1. The pain in Spain falls mainly…on Germany.
We said a few weeks ago that the LTRO’s (Long Term Refinancing Operation) would fall short of “curing” the solvency issues of the PIIGS – that trillions were needed instead of billions. It just so happens that this has become a reality. However, we didn’t expect trouble to materialize so quickly following what was declared a “victory” for the region (and globally) just a few short months earlier. This time the headlines feature Spain, whose government is required (as Greece was) to reduce its 8.5% deficit to 5.3% before they can qualify for a bailout from the now combined EFSF and ESM “firewall” fund. Early Friday morning the German parliament approved a new increase to the fund, bringing its capacity to near €800B. The resolution arrested sliding debt markets of said PIIGS and managed to put a bid into world equity markets, allowing them to finish in respectable territory. To clarify, it appears that money printing saved the day for the markets once again, and we emphasize the word “day”, since the economic and fiscal warning signs continue to surmount in favor of the bears (see the box scores).
On that note, there was quite a bit of U.S. economic data released this week. The GDP figures (+3.0 in the 4thQ of 2011) were in line; all others indicated trouble ahead. In abbreviated format: The Dallas Fed Manufacturing activity fell 7 points to 10.8 in March. Consumer confidence also dropped in March to 70.2 from 70.8. The Case Shiller home price index fell again, although slower this time, by 3.78% YoY in January. According to the index, home prices are now down 34% from the 06’ peak. Durable Goods orders (+2.2% in Feb) were weaker than expected – core durable goods orders have been declining for 18 months now. Jobless claims increased for the first time in several weeks. Personal spending (0.8% in Feb) outpaced incomes (0.2% in Feb) for the second month in a row. Revolving credit, as we have mentioned here ad nauseam, continues to be the drive behind consumer spending.
Overseas, the German-approved (and largely guaranteed/backed) bailout fund eclipsed all other news pertinent to the markets. Perhaps of importance, business sentiment indicators across the Eurozone, and in Germany specifically, fell in March. However, this was before the increase in the firewall, which may render current economic data worthless for the time being. A better read on affairs in Europe will be had in coming weeks. As an aside, China, Russia and Brazil have all voiced a willingness to print in support of the EU rescue package if needed.
The Brits on the other hand may be learning first hand that money printing doesn’t work – okay, maybe that’s overstating things a bit. Following several “stimulus” packages in the last year, Britain has suffered the biggest drop in disposable income in more than three decades as energy prices (inflation) increased. Real household disposable income fell 1.2 percent. That’s the biggest drop since 1977.
2. Liquidity trapped Fed.
The Fed may be approaching a similar kind of dilemma as that faced by the Brits, but with the addition of a few curve balls. Print and you may squeeze consumers with higher oil prices. Refuse to print and you slam consumers vis à vis higher borrowing costs (mortgage refi.). Bond supplies, both corporate and Federal, have been off the charts in the first quarter of this year. Because of our sizable deficits, it does not appear that supplies will let up any time soon. In fact, they very likely could continue to increase. Therefore, if the Fed chooses not to monetize (remove excess supplies via QE) it may be risking an eventual bond market collapse.
Bernanke has made several speeches and/or interviews in the last week in which he has stated repeatedly that he has very little concern for the oil price (or inflation) and its impact on consumers. We could conclude from this that he weighs a total collapse in the financial system as the greater threat, and may therefore be ready to print at the first sign of market turmoil. What is needed, of course, is a trigger; an economic one would be preferred to that of an “event driven” incident such as a war in the Middle East.
In that, we rather suspect that corporate earnings for the first quarter of 2012 may well provide the needed fodder for a market eruption. Earnings growth, as we mentioned in our last commentary, fell flat in the fourth quarter last year as companies (primarily financial firms) ran out of accounting gimmicks in the game of “beat the number”. In the current quarter, consumer credit and European issues may have a negative impact on earnings. If not this quarter, perhaps the next, in which case forward guidance may play a larger role. All things considered, when the Fed is forced to come to the rescue, as we believe they eventually will, the metals should benefit handsomely, ending what has been so far, an eight-month consolidation.
VP Investment Management