Does the Last-Minute Cyprus Deal Have the Markets Unsure?

Index ETFs finish lower after the Cyprus/EU deal closes

Index ETFs didn’t quite buy the Cyprus deal that was passed Sunday night despite the short relief rally seen early Monday morning in the U.S. markets. The SPDR S&P 500 ETF (NYSEARCA:SPY) lost 0.42 percent, the SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA) lost 0.48 percent, the NASDAQ ETF (NASDAQ:QQQ) lost 0.36 percent, and the iShares Russell 2000 Index ETF (NYSEARCA:IWM) finished with a 0.06 percent increase.

A deal between the troika (the European Central Bank, the European Commission, and the International Monetary Fund) and Cyprus was hashed out at the 11th hour Sunday night, just before the country faced near and certain collapse.

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European markets immediately rose 1 percent as a part of a relief rally, and then quickly faded into the red when euro group president Jeroen Dijsselbloem suggested that the bailout and restructuring system used in Cyprus should be a model for future restructuring efforts in other countries within the EU…

The deal for Cyprus was not a good deal for the country, as any depositor with over 100,000 euro faces a 10 percent “tax” and the country’s banks are now forced to restructure. Bond holders and shareholders of the banks will likely be wiped out completely, and the total haircut on Cypriot debt is expected to be around 4.2 billion euro. The Cypriot Parliament has approved the deal and has continued to limit capital flow on the island in the expectation of large bank runs when they do re-open in a few days.

Investors in the U.S. seem skeptical of the deal, as Monday’s morning relief rally quickly ended and then sunk back into the red. Investors possibly reacted to the fact that if the troika can force Cyprus into this kind of deal, other countries such as Spain, Italy, and Greece could be forced into something similar as well.

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The fact that Dijsselbloem indicated that the Cyprus deal was a good model for future bank restructuring only worsened fears, as it appears that at least one person in the EU does not see the Cyprus model as a “one-off” solution…

Furthermore, and perhaps most important, the Cyprus deal does not fix the underlying issue of a euro zone in recession and unable to grow its way out. At the end of the day, a lot of financial pain and a lot of financial growth is needed before this situation will resolve itself. Who gets hurt along the way is up to the EU officials.

At least things back home are picking up, as the Chicago Fed and Dallas Fed reported greater manufacturing and business activities in their respective areas.

Bottom Line: The Cyprus versus the troika battle has ended for now, with significant losses to Cypriot assets. The “deal” does not fix the underlying problem with Cyprus or the euro zone, which centers on too much debt and too little growth. Both of these issues are constant themes in this ongoing battle. The fact that the euro zone remains in trouble is likely why Index ETFs and the U.S. markets’ relief rally was short-lived on Monday.

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John Nyaradi is the author of The ETF Investing Premium Newsletter.