Bank stocks led the declines across Europe on August 18. Then, when the EU bourses were shutting down for the day, traders licking their wounds, the Dow took the bearish "baton" -- and promptly sunk some 500 points, too.
At EWI, we are not afraid to call a spade a spade. A year ago, when the rest of the world was praising the results of the July 2010 European bank "stress tests," the editor of our monthly European Financial Forecast Brian Whitmer made this comment in the August 2010 issue:
Panic Now and Avoid the Rush
...Meanwhile, the market’s collective sigh of relief is also reflected in authorities’ stress testing of 91 European banks. In case you missed last Friday’s results, their message is clear: relax. The Committee of European Banking Supervisors (CEBS) gave passing grades to nearly every bank on its list.
The group, for example, passed both Irish banks and all four UK banks that it evaluated. The CEBS gave clean bills of health to all four Portuguese banks, all five Italian banks, and five out of six Greek banks that it analyzed. And don’t lose any sleep over the four banks we showed on page two of the June 2010 European Financial Forecast either. Even with share prices that sit 29%-66% beneath their 2009 countertrend highs, the CEBS says that the Bank of Ireland, Piraeus Bank, Banco Popolare, and Banco Santander are all in good shape.
It’s not so much the stellar results that expose the optimism of a Primary degree rally, but rather the Banking Committee’s stress tests themselves. They are notable primarily because they failed to test for any real stress in the first place. As the chart shows, the Committee’s “adverse scenario” regarding economic performance assumed a mere 3% deviation from the European Commission’s GDP forecast.
Another test looked at banks’ resilience to a sovereign-risk shock, yet the analysis merely used conditions similar to those of May 2010. In other words, just like the UK budget office (see last month’s “Economy and Deflation,”) the CEBS is utilizing a woefully diluted version of the economic deterioration that is about to grip the continent.
The latest European Financial Forecast notes that, "The Bank of Ireland and Allied Irish bank did collapse in September 2010 -- shortly after they received passing grades from European banking supervisors."
Note that the forecast above was made a year ago -- before the Greek flameout, before the bailout of Portugal, before the crisis had spread to Italy -- and before the solvency of European banks was put into question by the latest events.