Italian Lending Increases

The European debt crisis reached a boiling point last summer until European Central Bank President Mario Draghi announced that the ECB would do “whatever it takes” to save the Euro. Since then bond yields have dropped significantly in financially troubled countries like Spain and Italy. Pro-growth reform is still badly needed and while the financial crisis is not over and the majority of the Eurozone is still in a recession, it is encouraging to see lending to small and mid-sized businesses picking up in Italy. We will continue to watch carefully for more positive developments.

For more click here:  http://on.wsj.com/12mNWrC

March Madness

In my family, March Madness is our favorite time of the year. My wife typically makes a delicious basketball cake in early March for me and the boys. Both of my boys completed a bracket this year and are faring better than I am, something my youngest is reminding me of on a daily basis.

In the spirit of March Madness, here is a graphic that depicts how the stock/bond markets are impacted by different variables:

 

The first quarter was very strong for the stock market with healthy gains and low volatility, almost a carbon copy of the first quarter last year.  The S&P 500 and the Dow led the way while bonds and gold struggled.  In 2010, 2011 and 2012, the US stock market peaked during one of the four weeks of April.  In each case economic momentum slowed down, fears from Europe resumed and a stock market correction of between 10 and 19% ensued. That being said, 2013 is a different year and the massive amount of money being printed by central banks across the globe could help keep any market pullbacks shallow.

In recent weeks I have repeatedly been asked if investors in the United States should be concerned about the economic unrest in Cyprus. If you have not been paying attention here are two articles that discuss the situation in Cyprus:

 

http://1.usa.gov/ZCvCYs

 

http://nyti.ms/14RsLDh

 

Cyprus is a tiny country, but in this particular case the response from the European Central Bank to Cyprus’ request for bailout funds is why an investor needs to pay attention to what is going on.  In the recent past, banks in Greece, Spain, France, Portugal have called upon the European Central Bank(ECB) for bailout funds.  But for the first time the ECB has demanded a one-time tax on individual bank deposits in return for the bailout money Cyprus requsted.  Up until this point bank deposits in Europe have been insured, much like FDIC insurance here in the United States.  

 

Now that the ECB has put seizing individuals bank deposits on the table as a prerequisite for bailout money the question is will the public’s trust in the banking system in countries like Italy, Spain and France begin to decline.  If so, the public could begin to withdraw their funds from local banks en masse and the European crisis could come back into focus. I am not predicting what will happen, and if history is any indication the ECB may come up with another temporary “solution” (shorter-term stopgap) that tries to contain any fall-out from the Cyprus debacle.  We will continue to monitor this situation very carefully.

 

Central Banks in 2012

We first want to wish you a Merry Christmas and Happy Holidays!

There are so many financial stories from 2012 but one has trumped all in the eyes of the financial markets. It has been a year when Central Banks around the globe have printed an unprecedented amount of money.  As you can see since 2008, Central Banks balance sheets have exploded.  This truly is an economic experiment since we have never seen this level of Central Bank intervention before.  This year the stock market has paid little attention to a struggling jobs market, weak economic growth and declining earnings expectations and has rallied on the surge of money in the system. 

The financial markets have paid little attention to the European debt crisis of late, due in large part to the European Central Bank’s aggressive money printing.  However, as we have repeatedly pointed out nothing has been “fixed” in Europe.  

First up, European GDP has tended to track US GDP growth, but there has been a wide divergence in the past year.  The US has slowly recovered while Europe continues to contract.

Source: Kit Juckes, Societe General

Next up is a chart of GDP growth in the large Euro countries.  Notice while Germany continues to grow, Italy and Spain continue to deteriorate.  All of the money printing by the ECB can temporarily deflect attention from Italy and Spain but unless these countries change course and pursue policies to stimulate growth the crisis will return.

Source: Laurence Boone, Chief European Economist BoA Merrill Lynch

Lastly, Europeans support of the Euro has dropped from over 80% to 53%.  If this trend continues it will be problematic for European leaders, who are trying to solve the crisis..

