Europe – a ticking time bomb for Global markets

Just when we thought that the Greece problem was sorted out with a bailout package from the European Union (EU), ECB and IMF, infamously known in Greece as the ‘troika’ bailout package, subject to strict austerity measures, which include further wage cuts and longer working hours, the recent elections in Greece and France have suddenly changed all that.  The victory of Francois Hollande over Nicholas Sarzoky in France is a clear rejection by the people of France of Sarzoky’s economic policies and austerity measures adopted by him. Hollande is already talking of an expansionist monetary policy to bring back growth in his country.

But, more importantly, the elections in Greece have again given a fractured mandate and have outrightly rejected the ruling coalitions acceptance of ‘troika’ bailout and more austerity measures. The top two parties, which had inked the deal, failed to get less than half of the seats in the Greek parliament. The conservative New Democracy party and the radical left wing Syriza have emerged as a surprise top two parties in these elections. After several days of consultations, neither the conservatives and the left wing coalition, nor the earlier socialist coalition is able to form a government because of no clear majority. The last ditch effort by the Greek President, Karolos Papoulias to cobble up a workable coalition also seems to have failed. This means that Greece will have to go in for fresh elections in mid-June. According to opinion polls, the left wing Syriza party is going to emerge as a clear winner. Syriza are lead by a 38 year old, boyish upstart Marxist leader, Alexis Tsipras and he has vowed to tear up the hated memorandum or the ‘troika’ loan package. Due to this aggressive stance, Alexis’ popularity in Greece has shot up.

Despite warnings from German chancellor Angela Merkel, Tsipras has showed no signs of backing off. “The people’s verdict clearly renders the bailout null and void”, he said.

This could mean a certain Greek default, a banking crash and a monetary union expulsion. But Tsipras says that this will bring down the whole EU system and therefore the EU leaders must come back to the negotiating table and should soften their terms considerably.

Reports in the German media say that German Finance Minister, Wolfgang Schauble is keen to push Greece out of the European Union, as an example to other countries and he is convinced that the EU is strong enough to absorb the shock.

But reality is far more different. Experts say that a Greek exit from EU would accelerate the flight of capital from vulnerable EU countries like Spain, Portugal and Italy, which could lead to the total destruction of the common currency. Netherlands has also slipped into deep recession.

In Spain, massive protests gathered steam, when tens of thousands of people marched to Madrid to mark the anniversary of the ‘Las Indignados’ movement on May 15^th. Las Indignados means the indignant ones, and the Spanish population is fed up of the situation, which has only worsened in the last one year. Specially, young Spaniards are frustrated because unemployment is rising rapidly.

The election of Francois Hollande in France has definitively changed the balance of power in EU. Even Italy has thrown its weight behind France and has refused to ratify the Fiscal Compact treaty proposed by Germany unless it includes Eurobonds being guaranteed by ECB, and turns ECB as the lender of last resort. Angela Merkel’s own position in Germany is shaky, with losses of her Christian Democratic Party in two consecutive states, where regional elections were held over the last two Sundays. She described the loss in the Rhine Westphalia region, which is the most populous state, as a ‘bitter, painful defeat’, where the Opposition Social Democrats won comfortably. These elections, in a sense, are a rejection by her own people of her austerity policies and the way she has handled the debt problems of the Eurozone.

All in all – this sudden turn of events have turned the Eurozone into a timebomb ticking away and waiting to explode, should Greece default and exit the EU.

What does it mean for our stockmarkets and those around the world? This means that risk aversion will return and there will be flight of capital from countries like India, leading to plummeting of the rupee and the Indian stockmarkets. It means a prolonged bear phase is in the offing and it is already beginning to show. While the ordinary investor may not be aware of these complex turn of events, those in the dealing rooms are already a worried lot. Both the Sensex and Nifty are trading below their 200 day moving average and they are continuously making lower tops and lower bottoms. It would be a good time to go short at every technical bounce.

Where will the Nifty bottom out? Some say 4650, but its hard to predict and we will have to wait and watch the events in Europe carefully as they unfold, but looks like the Nifty is headed for much lower levels than what it is at, today.

Even UK has slipped into recession, though it is not part of the EU. Prime Minister David Cameroon has also announced unpopular austerity measures, which have not gone down well with the people. Thousands of people took to the streets in London on 11^th May protesting against these measures. This was followed by ‘Occupy’ movement at the iconic St. Paul’s cathedral in London, which was basically targeted at the one percent rich people, mainly bankers and financial sector CEOs.

The only silver lining is that US is growing at over 2% as against an expected 1.5%, and its normal growth rate of 3.2%. But, if the Eurozone collapses, there is every likelihood that it will drag the US down too.

Therefore, it will be prudent for our investors to cut all long positions and go short at least for the next two months.