S. Dollar, which continued its six-week climb:
A stronger dollar is bad news for countries with large debt loads denominated in dollars like the emerging markets in general and Latin America in particular:
So far, we’ve seen the expected moves. Let’s move to the U.S. Indexes where we see some strange (and perhaps telling) anomalies.
First to blue chips, where the Dow broke down below its tight 2 ½ week trading range:
And we get similar behavior from the broader S&P 500 big cap index albeit from an even tighter box:
As we look at the more “risk on” assets in the Nasdaq tech index and the Russell 2000 small cap index, things start to get much more interesting.
First, to the tech heavy Nasdaq that basically said, “Ho Hum – what trouble in Italy?”:
And the Russell 2000 small cap index continued its recent outperformance and was hardly down at all when all was said and done on Tuesday:
In a traditional worried market – the Dow and the S&P usually take smaller losses than the riskier Nasdaq and Russell indexes.
That didn’t happen on Tuesday. This really looks like big pockets of the market recovered quickly from the news. Additional support for this thesis is that market breadth was only modestly negative on Tuesday – and ended the day not much different from Friday.
How quickly the smoke clears in the S&P will tell a lot about the health of the market and the market’s perception of how big the Ital-leave problem is. And even amidst down energy markets and geopolitical turmoil, the U.S. market is still looking pretty darn resilient.
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That’s why I’m adding more long positions in my 10-Minute Millionaire Pro and Stealth Profits Trader premium services this week. (You can find out more about our Pro track record right here.) And we’ll have the opportunity to turn turmoil in Italy into profits.
In particular I believe that banks have been overly punished during this move – especially those based in Europe. That sets up some nice extremes where we can buy strong banks at a discount. Watch for a trade coming your way later this week…
Great trading and God bless you,
D. R. Barton, Jr.