Equity ETFs Get a Rude Wake Up Call Amid European Woes

[Chart courtesy of MarketWatch.com]

After days of relative inactivity, markets finally erred to the downside as news coming out of the EU summit highlighted the difficult landscape that Europe continues to face.  The S&P 500 fell 2.11% while European indices dropped as well. For instance, France’s CAC 40 experienced a 2.53% dip.

For the first time in a couple weeks, the VIX had a large upswing, jumping 6.70% to end above the 30 level once more. And in line with heightened risk, the 10-year Treasury rate dropped 2.23% to yield 1.97%. Commodities also took a hit today with gold and oil falling 1.90% and 2.45%, respectively. In essence, bad news finally seeped into global markets.

As EU leaders met in Brussels today to kick off the EU summit, the outlook isn’t getting any better. There’s significant concern around whether treaty changes can be agreed upon by all Eurozone members and be fully implemented.

Additionally, uncertainty looms in relation to whether the Eurozone will combine the EFSF and ESM to create a massive bailout fund. “Uncertainty” is becoming a dirty word that can only continue to arouse fears that Europe doesn’t have a long-term solution in place.

A couple months ago we were talking about how Europe seemed to have bank recapitalization somewhat under control. Again, the severity of the situation was underestimated as the European Banking Authority announced that banks would need an additional $153 billion to reach adequate capital levels as conditions have worsened.

To nourish the anemic banking system, ECB President Mario Draghi cut interest rates as expected to 1% in order to stimulate lending. Furthermore, he has offered banks unlimited cash for three years, otherwise known as long-term refinancing operations. The ECB also decided to cut the reserve requirement in half, an action China recently undertook so banks could have more lending firepower.

And to make matters worse, the ECB has revised the EU’s 2012 GDP growth from 1.3% to 0.3%.  With lower forecasts in the U.S., as well as other major developed nations and emerging economies, it looks like we have a global recession on the books. Here’s an interesting opinion piece on Europe’s impending doom.

While the proof should be in the pudding about Europe’s mounting troubles by the end of tomorrow’s summit, now is the time to start preparing. Sure, equity ETF exposure may have been especially attractive in the recent past, but it looks like markets have once again woken up to Europe’s problems, bolstering my choice to keep a majority bond ETF position.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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