As the S&P 500 and Dow flirt with record highs, a cautionary market note is in order.
To be clear, December is loaded with catalysts which could derail Europe's fragile economy and have ripple effects across interconnected global markets. Potential flash points include this week's big Italian referendum, Greek bailout discussions (Greece again!?) as well as a fragile European banking system plagued by bad loans. Investors should remain vigilant of post-election market exuberance here in the U.S. An implosion in Europe could be coming.
Below is a list of key dates and why they matter.
December 4th
ITALIAN REFERENDUM: This one could get ugly. On the table are reforms which would impact 1/3 of the Italian constitution. It has already (narrowly) passed parliament. A 'Yes' vote would make Italy's two chambers of parliament (the Chamber of Deputies and the Senate) equal in power. This means both would have to agree on legislation before it is passed.
Italian Prime Minister Matteo Renzi has said he will resign if the 'No' vote prevails. A 'No' vote could also bolster the growing "Five Star Movement," which favors exiting the euro. It won more than a quarter of the vote in Italy's last general election in 2013.
This would clearly have widespread ramifications in Italy. Many have suggested that Italy's struggling banks, which collectively have about €360 billion in impaired loans on their balance sheets versus €225 billion in equity, could be impacted by a 'No' vote (more on this below). Polls suggest this is far from an open-and-shut issue. The most recent polls show about one quarter of Italian voters remain undecided.
AUSTRIAN PRESIDENTIAL ELECTION: This could be a good barometer of European political sentiment. Austria will decide whether to elect Europe's first post-World War II head of state drawn from the far right.
Norbert Hofer is the country's Freedom Party candidate. He has gained popularity around his opposition to immigration and Islamic extremism. Hofer won't rule out a referendum on Austria's membership in the E.U. This could signal a shift in Europe's general mood heading into 2017 elections for the Netherlands, in March, and France, in April and May.
December 5th
GREEK BAILOUT DISCUSSIONS: A perennial European concern, the Greek bailout countdown starts yet again. The International Monetary Fund (IMF) is weighing participation in Greece's €86 billion bailout amid a divisive and ongoing debate about the country's economic reforms. Greece's debt-to-GDP ratio is currently 180%.
Germany and the Netherlands have said that getting the IMF on board is essential to a deal ahead of the last scheduled meeting this year of European finance ministers. (The German people have long opposed bailouts and with countrywide elections coming in 2017 [between August and October] this will remain a hot-button issue for the German electorate.) Last week, Greek and IMF representatives left Athens without concluding the country's bailout review.
The debate wages on. A key sticking point? How long Greece should have to maintain the 3.5% surplus target, which European leaders suggest should be reached by 2018. Greek government spokesman Dimitris Tzanakopoulos implied recently that the IMF was setting up obstacles to comleting the bailout review and that economic projections were unrealistic.
DECEMBER 8th
ECB MEETING: At European Parliament on Monday, European Central Bank head Mario Draghi told lawmakers that prolonged periods of low rates created "fertile terrain" for macro market risks. Draghi expressed concern about piling debt and risk taking. In particular, he highlighted the real estate market where he saw "significant vulnerabilities."
That stands in stark contrast to Draghi also calling on E.U. governments to do more. “[Central banks] cannot generate sustainable and balanced growth on [their] own,” he said, adding, “Right now, the greatest risk comes from impaired growth, from the possibility our recovery doesn’t firm and growth stalls."
At the December 8th meeting, will the ECB continue its €80 billion in monthly bond purchases, otherwise known as quantitative easing? We'll have to wait and see.
December 7-30
BANCA MONTE DEI PASCHI DI SIENA: The European Central Bank has set a deadline between December 7-30 for Italy's third largest bank by assets, Banca Monte dei Paschi di Siena, to raise €5 billion in additional capital and rid itself of €28 billion in bad loans.
Earlier this week, the bank made a crucial first step. It offered a debt-to-equity conversion to raise €1 billion of the €5 billion. In an effort to persuade its bondholders, the bank proposed swapping certain bonds at 100% of face value (some of these bonds now trade at half of their nominal value).
The Italian referendum could derail these efforts if a 'no' vote prevails and punishes Italian debt markets. The ECB has said it would step-in to help manage any volatility in Italy. But the help could be short-lived.
Reuters cites sources that "stressed this would be limited to days or weeks, to counter any immediate market volatility, because the asset-purchase programme was designed to shore up inflation and economic growth in the entire euro zone and was not intended to fight crises in individual countries." Furthermore, the ECB already owns €120 billion worth of Italian debt. The Germans might have a few choice words for any sustained ECB bond purchases.
Bottom Line:
There is a great deal of risk in owning European equities ahead of these dates. There may also be ripple effects in the U.S. We encourage caution. Mark your calendars.
