Debt Facade Cracking in U.K. as Sovereign Contagion Spreads

When Greece’s markets first started cracking wide open, a lot of claptrap spewed forth from Wall Street. The general consensus:

• The problems in Athens would stay bottled up in Athens.

• They would remain “contained.”

• They didn’t mean anything for larger economies, including the rest of Europe, the U.K., or the U.S.

Me? I told you the exact opposite …

I said the implosion in Greece’s stock and interest rate markets — stemming from concerns about that country’s massive debt and deficit problems — were a huge red flag. They foretold a collapse in other sovereign debt markets, with collateral damage in currencies and equities.

Lo and behold, markets are now weakening worldwide. And this week, the contagion spread to the U.K. The British pound got hammered, while the FTSE 100 Index rolled over, amid concern the U.K. would be the next domino to fall!

The U.K. Gets Its Turn In the Docks

What triggered the latest batch of trouble?

On Monday, the country’s new prime minister, David Cameron, warned that the U.K.’s fiscal position is “even worse than we thought.” He went on to say that “How we deal with these things will affect our economy, our society — indeed our whole way of life.”

You have to admire PM Cameron for telling it like it really is.

The real “money quote” though came when he said:

“Greece stands as a warning of what happens to countries that lose their credibility, or whose governments pretend that difficult decisions can be avoided.”

That’s exactly what I’ve been saying for months. And it’s good to finally see a courageous politician acknowledge reality. The problem is that the U.K. is in such dire financial straits, it will take drastic action to get the country back on track.

The U.K.’s budget deficit equals more than 11 percent of gross domestic product. Meanwhile, its total debt load has already risen to $1.12 trillion — and it’s on track to DOUBLE in just the next five years!

Ratings agencies are also starting to lose patience with the government there …

Fitch weighed in with a debt warning this week, calling the country’s fiscal challenges “formidable” and warning that its debt reduction plan wasn’t aggressive enough. Fitch could soon cut the U.K.’s AAA debt rating, a move that would lead to even more dislocations in the country’s equity, debt, and currency markets.

As if that weren’t enough, yet ANOTHER European sovereign market blew up in recent days. I’m talking about Hungary …

A government official there said the economy was in a “very grave situation,” raising fears the country could default on its debt. That’s amazing considering Hungary just got a $24 billion bailout back in 2008.

A Hungarian official’s remark spooked investors, triggering a slide in its currency, bonds and stock market.

The result? The yield on Hungarian bonds soared relative to U.S. Treasuries. The Hungarian currency, the forint, plunged in value. And the Budapest Stock Exchange index collapsed almost 1,300 points, or 5 percent, over the span of five days.

Bottom line: The sovereign debt crisis is spreading like wildfire, with no sign of letting up.

What It Means to You …

The U.S. has still not suffered the consequences of its profligacy. Our bond market is hanging in there, while our interest rates haven’t surged … yet. But I still believe it’s only a matter of time.

Meanwhile, while our bond market is temporarily ignoring these problems, the stock market sure isn’t. The Dow plunged more than 320 points last Friday and another 115 points on Monday before experiencing a minor dead cat bounce.

My big picture view?

It looks like the easy money, “bought and paid for” rally is coming to an end. Investors are waking up to the fact that governments can’t keep borrowing and spending forever without torpedoing their own balance sheets.

Worse, if private spending doesn’t ramp up as government spending ebbs, the global economy will careen into a double-dip recession. The latest economic data suggests that scenario may very well be unfolding.

For conservative investors, that means it’s time to once again focus on bear market strategies. Among them? Hedging with options, selling down positions, and selectively using inverse ETFs to generate profits from stock market declines.

Until next time,

Mike