European Sovereign Debt Crisis Redux, What's the Playbook?

I wrote this post originally  as a guest feature on Check out the website for great investment ideas and original analysis.

Now that Greece has officially rejected austerity it’s time to examine our 2011 playbook to get some clues as to what might happen. More importantly depending on your timeframe there should be plenty of strategic and tactical strategies for profit due to the increase in volatility.

Let’s compare EUR/USD, Treasury yields, EU yield spreads, and other Developed Markets from 2011 to 2015 for insights on portfolio positioning.

EUR/USD Annualized Rolling Mean Returns suggest a possible structural change

Examining the chart it is easy to see that since 2014 the rolling returns have declined dramatically. In fact it is at a level only seen twice on the chart. First, in 2001 and again in 2009. Both of those periods were tail ends of global recessions. The fact that we are not in a global recession currently(yet?)  suggests potential major trend changes are continuing. 

2011 and 2015 time periods of interest are shaded gray

EUR/USD 252 day rolling volatility is spiking

Simply observing the chart the low-to-high is unparalled since 2008 although much lower on an absolute basis. This is indicative of investor indecision and whipsaws.

2011 and 2015 time periods of interest are shaded gray

Developed Markets' Rolling Mean Returns show decoupling

During periods of global financial streess the commodity countries appear to show acute weakness. EWA and EWC are seriously underperforming their developed market, non-EU peers. QQQ appears to show the most resilience in the face of Eurozone stress in both 2011, and 2015. 

2011 and 2015 time periods of interest are shaded gray

Treasury Yields are likely to fall in a flight to safety trade then continue rising

During the 2011 crisis you can see treasury yields collapse on a lagged basis before continuining to rise. It is likely that yields will follow the same playbook by compressing until more market participants feel certainty regarding potential contagion risk. Barring a total collapse in investor faith in the EU I doubt yields stay compressed for very long given what appears to be a structural shift in rates. 

2011 and 2015 time periods of interest are shaded gray

Treasury Yield volatility is rising yet remains muted when compared to 2011

All 3 maturities remain below their 2011 and subsequent 2012 peaks. They could test those highs but the chart shows a general downtrend in rolling volatility. 

2011 and 2015 time periods of interest are shaded gray

Long term lagged Eurozone interest rate spreads do not show contagion risk like 2011

Examining the long term rates pulled from the ECB’s website we can look at the yield spreads over German Bunds to get an indication of the potential contagion risk this time around. The entire year of 2011 is shaded given the bulk of the crisis happened within that time period. Compared to 2011, Italy, Spain, and Portugal are not yet seeing the same ‘stress’ in 2015. 

2011 and 2015 time periods of interest are shaded gray


1.       Expect increasing volatility across the board as market uncertainty heightens regarding potential contagion risk.

2.       Create your shopping list for ‘overvalued’ ETF’s and individual equities as the potential flight to safety trade will likely create reasonable longer term buying opportunities in quality names.

3.       Barring a complete debacle in the Eurozone US markets are likely to outperform other developed market peers.

4.       Pay particular attention to the EU yield spreads over ‘safe’ German Bonds. If the peripheral spreads start to blow out again as they did in 2011, all bets are off and safety of investment capital becomes critically important if it hasn’t already. 

Swiss FX Shock

On January 15, 2015 the Swiss National Bank (SNB) shocked the world with a surprise break away from the Euro peg which caused a cataclysmic revaluation of the relative value of the Euro and Polish Zloty.

Some context: During the summer/fall of 2011, in response to the European debt crisis the SNB stunned FX traders ~2.5 years ago when it announced it would peg it's currency to the Euro in an attempt to neutralize the Swiss Franc's (CHF) rapid appreciation due to its safe haven status. The SNB did this to protect the Swiss local economy which is 70% based on exports according to The Economist. Clearly, the SNB is no stranger to catching the market off guard.

As a trader I'm always interested in the circumstances surrounding these major announcements. Let's take a look at some of the relevant headlines from the 2011 European Debt Crisis.

Portugal’s $111 Billion Bailout Approved as EU Prods Greece to Sell Assets - May 16, 2011 -

Agency Cuts Greece’s Debt Rating Again -June 13, 2011-

Greece set to default on massive debt burden, European leaders concede -Monday 11 July 2011 -

Debt Contagion Threatens Italy -July 11, 2011 -

Global Finance Leaders Pledge Bold Action to Calm Markets - August 7, 2011 -

Swiss bid to peg 'safe haven' franc to the euro stuns currency traders - Tuesday 6 September 2011 -

5 Central Banks Move to Supply Cash to Europe - September 15, 2011 -

Clearly these were some hectic times in 2011. The headline risk was high as bad debt blowups lurked around every corner and Greece's default was all about assured. Let's look at how various markets were holding up then vs now. 

