Why traders should not worry about Europe’s plight

HE E

HE European markets shrug off another short-lived rally, it is not just the frequency with which the Eurozone is hit by bad news that is striking, but also the speed with which the European markets move from each brief rally to a return to their downward trend.

News that Greece’s pro-bailout parties had won enough seats in parliament to form a ruling coalition meant European equity markets showed some small signs of recovery in premarket trading, but once they were up and running, it was the usual run of play. By midday, Spanish ten-year bonds were up 24 basis points to 7.12 per cent, Italy’s bonds were up 12 basis points to 6.05 per cent and euro-dollar and S&P futures were down.

The main source of concern had been that Syriza, the party that stood on a platform of wholesale rejection of the Greek bailout, would succeed, making a Greek exit from the Eurozone a foregone conclusion. Things are still not straightforward, with New Democracy and Pasok indicating that they want to negotiate some concessions on the bailout terms. This could result in drawn-out negotiations between the two parties. But what the two parties want, and what German Chancellor Angela Merkel will let them have are two very different things. Both parties had been pushing for a further reduction in the interest rate on bilateral loans, an extension on loan maturities and a third round of Eurozone bailouts. Merkel responded yesterday with a resounding, but not entirely unexpected “nein, nein, nein” on Greece’s call for help. Merkel said that she could not accept any loosening of agreed reform pledges after the election, and that she could not see any reason to speak about a new aid package for Greece on top of the two that were already received. This kick in the teeth highlights the dangers for traders hoping to piggyback upon a blindly benevolent Germany – as the only relatively financially sound Eurozone economy – bankrolling the failings of its European neighbours.

Whoever is in charge of Greece, things are unlikely to get better before they get a whole lot worse. There are reports that it is nigh-on impossible to get a bank safety deposit box in the country, as Greeks hoard tangible assets, rather than trusting the electronic money in their bank accounts. Bank runs are not yet a regular fixture in Athens, but Greeks are still withdrawing hundreds of millions of euros from banks every day – not wanting to see their savings redenominated into drachmas in the event of a Greek exit from the Eurozone. In May, bank withdrawals totaled €5bn (£4bn) and according to official figures, Greeks have withdrawn €80bn since the start of the crisis.

But the ever-decreasing lifespan of any “hopium” injected into the markets presents a great opportunity for opportunistic traders. Let’s face it, when a country – in the financial situation that Greece finds itself – elects a new government, its economic situation is not going to suddenly reverse. If the markets react favourably to a coalition that is less resentful of the bailouts than the alternative, that rally is not going to run and run. As such, traders only need to sit back and wait to pounce on the eventual downturn. The only question is what to target for the best shorting strategies. With an economy reduced to ouzo distillation and gyro making, there isn’t much to go after in the Greek markets. Greece represents about two per cent of the Eurozone economy and is of little significance in itself. But what happens in Greece has a knock-on effect upon other struggling Eurozone countries – increasingly, the Eurozone minus Germany.

One person’s loss

This may seem a simplistic strategy, but in the current markets it is a strategy that can, and does, yield results. The market trends flat in the run-up to a vaunted “important moment for the future of the Eurozone”, it rallies when it gets the news that everybody was expecting. And then it tanks when everybody realises that we are still in as dire a situation as when we started. Except that more institutions owe more money to another institution. Most commonly, the Club Med countries to Germany, by way of the European Central Bank. And from a trading perspective, the ever-darkening prospects for the European economy are not your concern. You are not concerned about inflation, about capital preservation, or about the ethics of the German taxpayer paying for Club Med profligacy. As a short-term trader, your concern is making consistent trading profits within a controlled risk-reward strategy. And by taking a position on the almost inevitable widening of Spanish and Italian bond spreads, or on European financial equities falling once each burst of short-lived optimism has worn off, your trading account can end up looking a lot more German than Spanish.