Source: Nomura Securities 

More Stimulus Please

It has been an action-packed two weeks with a variety of economic/political events. Let’s get to it.

1)  The European Central Bank announced their latest attempt at solving the Euro debt crisis.  This time the ECB stands ready to buy an unlimited amount of Euro-zone governments’ bonds.  From The Guardian:
The scheme is aimed at depressing the costs of borrowing for Spain and Italy and countering the risks of a fragmentation of the eurozone and the unravelling of the single currency.  But Draghi also set strict terms for triggering the bond-buying programme, putting pressure on the eurozone’s political leaders to request help, enter austerity programmes, and agree on direct bailouts for struggling governments before the ECB will act.

For more on the ECB’s announcement:
http://www.guardian.co.uk/business/2012/sep/06/debt-crisis-mario-draghi?newsfeed=true

The ECB is saying that if a struggling country agrees to cut government spending and agrees to other restrictions, the ECB will buy an unlimited amount of that government’s bonds.  The problem, as we have seen in Greece, is that the governments in Europe have a very hard time implementing the spending cuts and sticking to the restrictions.  If spending cuts and reforms are not implemented then you have a transfer of wealth, via the ECB, from stronger countries like German, Belgium and The Netherlands to weaker countries like Spain, Italy and Greece.

As we have said from the beginning of this crisis, it is challenging to identify a scenario where this does not end badly.

2)  The August jobs report was disappointing with only 96,000 new jobs added and a downward revision to the previous two months.  The Unemployment Rate dropped from 8.3% to 8.1% but this was largely due to discouraged workers dropping out of the labor force.  

For more commentary on the fourth poor jobs report in the last five months:
http://www.nationalreview.com/corner/316233/jobs-report-what-recovery-veronique-de-rugy#

3)  Finally, the Federal Reserve meets this Wednesday and Thursday and may announce further monetary stimulus for the economy.  The Fed has already had two official rounds of bond-buying (QE) and a third round called Operation Twist. There is a spirited debate about whether the Fed will announce a QE3 this Thursday.

Here are both sides of the debate:

Why QE3 won’t be announced this week:
http://pragcap.com/why-qe3-isnt-coming-this-week

Why QE3 will be announced this week:
http://www.calculatedriskblog.com/2012/09/analysis-i-expect-qe3-on-sept-13th.html

On top of all of this we are keeping our eyes on the impact of the election, the looming Fiscal Cliff and Apple’s upcoming product line, as all three events will have an impact on the stock and bond markets.

Europe… past and present.

Spanish bond yields continue to hover just under 7%, an unsustainable level.  European Central Bank President, Mario Draghi, ignited a stock market rally with his comments two weeks ago that the ECB would do “anything it takes” to save the Euro.  Last week the ECB met but did not take any new action to help stem the crisis and that is a major reason that Spanish bond yields have not had a significant drop.  My take is that after Draghi made his remarks the German Finance Minister reminded him that currently they are not willing to to do “anything it takes” to save the Euro as that would mean Germany standing behind the debt of countries like Greece, Spain and Italy. The German people are not in favor of writing a blank check to their Euro neighbors, nor is the German Finance Minister.

As a refresher, the German economy was in real trouble ten years ago and then Chancellor Gerhard Schroder began reforming the country by lowering taxes, reducing stifling regulations, reduced welfare programs and cut down on the level of government spending.  These reforms were not popular at the time and there were some difficult times immediately following implementation.  Chancellor Schroder stuck with the reforms and the German economy began to flourish.  I bring this up because today Spain, Italy and France, among others, have a choice.  The choice is whether or not to go in the direction that has worked so well for Germany or double down on the policies that have brought so much pain to the Eurozone, such as high taxes, excessive regulations, extremely high levels of government spending, etc.

