Political Chaos in Europe Is No Good for Equity ETFs, Despite Today’s Sentiment

[Chart courtesy of MarketWatch.com]

Despite the European turmoil at the political level, markets responded positively as the S&P 500 gained 0.63%.

The dollar remained relatively unchanged versus the Euro, staying at $1.38/Euro. Oddly enough, the Volatility Index was relatively flat, dropping 1.03%. While markets might be saying that Europe might be working to solve its solution, I still believe the worst is far from over. Equity ETFS are destined for a big shakeup sometime soon, unless a credible debt solution is planned and implemented.

Whereas much of the focus as of late has centered on how the Eurozone could create an economically viable bailout and bank recapitalization package, the spotlight now turns to politics.

Though it’s not official yet, Greek PM Papandreou is planning to step down, making the way for a new coalition government. While some might argue that a new coalition government might benefit Greece, the uncertainty surrounding how a new government plans on tackling the country’s debt issues is rather unsettling.

Already, Greece’s creditors have put the brakes on a near-term $11 billion loan due to the lack of political consensus on the bailout. I think it’s safe to say that the probability of default has certainly increased given this setback.

In addition to Greece woes, Italy’s political tension has reached an all-time high. Berlusconi’s stubborn desire to maintain his presidency despite public disapproval could severely hamper markets in the next few days, especially as Italy’s 10-year bonds inch closer to 7%. These high borrowing costs would make it incredibly difficult for Italy to pay off its current $2.6 trillion debt load.

All is not well in Club Med to say the least. The consensus coming out of the G20 is that Europe has the financial ability to bail itself out and should do so. But I’m not so convinced that it can survive without outside help.

You can now see why we’ve stayed out of international equity ETFs, as supported by our International TTI, which is negative and has been hovering below its long-term trend line since 6/16/11. Until some semblance of political order is restored, I’m going to be on high alert as it pertains to any equity exposure.

Our limited equity ETF exposure along with bond ETFs and cash serve as a solid buffer against the current volatile environment. The focus this week will be on how the Eurozone can move forward given the extent of political transformations taking place.

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