European Financials Are Doomed!

We are hearing all kinds of headlines and sound bites about why it’s time to invest in Europe.

The political risk has subsided … capital inflows are strong … GDP growth is outpacing the U.S. … the business climate is favorable … European market valuations are attractive relative to U.S. market valuations.

Things like that.

Clearly, one could produce just as many reasons why Europe and its markets are not out of the woods.

I don’t intend to do that. But I will raise the point that Europe has been experiencing capital inflows, yes. But it’s done so despite lingering risks to its economies and future as a common currency system.

I suspect the strength in European markets challenges many traders’ preconceived notions.

So, today, as those expectations adapt to the mainstream narrative that "Europe is OK," let me give you an idea that challenges this narrative …

Investors have little concern for the European financial system right now.

Also right now, I have one chart to suggest now is time to sell European financials.

Here is the iShares MSCI Europe Financials ETF (EUFN)

The rally from June 2016 unfolded in five waves (A-B-C-D-E) to date. And that represents a 61.8% Fibonacci retracement rebound from the five-wave decline from May 2014.

Together, they suggest EUFN is due for a slide.

I would expect a downturn to take EUFN 12% to 21% lower than its current levels. And I imagine the decline could begin within a week or two. If so, the move is likely to span a couple months.

I think European financials are doomed. And if you would like some other rationales besides just a chart, consider this …

Smart-Money Bets Go ‘Flat’?

When Brits surprisingly voted last year to exit the European Union, we saw a corresponding flattening of the U.S. yield curve. That is, long-term rates declined relative to short-term rates.

This tells us investors do not expect healthy long-term growth prospects. If long-term growth is elusive, then investors cannot comfortably expect to earn higher yields down the road.

A flattening yield curve happens before an inverted yield curve happens. An inverted yield curve tends to suggest that investors are so pessimistic about the future, a recession becomes likely.

Today, the U.S. yield curve is flattening. It’s early still, but longer-term rates are declining relative to shorter-term rates.

Here is a look at the 10-Year/2-Year Spread. It’s on the decline year-to-date …

Watching the curve for more flattening …

Whatever flattening we’re seeing — and will see — is probably not an indication of what’s going on in Brexit negotiations.

And it’s probably not an indication that something is palpably wrong in the Eurozone. (Even though there pretty much is something palpably wrong with the Eurozone.)

It might be an indication that prospects for the U.S. economy have become overdone, and that reasons for optimism are disappearing. Some say the Trump economic agenda is dead after a special counsel has been assigned to investigate Trump & Co.’s dealings with Russia.

So if the yield curve flattens further, does it bode ill for Europe?

Why Europe, and Why Not the U.S.?

Surely, a look at iShares U.S. Financials ETF (IYF) suggests that a decline is due. So why look to EUFN instead?

Perhaps there is no solid rationale. But where U.S. business is 40% leveraged to banks for financing, an estimated 70% of European firms depend on banks for financing. If longer-term rates in Europe follow longer-term rates in the U.S. lower, the margins that banks can earn on borrowing short and lending long will narrow.

For that reason, a decline in European financials could create a feedback loop. One that threatens European economic expectations and then applies deeper pressure on financials.

Are European financials due for a rest?

It doesn’t seem anyone is expecting it, except maybe bond investors.

That’s why I think now is a good time to consider a short position in EUFN.

Do right,
JR

Your thoughts on “European Financials Are Doomed!”

  1. Take a close look at bonds around the world, when they reach a certain low, the large banks, and major monetary funds have to invest elsewhere with depositors money to keeps earnings high on interest positive. Look where they have there money. Not looking at local monetary decline alone, but world wide decline, too much in on no asset high rate growth, with nothing but service growth, not asset recovery value, everyone running on cheap money for service growth, with no solid profits. Take a wider overall view and you will see the likely out come for every one around the world. sincerely , JDM

  2. funny thing about trump’s dealings with russia; there were none! he had/has ‘dealings’ with china via his special man using the sun tzu tactic of confusing the enemy. it is/was dear hillary who was doing the russian deal and deflecting it to trump via the so called media of the western world, which outfit issues so much ‘fake news’ it is laughable. and it is laughable because so many supposed intelligent people believe it! dear hillary sold american interests in the kazakhstan uranium mines to putin for many, many millions of u.s. dollars and put it in her piggy bank. true and putin wasn’t impressed as hillary was originally settling for less than what was eventually paid by mr. putin. he was not impressed. you didn’t read that in the western press! and i think it is about time for a huge ‘correction’ everywhere to get rid of all the financial ‘shit’ in this corrupt western world. there is corruption all over the place and you guys know it. and the most corrupt nation is u.s.a. your economy is built on continual warfare. trump is trying to divert this stuff to more peaceful workings. if u.s.a would just stay away from n.korea, china, russia etc and enjoin with everyone else instead of being bully boy things would be much …’nicer’. we never hear of the russian or chinese navies floating around san diego harbour or cruising in lake michigan. n. korean troops have never left their homeland to attack anybody despite the propaganda of the 50’s. it WAS an american backed s. korea which attacked n. korea, thereby forcing n. korea to enlist the aid of china. they, china, lost over 900,000 troops in that war. good ol’ u.s.a. the blight of the world, invading 37 countris and killing over 20,000,000 people for the glory of the stars and stripes ‘forever’ and gluttony for your people. i hope that you have the guts to print this as a lot of oz people are against your western press and everything else to do with u.s.a. i know that war will never cease in our world but we can try to resolve things a lot better than before with our super intellect and modern technology and more awareness. cheers, ron.

  3. Europe and the US are both doomed to a financial collapse in the very near future. The Governments at all levels have been living in fantasy land promising and spending way beyond their means to fund. The US National Debt Clock paints the real picture of the the future of our once great country and it doesn’t look very rosy. The pentagon has spent this country into a debt which can never be paid off. Maybe they should look back at the former Soviet Union as what uncontrolled military spending can do. Social Security has had at least 2.8 trillion stolen from it while the people are told it wasn’t meant to be a retirement fund. The country is waiting for a hand to flush all the accumulated crap down the toilet, only a matter of time.

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“JR” specializes in trading commodities, currencies and options. He has spent nearly 10 years analyzing financial markets and writing about global economics. JR honed his trading techniques and global-macro worldview alongside his father, Jack Crooks, at Black Swan Capital. JR also…