In France, President Francois Hollande is proposing a 75% tax rate on the highest income earners.  This is not a recipe for increased economic growth.  Here are a few of the important points from a New York Times article addressing France’s economy:

– “French people have an uncomfortable relationship with money,” Mr. Grandil said. “Here, someone who is a self-made man, creating jobs and ending up as a millionaire, is viewed with suspicion. This is big cultural difference between France and the United States.”
– They also know of companies — start-ups and multinationals alike — that are delaying plans to invest in France or to move employees or new hires here.
– Taxes are high in France for a reason: they pay for one of Europe’s most generous social welfare systems and a large government. As Mr. Hollande has described it, the tax plan is about “justice,” and “sending out a signal, a message of social cohesion.”
– “The thing French politicians don’t seem to understand or care about is that when you tax away two-thirds of someone’s earnings to appeal to voters, productive people who can enrich businesses and the economy won’t come — or they will just leave,” said Diane Segalen, a corporate headhunter.

For more on the potential 75% tax rate in France click here:
http://www.nytimes.com/2012/08/08/business/global/frances-les-riches-vow-to-leave-if-75-tax-rate-is-passed.html?pagewanted=all

Good news as the U.S. housing market continues to improve. Checking back in with Bill McBride at Calculated Risk:
http://www.calculatedriskblog.com/2012/08/the-economic-impact-of-slight-increase.html

U.S. Retail Sales, Weekly Jobless Claims, Europe

I hope you had a pleasant weekend. Let’s take a look at what is going on in the economy.

Last week we learned that:
– U.S. retail sales fell for the 3rd straight month, something that usually only occurs during recessions.

– Weekly jobless claims came in much higher than expected (translation: more employers laying off workers than expected).

– Quarterly earnings reports are in full swing and so far companies are reporting disappointing revenue growth. From Factset.com:
“Of the 104 S&P 500 companies that have reported earnings to date for Q2 2012, just 45% have reported sales above the mean estimate. This is the lowest percentage of companies to report actual sales above the mean at this point in the earnings season since Q1 2009.”
Revenue growth is something we watch closely and the trend this earnings season is not encouraging.

-Spanish bond yields hit an all-time Euro-zone high, closing Friday at 7.26%. Anything over 7% is dangerous to Europe so we will be extremely focused on this rate to see where it goes from here.

Despite this news, the S&P 500 and the Dow both posted gains for the week. I think there are several reasons for this. First, bond yields are so low that for many investors they would rather take their chances in stocks. Secondly, investors worldwide tend to invest more money in the U.S. when there is turmoil abroad and at this point that is helping U.S. stocks withstand some of the negative news. However, the earnings data and economic data need to improve soon if stocks are to continue to move higher.

A positive note, Bill McBride, a guru on the housing market, says the housing market has bottomed and has begun to recover. He does not believe that the recovery will be strong, or occur quickly but if he is right that the housing slide is over that is a positive to economic growth in the U.S.

For more on this issue read Bill’s blog CalulatedRisk:
http://www.calculatedriskblog.com/2012/07/wsj-us-housing-bust-is-over.html

Europe, again… plus LIBOR

No update would be complete without discussing Europe.  We found an interesting chart that compares credit creation (bank lending to consumers) in the Unites States to credit creation in Europe.  In the past year banks in Europe have stopped lending, while lending has increased in the U.S.  This is one reason why Europe is in a recession and the U.S. still is growing (albeit at a slow pace).  We anticipate lending in Europe will continue to deteriorate, driving them into a deeper recession.

For more on Europe vs United States click here:

http://blogs.wsj.com/marketbeat/2012/07/09/heres-one-reason-why-the-u-s-economy-is-leaving-europe-in-the-dust/

Stock markets around the world soared after the latest European Summit and plans to stem the European debt crisis.  Spanish bond yields initially fell sharply however in recent days the bond market has realized that once again nothing was solved in Europe.  Spanish yields have rocketed back above 7%, signaling further trouble ahead.

