Markets Dive on Fears of Eurozone Contagion

Tuesday, May 04, 2010

After a full day of trading in a volatile stock market and several hours of CFA studying this evening, my brain power is quickly deteriorating but after today's bruising, I would be remiss not to have a post up.

The bears were chasing investors today as the Dow saw a high volume, 225-point (-2%) tumble after Europe was rocked overnight. London fell 2.6% and the Madrid Stock Exchange (IGBM) cascaded 5.5% after rumors swirled that Spain is rapidly crumbling and is also now looking for a bailout from the IMF. Spanish Prime Minister Jose Luis Rodriguez Zapatero dismissed these rumors as "complete madness" and the IMF denied these speculations but they did little to buoy concerns.

The primary worry relates to the size of Spain's economy relative to Greece and its implications for eurozone contagion. Spain has a population of 46 million and a GDP of $1.46 trillion versus Greece's population of 11 million and GDP of $331 billion. Spain is the 9th largest economy in the world currently suffering from a 20% unemployment rate (double Greece's rate) and a 54% ratio of debt-to-GDP (a ratio that doubled in the last year as Daryl G. Jones reports). Spain binged on the global real estate boom and now sits with a staggering private sector debt-to-GDP ratio of 178%. These problems are clearly not to be taken lightly and investors are selling as more downgrades and steeper borrowing costs seem likely for the PIIGS. Massive protests are planned in Greece tomorrow which could easily dominate headlines and add to the selling pressure.

The VIX spiked over 25% today before settling at 23.8% on the close. A VIX back over 20% signals increased volatility and indicates a possible topping pattern in equity markets. The flight to safety is on. The dollar jumped over 1% as the euro has fallen below $1.30 and Treasuries found plenty of buyers today with yields on the 10-year falling to 3.59% from 3.688%. Gold ended the day lower by about 1% after making new highs on the year. Luckily, I was smart enough to take some profits (via NYSE:GLD) in the $1,180s but I still have over half my position now back below the breakout area of $1,170. I would be surprised to see gold trade back below $1,150.

On the plus side, attempted terrorist, Faisal Shahzad, was caught at JFK airport just before his plane took off for Dubai today. He is charged with five felony charges and faces possible life in prison if convicted. Good work, FBI!
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