Even before this week began, some rather shocking news came out of Europe: all deposits in the Mediterranean nation of Cyprus would face a levy of 6.75% for all deposits below 100,000 euros, and 9.9% for all deposits above. The funds would be withdrawn from all accounts over this passed weekend (Monday was coincidentally a bank holiday, but banks were closed beyond that to stop a bank run). The deal was made by the EU amidst hardline German negotiations.
To say the least, the Cypriots were unhappy. Proponents and defenders of the move point to Cyprus’s banking sector, which is increasingly insolvent thanks largely to investments in Greek bonds and the country’s overly generous return rates on bank accounts. Critics say this has undermined the banking sector in Cyprus and in all of Europe, arguing that only a fool would keep his money in a European bank. Cyprus did have depositor insurance, but critics say that promise was simply broken as part of this deal. Defenders of the move counter that the insurance only guarantees against bank failure and not taxes, which, they say, the levy is considered.
To put this in perspective, imagine if the UN pressured the United States government to clean up its balance sheet by withdrawing cash from every account in Citibank (C ), Wells Fargo (WFC), and Bank of America (BAC) accounts. And the United States government reluctantly agreed. The announcement is then made over the weekend: for every $1,000 in your checking account, the bank will take out $67.50.
Many economists such as Paul Krugman were shocked at the move, calling it an invitation to a Europe-wide bank run. Staggeringly massive bond investor PIMCO said that it was reducing its euro exposure in response to the Cyprus levy, saying that it was a warning sign to cut European exposure. German consumer confidence also fell after the news, in a surprising move that suggests individuals in Germany agree with PIMCO’s money managers: if there are talks of taking money out of bank accounts in EU nations, the economy is hardly strong.
Yet there was little move in the markets in response to the news. A quick glance at the S&P 500 shows that some intraday panic last Tuesday was quickly corrected, and the U.S. large caps ended last week roughly flat. Volatility, meanwhile, is still falling, and while VIX options have shown unusual activity signifying an expectation of a reverse to the American equity bull run, that hasn’t materialized yet in the large-cap world.
So why didn’t Cyprus hit U.S. stocks? After all, the global economy is deeply enmeshed and this move signals the likelihood of economic contraction and bank runs throughout the EU. We would suggest there are three reasons:
- We all know Europe is struggling. Europe’s debt crisis is old news in 2013, and much of that is already priced into stocks.
- Economies are global, but not that global. For most U.S. large caps, European operations account for less than 10% of total revenue. Of course a European slowdown isn’t good, but it isn’t exactly a disaster for the U.S. either.
- What is bad for Europe may be good for the U.S. Central Banks are not releasing enough money to meet demand, causing a liquidity trap. Yet there is still a lot of cash and demand for investments in Europe and the world. If Europe will not offer the investment opportunities and liquidity that investors demand, they could go elsewhere. A bank run in Europe could mean people with money abandon the continent and look for a better alternative. For developed economies, the only real alternative is the United States, so this newest chapter in the Eurozone may actually cause greater demand for U.S. equities, causing stocks to rise.
Now, we are seeing American markets move on their own fundamentals and less on Europe. If the European Central Bank cannot save the euro project, this might turn out to be a very good thing for American stocks.