Spanish 10-Year Bond Yield

Source:  Bloomberg.com

A parting shot, for those who are interested:
Cullen Roche, one of our favorite bloggers, points out that their is way too much media coverage on the LIBOR-fixing scandal:

http://pragcap.com/why-is-no-one-freaking-out-about-the-libor-scandal

$125 billion Spain Request

The big story in the news this weekend was Spain officially requested a $125 billion bailout to rescue its banks.  As recently as May 28th Spain’s Prime Minister, Mariano Rajoy, had said Spain would not need to request the bailout.  With the $125 billion bank bailout all but guaranteed from European finance ministers, the bigger question is will Spain itself need a bailout?  I believe they will, but it is unclear where the huge sum of money that would be needed to bail the country out would come from.

For more on Spain’s request click here: Spain seeks Euro bailout…

Here in the U.S., the Dow (a stock market index) was up over 280 points this past Wednesday on expectations the Federal Reserve would extend its current Treasury bond buying program(called Operation Twist).  Currently there is a tug-of-war occurring between bad news out of Europe and any news of government intervention in the U.S. or abroad.

The stock market has tended to rally on even a hint of government intervention even though to this point intervention has not solved the crisis.

I would not be upset if I never had to write about Greece again but it is worth mentioning that they are having elections again this Sunday.  The elections will determine whether or not they will implement the austerity measures (read: cut the level of government spending) that was required in return for their country to be bailed out by the European Union.

This story will be a key driver of stock and bond markets this week.

Global challenges

For the third straight year, summer is being welcomed in by a slumping stock market. This is something we warned about in our update on April 3.

Here is the latest on the situation:

Last week:

-By now I am sure you have heard plenty about the dreadful U.S. jobs report on Friday. There was an increase of just 69,000 jobs in May compared to expectations of 160,000 jobs added.
http://www.ft.com/cms/s/0/0a3ed818-abe2-11e1-a8a0-00144feabdc0.html#axzz1wmgbTXND

-Manufacturing activity in Spain plummeted to a three-year low. Germany and France also posted manufacturing figures at or near three-year lows.

-European Union statistics agency Eurostat said there were 17.4 million people without jobs in the 17 nations that use the euro in April. This is the highest level of unemployment ever recorded in the history of the European Union. The rise in unemployment is likely to add to discontent with the austerity programs underway in the euro member states.

-Brazil’s manufacturing sector showed contraction for a second straight month.

-Manufacturing activity in China slowed dramatically in May.

-This weekend, German Chancellor Angela Merkel doubled down on her opposition to joint debt sharing in the form of the euro bonds. If she does not change her mind it is hard to see how this crisis gets solved as it is apparent Spain, Italy, Greece and the others have no intention of real reform.
http://www.bloomberg.com/news/2012-06-02/merkel-rejects-debt-sharing-as-obama-urges-end-to-crisis-cloud.html

On the horizon:

-It appears to be a matter of time before the European Central Bank or the Federal Reserve attempts to ride to the rescue with some sort of stimulus plan.

-Will Spain’s 10 year treasury bond rise to 7%, a rate that would signal serious trouble

-Oil prices are down more than 20% in the last month. This should be a boost for consumers as well as for companies’ profit margins.

As always, we will continue to manage risk and look for opportunities!

Deterioration in Europe

The S&P 500 is now down over 9% from its recent high. This pullback was long overdue as news over the past few months had indicated the deterioration in Europe was picking up steam. Economic data in the U.S. has also been weakening.  As I pointed out in early April, the pattern of the last two years of the stock market rising in the first quarter on stronger economic data and seasonality only to peak and reverse course in April was a very likely scenario again this year and indeed has taken place.

Stocks are certainly more attractive now than they were a month ago, however we still do not know if the market will be able to avoid a contagion if/when Greece leaves the Euro.  If Greece were to leave the Euro, the market’s attention would likely increase its focus on Spain and Italy.

With the 10-year US Treasury rate down to 1.70%, it is obvious the market is bracing for more volatility.

On a different note, Facebook shares began trading this past Friday. With shares closing the day just pennies above their $38 IPO price, there was disappointment among investors and market pundits who had expected a strong rally in the shares after the incredible hype of Facebook’s IPO. For more on Facebook’s IPO, read on…

Facebook’s IPO