During 2011

In 2011 you can see ( TLT ) marching higher and higher all year, even after the surprise SNB peg to the Euro ~ 9/6/2011. Furthermore you can see the extreme appreciation of the ( CHF ) reaching ~30% in August basically forcing the SNB to act. Also of note, ( SPY ) tanked in late July, and increased volatility followed through November.

Current - 2015

Examining 1 year to today, we can see that ( TLT ) is similarly strong and gaining as headline risk increases. Of particular interest is the low relative volatility in ( SPY ) compared to 2011. Note however there was a market selloff prior to the current surprise SNB announcement. Look how big that   ( CHF ) revaluation is. 

SPX, FXF (CHF) daily log returns since 2010

Just to put the move in perspective the above chart shows the returns of the ( SPX, FXF ) since 2010. Talk about an outlier... 

The Bureau for International Settlements (BIS) triennial survey in April 2013 estimated that average daily turnover in the currency markets had reached $5.3 TRILLION! Factoring the size and breadth of the FX markets and the inherent leverage involved, a ~20% move in a major currency like the Swiss Franc is a major change in market dynamics that has wide reaching implications that aren't always immediately apparent.

Something like the Polish Zloty's ~20% decline vs the Swiss Franc could cascade into something bigger. According to Bloomberg News Poland has ~46% of total home mortgages denominated in ( CHF ) for a dollar value of ~$35 Billion. Imagine your monthly mortgage payment increased 20% overnight, would you be able to pay it? What would you have to give up to make good on your house note? This is the reality staring Polish citizens and banks in the face. My guess is a massive increase in bad debts, and asset writedowns are soon to follow. Accordingly, I'm not sure how much, if any of this is priced in equity markets with ( OIL ) dominating headlines and investor focus.

With that said I believe a bearish bias is prudent at this time as any 'unexpected' shock is likely to increase volatility in equity markets.  IMHO, the risk of the unexpected including: asset writedowns, profit warnings, bankruptcy's etc. likely resulting in margin calls, and forced selling; has increased dramatically. Be nimble, be adaptive, and manage your risk.


trading desk

A simple question, often overlooked to the investors' detriment.... In my ongoing pursuit to gain an edge in the market I’ve often thought it critical to analyze who the key players are. But even more broadly and perhaps of greater importance, I’ve often considered who or what forces have the power to “move the markets”. As a casual observer, or "unsophisticated" investor the most common market news you may encounter is pundits discussing stocks and the stock market, earnings reports, the FED and various economic indicators. The layman could hardly be blamed for thinking the stock market is the most influential economic market in the U.S. if not the world. Consider the enormous amount of attention that is given daily to the U.S. stock market. How critical it was and continues to be for the FED and government decision makers to consider “the market” in their decision making.

Here exists the ironic, easily obscured truth. When the FED and key shot callers reference “the market” most investors immediately think  "the stock market". I used to be guilty of this myself, but it is not only a serious error but also a limiting thought process.  Consider why? The equity market is in actuality the smallest of the actively traded markets. Let’s examine the data and the importance of this analysis will become  clearer.

According to 2012 World Bank data, global equities had a market value of approximately $53 trillion current USD. The Bureau for International Settlements (BIS) quarterly data approximates Total global debt securities at $86.6 trillion. That’s over 1 and a half times the market value of all equities. The BIS Triennial 2010 survey, reported the foreign exchange (Forex) market had an OTC notional value of $63 trillion in total contracts. Total OTC derivatives accounted for $632 trillion in outstanding contract values. That’s 12x the size of the global equity market.

Global Markets Securities Size

 Average daily trading volume (ADTV) also helps tell the story.


Forex trading has the largest ADTV followed by U.S. debt securities, then global interest rate derivatives. Examining the ratios; Forex trading volume is almost 19x larger than U.S. equity market volume; U.S. debt securities 4.2x larger and interest rate derivatives are 3.4x larger.

Bottom-line, U.S. equities account for the smallest piece of the asset market pie, both in market value and average daily trading activity.

The implications cannot be overstated. The “market” is a huge web of interconnected asset classes arranged in a hierarchical order with U.S. equities located at the bottom. Equities serve as both an expression of market expectations on real economic output; and of the volatility occurring across all interest rate based securities.

Examining these larger securities’ markets can provide indicators to actionable trading ideas. The leverage and capital at risk is so large in these markets, significant, far reaching dislocations can occur as a result of something conceptually “simple”, like an interest rate hike or a currency peg. These events blow holes in the efficient market hypothesis and allow for astute traders to place favorable bets with asymmetrical risk-reward properties.

This subject will be an ongoing topic of discussion and analysis, as these events typically increase emotional intensity and therefore volatility. The extremes in emotions present the greatest opportunities for the prepared and courageous investor.