Cyprus fiddles, while markets burn

Founder and Publisher of the Switzer Report
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As prospects brightened for a Cypriot bailout, Wall Street reacted positively and closed up 90.54 points or 0.63% but I don’t think Cyprus is a driver for the overdue pullback.

Even more so now since, just as we were going to press, a Cyprus deal was brokered. All deposits under 100,000 euros will be “fully guaranteed”. Laiki Bank, the second-biggest bank in Cyprus, will be closed and anyone with 100,000 euros plus will cop a big haircut! A 40% levy could apply! Large deposits in the Bank of Cyprus will also cop a levy.

The first market reaction will be positive but there could be a rethink after what has happened to big depositors sinks in.

At least Cyprus will stay in the Euro zone and the worst case scenario has been averted.

The more important issue that should the sow the seeds of a sell-off in shares is the fact that the Dow is up 10.74% this year alone! Over the same time we in Australia are up around 7%.

Sure, we could be in a historically unique situation because the loose monetary policy right around the world is very unique, but history tells me we can’t keep going up forever. However, waiting for this pullback has been like pulling out your back teeth with a set of tweezers!

Contagion concerns

March is the end of the financial year for Europe and this can result in some selling of stocks. Undoubtedly, Europeans are worried about the implications of Cyprus in as much as economies such as Italy and Spain might be asked one day to tax their savers.

EU officials have denied this, but uncertainty is never good for stocks. In a nutshell, the IMF, the ECB and the EU want Cyprus to slug their savers to qualify for a 10 billion euro bailout package.

If the European trio aren’t pleased by the deal, Cypriot banks will go bankrupt. There won’t be a run because they won’t open their doors but wages won’t be paid, neither will bills be covered and the economy will be cashless and stuffed.

Exit plan

If that ever happened, the government would, in all likelihood, leave the eurozone and issue their own money but no one would want to lend to Cyprus because they would be afraid that they would not get paid back.

In the end the country would have to deal with the IMF and any help there would be designed to make Cypriots pay via taxes to secure that support. I am talking nightmare stuff for Cyprus but how would it extend to other economies and stock markets?

Cyprus is only 0.2% of the eurozone’s GDP, but its failure could really hurt Greece and that’s where the EU would need to be involved. Obviously, if Cyprus left, and Greece was under more pressure, then it could also think about leaving the eurozone.

The ECB would fight this, as it would undermine the euro even more. The Russians apparently have told Cyprus to sort out their mess, despite Russians having 20 billion euros in Cyprus banks and Russian banks having 40 billion euros worth in loans to the island!

The next few days

For the moment, markets seem to believe that Cyprus will not be allowed to fail – I guess they believe Mario Draghi, the ECB boss, who said they would do “whatever it takes” to save the euro. The one thing that worries me is that Cyprus is a player in the international banking system and if it goes bankrupt, other banks will cop losses and that will lead to stock market uncertainty.

The ECB has not only got to come up with a smart, sellable plan for the Cypriot government – which it appears to have done, it has to make sure that a contagion of a Cyprus-kind does not lead to savers rushing to ATMs to withdraw and then stash their cash under their mattresses.

What happens over the next few days will determine the stock market reaction, but if the ECB and its buddies play their cards right, then the market will avoid being spooked and we will have to wait for another trigger for the overdue pullback.

Of course, if the worst-case scenario happens, then I expect a sizeable pullback, which eventually will create a buying opportunity. Watch this space!

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