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Not Much Of A Parade

Markets gave a half-hearted attempt at retracing some of Friday’s moves, but volumes were pathetic and the bounces unconvincing to this observer.

There was an almost audible grimace when the July NAHB survey of homebuilder sentiment was released. The level (14), lower than expected, is the lowest that survey has seen since April of last year. For those keeping score, too, we are now closer to the all-time lows at 8 than to the May print of 22. Easy come, easy go.

However, there is more-concrete housing data on the immediate horizon: on Tuesday, the consensus for Housing Starts is for a decline to 576k from 593k. The NAHB surprise foreshadows something worse, but it is hard to tell because as the NAHB approaches the absolute lower bound, it ceases to correlate well with the level of Housing Starts. In any event, with Housing Starts tomorrow, investors seemed willing to wait rather than let NAHB rain on the parade.

It wasn’t much of a parade, though. Moody’s cut Ireland’s sovereign bond rating to Aa2 from Aa1 (just last summer, it was a AAA credit). There also was a story on Bloomberg (link) which cited “sources” as saying that a German bank, Hypo Real Estate, had failed the “stress tests” being administered by the ECB. This is a curious leak. Hypo Real Estate has already been taken over by the German government, so whether it failed the stress test or not is fairly irrelevant. But the fact of the link is interesting to me.

I would have put fairly long odds against any bank actually failing the “stress tests,” which results are to be released on July 23rd. After all, the Fed’s “stress test,” meant to add confidence during the crisis, was carefully designed so that it was easy to pass, and then re-designed when some banks allegedly objected that they were likely to fail. The watered-down criteria included a “worst case” in which Unemployment would reach 8.9% in 2009. In actuality, it reached 10.1%. So it wasn’t a very bad “worst” case. Unsurprisingly, everyone passed. This was preordained, of course, because if a bank had failed the test, it would have been immediately shut out from the capital markets. Failure was not an option, because it wasn’t offered as an option.

So it would seem to be quite shocking that some banks in the ECB test might actually fail. It makes more sense, of course, for the test to actually have teeth – why have a test at all, if everyone knows it’s rigged? But, on the other hand, the EU cannot risk panic, and cannot know in advance how the market might react to news that a bank failed the stress test.

Or…can it? One way to gauge the market’s reaction might be to leak that a bank had failed the test – say, a bank who wouldn’t in any case need to access the capital markets anyway. At the worst, this might seem to imply that the test did have some teeth, even if this was the only bank of the ninety-something banks that failed the test. (It would just show that the authorities had had the foresight to have already taken over the weak one!) If the market reacts poorly to the news about Hypo Real Estate, then perhaps the test ought to be softened just a bit….

In the event, European equity markets didn’t fare well, although it is hard to tell whether that might be partly a hangover from Friday’s decline in the U.S. The Eurostoxx 50 fell 0.4%, while the Bloomberg European 500 dropped 0.7%. Certainly not a calamity, but as I said – it isn’t clear why we should care at all about Hypo Real Estate.

Maybe I need to stop looking under every rock for the cloak-and-dagger guy, but it is hard not to be suspicious of the motives of central banks and legislatures when economic pressures remain high and seem to actually be rising again. Institutions have selfish memes. It is reasonable to be wary of motives when the institution itself is threatened, or perceived to be so.

I remain bearish on equities. The speed of the first move down from the top of the range gives me some confidence that a break lower is feasible. It needs to happen reasonably swiftly, lest the bears lose heart and cover near the bottom of the range and the consolidation continues. I’d give it a few days. With IBM missing sales today and Texas Instruments missing sales and profits, with NAHB and Hypo Real Estate, there is potential. I think I detect the redolence of disappointment beginning to grow.

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