Memorial Day

Morris Segall     

As we conclude the celebration of Memorial Day and the end of the month of May we look back at a month that in our opinion signaled a “Sea Change” in the international capital markets cycle of 2009-10 and a refocusing on the crisis of international sovereign debt. As we wrote in our blog entries of May 6th, “From Optimism to Panic: A Greek Tragedy” and May 10th, “From Panic to Relief…”, the swift and severe collapses in equity and commodity prices signalled to us something more than a correction in overbought markets. The events since then have confirmed that despite substanial moves on the part of  worlwide international banking authorities to support the Eurozone and the euro currency. As we forecast, international monetary support has also been joined by austerity fiscal programs forced into enactment by the large debtor nations of Europe. Very good economic news around the world, particularly in the U.S., has largely been wasted by eroding asset prices and declining investor confidence. Unfortunately, the European efforts to “turn” the crisis are shorter term palliative measures and do not address the longer term concerns of successful debt reduction and economic vitality. We mentioned in our previous posts that the sovereign debt issues in Europe and the U.S. are longer term problems that will not go away with monetary bailout and fiscal austerity programs. The capital and commodity markets are signalling that. We will publish shortly our analysis of sovereign debt problems on our website, www.spgtrend.com. Suffice it that we are pessimistic because of retarded economic growth and strained liquidity in Europe and our belief lower debt/GDP targets in Europe over the next 2-3 years will not be met. We believe this will continue to overshadow the equity markets. 

As a result, we have dramatically shifted our capital markets strategy after our May 10th posting. While near term rallies from oversold conditions are likely, we are not expecting the capital markets to resume their sustained “uptrends” and reach new highs in this cycle. We have been counseling our clients and our audiences of our concerns and the need to become more defensive, reduce volatility and protect principal. We will delineate our new Capital Markets strategy in a new website article also forthcoming.  Readers should contact us for details.

The ongoing oil spill in the Gulf of Mexico is a long term ecological disaster and will have more serious economic consequences the longer it continues. The governmental and public response will parallel the reaction to the Nuclear power accident at Three Mile Island in 1979. America’s nuclear power program has been stunted ever since. We believe one of the beneficiaries of the Gulf oil spill will be a revisiting of the nuclear option as an answer to America’s power generating problems.

Lastly, some good news in May. On Friday, the Commerce Dept. announced  increases in personal income in March and April that would signal improvement in consumer disposable incomes. Just what is needed to support a continuation in consumer spending that increased in the first quarter. While consumer incomes increased in April, consumer spending did not and we now have to worry whether the stock market decline in May will show up in restrained consumer spending in June and beyond. With the stimulus to housing expiring, elevated consumer spending will become more important to overall U.S. GDP growth going forward into next year. Readings on consumer income and spending will become amongst the most watched economic statistics as we go forward. We will certainly be among the spectators.

Morris R. Segall, CFA, CIC

From Panic to Relief: The EU Steps Up

Morris Segall     

In our last posting, “From Optimism to Panic…”, May 6, 2010, we stated last week’s panic in the capital markets needed a quick and forceful international response to restore order to avoid further destructive speculation. Refreshingly, the Europeans moved quickly and decisively and along with assists from the IMF, the Federal Reserve and the Bank of Japan, structured an aid and liquidity package totalling almost $1 trillion. Importantly the package includes mechanisms for the European Central bank to purchase sovereign and bank debt and, along with other central banks, add liquidity to the Eurozone. Clearly, the EU leaders and finance ministers meeting in Brussels over the weekend learned the lessons from their mistakes in the Greek bailout. They wasted little time and came up with a large package that addressed the current problems facing  European governments and banks. It was also important for the response to be global so the participation of central banks around the world left no doubt of the international support for the euro and the eurozone.

In response, equity markets around the world, led by Europe, have surged today, relieved at the strong international response to the current crisis.

However, the sovereign debt problems in Europe are not solved and the countries of southern Europe and the U.K. will need to initiate significant spending reduction programs as part of overall debt reduction plans. Those spending reduction programs will not be popular domestically and social unrest should be expected.

