Ugly Greek Default Could Send Market Down 40%

It takes a 20% decline to enter "bear market" territory. So far, the Dow is
13.8% off its April 29 high. NASDAQ is 12.4% off its peak and the S&P 500 is
down 14.7%. However, the MSCI ACWI (All Country World Index) entered bear market
territory last week, falling 21% below its April 29 high. Ironically, this sharp
decline came at the same time that G-20 finance ministers and central bankers
said they would take "all necessary action" to "maintain financial
stability, restore confidence and support growth." In essence, however, global
financial markets have fully discounted a default by Greece. The market is
preparing for the worst. So the only remaining question, then, is how bad that
loss will be. If Greece restructures its debt, a loss of about 21% is
anticipated. However, if this debt restructuring fails, losses of 40% or more
are likely. Overall, the International Monetary Fund estimates that European
banks face $411 billion in potential losses. IMF Managing Director Christine
Lagarde told last week's assembled G-20 finance ministers and central bankers
that "the bad news is that there are downside risks on the horizon, and they
are piling up." She said the global economy is in "a negative feedback
loop," marred by "inefficient political commitment." Earlier in the week,
the IMF officially said the world economy had entered a "dangerous new
phase." After Greece, the top priority in the euro zone now seems to be
preventing Italy from defaulting. Since Italy is the third-largest sovereign
debt market in the world, after the U.S. and Japan, European banks tend to be
loaded with Italian debt, so as euro-bond yields rise, their capital erodes. S&P
downgraded Italian sovereign debt to "A" last week with a "negative
outlook" due to Italy's fragile governmental coalition. In my opinion,
global financial markets grossly overreacted to Thursday's preliminary report
from HSBC (NYSE: HBC ) that China's Purchasing Managers Index fell to 49.4 in
September, down from 49.9 in August. This single report formed the basis for the
panic sale of most commodities. But HSBC's chief China economist, Hongbin Qu,
said that "fears of a hard landing are unwarranted." HSBC said domestic
demand in China remains "resilient" and should support Chinese GDP growth of
between 8.5% and 9%. Because of continued robust growth in emerging markets, the
IMF still is expecting 4% global GDP growth in both 2011 and 2012. Economic
growth is sputtering in the established economies, but not in the emerging
markets. The IMF now expects the U.S. economy to grow 1.5% in 2011 and 1.8% in
2012, down from its June forecast of 2.5% in 2011 and 2.7% in 2012. In the euro
zone, the IMF lowered its outlook to 1.6%. Those numbers are low but still
positive, and a 4% global growth figure should be a cause for celebration.