Precarious financial markets looking for a black swan to sell-off

Last week’s poor US jobs data spooked financial markets but the sell-off that followed was modest. It was after all balanced against a rather better competing data series earlier in the week.

But after a long rally and rampant government intervention, financial markets are looking ripe for a correction. The problem always is isolating the particular ‘black swan’ event or catalyst that will bring about a sell-off.

Black swans

The obvious candidate is another sovereign bond crisis from Europe. Portuguese bond yields soared last week and the formation of a new government in Belgium is an ongoing crisis. Then again the loss of a key law suit by two top US mortgage lenders threatens a new housing crisis in America.

It is hard to underestimate how this might impact on the financial sector. The US subprime mortgage crisis brought the sector to the brink of destruction in early 2009. But the underlying problem of bad loans and falling house prices has not gone away.

Now banks find that the securitization of mortgage debt means that they cannot repossess property because their right to the title has been lost in the securitization process. Does that mean the collateral behind almost every US mortgage made since the early 80s is bad?

Already many mortgage holders are stopping payments and sitting tight, knowing that they will not be evicted because the repossession process is not working. But at what stage Wall Street acknowledges this problem as a serious issue is unsure. For now it brushes legal cases under the carpet with the hope that they will be resolved.

Geopolitics

What else could shatter a fragile market calm? Bad news from China. A major corporate bankruptcy somewhere? Some geopolitical flash point? North Korea? Iran?

Or will markets just eventually fall under their own weight if recovery is not as promised and investors get disillusioned with the rather lackluster reality. Fourth quarter results may be weak. Disappointed expectations have a gravitational effect of their own.

That Wall Street has pumped up expectations to levels that will be impossible to fulfill is painfully obvious from the last jobs figure. And so much has been spent and borrowed to achieve so little.

The debt burden is now much higher than the one that caused the problem in the first place, reason enough to be cautious about the outlook and worry about what rising interest rates will mean.