 There are political costs as well as seen in the indecisive elections in Britain which turned out the long reigning Labor Party but left the victorious Conservative Party short of a majority in Parliament. The Conservatives will have to fashion a parliamentary coalition in order to govern. In yesterday’s regional election in Germany, Chancellor Merkel’s governing Christian Democratic Party lost decisively thus depriving Chancellor Merkel of a mjority in the Upper House of the German Parliament. She will now have to compromise with opposition parties to successfully govern. Indeed, today Chancellor Merkel announced she would not be seeking tax cuts that she had promised to pursue in her fiscal agenda but have been opposed by her principal political opposition.

The political uncertainty now being created in Europe will raise political and economic risks in Europe and the U.K. While Europe has for the time being avoided financial disaster, the longer term problems of sovereign debt risk remain.

Morris R. Segall, CFA, CIC

From Optimisim to Panic: A Greek Tragedy

Morris Segall     

Thursday’s roller coaster ride in the stock market, punctuated by a nearly 1000 point drop in the Dow Industrial average before recovering 700 of those points, is culminating a shift from market optimism to outright panic. Since Monday, May 3, the major market averages have declined 6%-7% based on increasing fears of debt defaults in Europe led by the well publicized difficulties in Greece.  After protracted negotiations with its eurozone partners and the International Monetary Fund, a financial “bailout” package for Greece was announced last weekend that would appear to have headed off an imminent debt default.  Prior to the selloff of the last three days, the major market averages had risen on average 9% from the period February 3 to May 3  spurred by improving economic news in the U.S. and confidence in a “bailout” solution to Greece’s debt problems. Investor sentiment was overwhelmingly positive and risk aversion had been replaced by risk assumption. So what went wrong?

First, the Europeans, particularly Germany, horribly botched the Greek bailout and turned a serious dilemma into a full blown crisis. The reluctance of Germany to agree to contribute to a eurozone loan facility for Greece dragged out the process of support and brought Greece to the precipice of default. It allowed market traders and creditors to speculate on a Greek default when the issue should have been put to rest weeks ago.

Second, the draconian spending terms imposed on Greece by its European partners and the IMF apparently did not allow for the response of the Greek people. Reform of Greek finances and reducing its outsized debt must certainly entail large spending cuts by the Greek government. However, a population long dependent on public spending was not going to accept such life changing spending reductions without protest, including demonstrations, riots and strikes. The violent reaction of Greeks to the austerity program approved by its government has upset investors, market analysts and market traders. It has led to questions about the ability of the Greek government to enact the austerity program and thus successfully access the bailout money and avert default.

Third, once again the credit rating agencies have not done their jobs and have added to the current climate of fear by now lowering credit ratings on eurozone countries including Spain and Portugal. Italy may be next. Where were these agencies over the last two years when the balance sheets of these countries became so leveraged?  The credit ratings of these countries should have already been lowered. Reducing them now only adds to the negative speculation.

This “Greek Tragedy” has now led to rampant speculation about possible debt defaults in other eurozone countries, namely Spain, Portugal and Italy. It has refocused attention on the massive sovereign debt levels of the industrialized world, including the U.S. and raised fresh questions on how these debt levels will be reduced or if they can. We believe the events of the last three days have dramatically changed the equity market environment here and abroad. In the short term the panic selling of the last three days will expend itself. It may have done so on Thursday. It is also possible that U.S. equity markets may have seen their highs in this cycle. We are reevaluating our capital market strategies.  A strong employment report for April will help stabilize the equity markets temporarily.  A dissapointing report will accentuate the current market downslide. 

The sovereign debt issues in Western Europe are not going away. They will overhang debt and equity markets until creditors and investors are convinced credible debt reduction fiscal programs are enacted and accepted by the local populations. We will address the intermediate and longer term issues of soverign debt in a more extensive article on our website. For the moment, we believe a forceful international response to the destructive speculation regarding soverign debt defaults in Western Europe is necessary, and quickly, to restore order to the equity and credit markets.

Morris R. Segall, CFA, CIC