Morning Comment: European Banks on the Brink?

What do they know that we don't know?

Twice now…over the past several weeks…we’ve asked the question, “What do they know that the rest of us don’t know?”…..We first ask it when the Fed sent out definitive signals that they are going to cut interest rates even though the U.S. economy is “solid” (their description) and the markets are sitting at/near all-time highs. In other words, why would they feel the need to lower rates under this situation…unless they knew things were going to get worse?

Yes, some people will argue that the Fed is only following the market. They say that rates are SO low in other parts of the world that U.S. rates are simply very attrictive to investors…and THAT’S why our market rates are so low…and why the Fed is following the market by lower rates. That’s great, but there is a REASON why those rates are SO low around the world…and THAT is telling us that there is probably something out there that falls into the category of “they know something that we don’t.”

The second time we asked this question is when we saw millions of dollar invested in the options market very recently…that will only make money if the stock market declines in a meaningful way over a short period of time…1-2 months. (See our “Morning Comment” from last Friday or our most recent “Weekly Top 10”). We saw it with HUGE purchases of VIX calls that are price in the $20s and expire in August & September. We also saw it in huge purchases in puts in the IWM Russell 2000 ETF and the HYG high yield ETF…that are also well out-of-the-market and expire in the Aug/Sept time-frame. (For more details, check out our “Morning Comment” from last Friday or our most recent “Weekly Top 10”).…….Why would a small number of people spend SO much money on investments that will fall to zero in just two months…unless they “knew something” (unless they knew it was a winning bet)???

"Insurance" rate-cuts by the Fed have an uneven record

Of course, some people are saying that we don’t have to worry…because an “insurance” rate-cut from the Fed will prevent the market from seeing a substantial decline. However, if that’s the case, why would these investors still buy all of these bearish bets in the options market? Besides, we have to rememeber that although the “insurance” rate-cut workd out VERY well in 1995, it did not prevent the market from imploding after their 2007 “insurance” cut……No, we’re not saying the market is about to implode like it did a decade ago, but the timing of these two developments raises a major warning flag in our minds…and tells us that a meaningful decline in the stock market over the near future is much more possible than most people are thinking right now.

What could be the catalyst to cause stocks to decline?

What is this “something” that these few people might “know” is going to rock the markets? Well, there are certainly plenty of candidates for such a catalyst (or it could be a combination of issues). The trade negotiations could break-down again (both sides have certainly lowered expectations). A “hard Brexit” could cause problems (PM Boris Johnson certainly hasn’t pulled-back from that possibility since taking power). Investors might finally wake up to the fact that full year earnings are going to be close to zero this year. Heck, the Yankees might finally even finish ahead of the Red Sox in the regular season standings (which would be the end of the world)!

Major divergence between the Euro banks & the broad European market

However, the one issue that stands out in our minds is one we’ve been talking about for quite a while now…the European banks. The group did see a mild relief rally at the beginning of July, but the STOXX Europe 600 Bank Index has rolled back over and is testing its December/June lows. That leaves this index more than 33% below its early 2018 highs and 42% below its 2015 highs!!! So we have a situtation where European banks stocks stand at the same level they stood after the broad European stock market (and U.S. stock market) were flirting with bear market territory! In other words, since late December, the broad European stock market is up 17%...while the European banks are unchanged! Put another way, since late April, European stocks are down just 1.3%...while the European banks are down 14%!!!

Of course, we have been harping on this divergence for a long time now…and it hasn’t had a negative impact on the U.S. stock market. However, that does not mean it won’t have a big impact eventually. One just has to look at how the Fed tightening policy did not have a negative impact on the broad market in 2018…until it did!.....We just think that ignoring the horrible action in the European bank stocks is a big mistake…and if those stocks fall further, it could/should be something that staggers markets around the world.

Hanging over this entire situation is Deutsche Bank. We do not cover DB, so we cannot speak to its impact on this situation…but the action in the European stocks speak for themselves. No, we’re not seeing anything in the credit markets…like a widening credit spreads…that would indicate a major problem with DB or the other European banks, but there was no signs of that until the stock market began to decline in 2007 either. In other words, credit spreads don’t always sniff-out these kinds of problems as early as investors assume that they always do.

With the 2.2% decline in the STOXX Europe 600 Bank Index so far today, it s back down testing a critical support level for this group. Click here to subscribe to my premium newsletter to see the key level on the charts I'm watching......We have a situation where a small number of investors are taking out a lot of "insurance" on the stock market...and the U.S. Federal Reserve is taking out "insurance" as well. Given the action in the European banks stocks, we're shocked that more people are not asking, "What do they know that we don't know?"

Matthew J. Maley

Managing Director

Chief Market Strategist

Miller Tabak + Co., LLC


275 Grove St. Suite 2-400

Newton, MA 02466


Although the information contained in this report (not including disclosures contained herein) has been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. This report is for informational purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security. Any recommendation contained in this report may not be appropriate for all investors. Trading options is not suitable for all investors and may involve risk of loss. Additional information is available upon request or by contacting us at Miller Tabak + Co., LLC, 200 Park Ave. Suite 1700, New York, NY 10166.

Posted to The Maley Report on Jul 30, 2019 — 9:07 AM
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