An Air of Desperation – Aug 3, 2012;

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

An Air of Desperation

It’s hardly worth discussing the topics emanating from Europe or the US anymore, since there’s been a complete breakdown of veracity in the headlines. We seem to have entered into a phase where anything at all is spun into a bullish case for stocks. Losses appear to be simply unacceptable to the legions of leveraged investors crowding the markets.

Today we read in Bloomberg headlines that Merkel’s coalition members “won’t stand in the way” of further bond buying initiatives. Also, we read that the US job market has stabilized, as non-farm payrolls came in higher than expected. These two headlines were enough to make markets leap higher and “melt up” all day Friday. Yet, when one examines the details, matters are not as bullish as one would expect. It’s perhaps true that ECB bond buying may in fact happen, but measures to do so can be vetoed by German authorities if “tough” austerity measures are not met first. And in the case of US jobs, more were lost than created, raising the unemployment rate to 8.3% from 8.2%.

At some point, the details will matter, and mere jawboning by central bankers will not be enough to sustain current market levels. Even if the ECB is allowed to print at some juncture, it still stands a very poor chance of curing the insolvency issues of the PIIGS. In fact, the opposite may occur, where higher rates of inflation (caused by debasing the euro) could crimp bloated balance sheets even more – an issue similar to the one the Chinese economy has been grappling with for some time now.

As we mentioned last week, these countries do not possess the privilege of reserve currency status. This is not to say that the US hasn’t abused that privilege; we have. Since the crisis of 2008, the U.S. has printed some $2.3 trillion in monetizing debt – more than 10 times the ECB’s tally. In the past, however, this would have equated to 8.0% growth in U.S. GDP. Instead, we’ve experienced no better than 4.1%. This is all to say that money printing in its entirety, both here and abroad, has been losing its effectiveness in promoting desired growth.

Ultimately, then, we hold the much-ballyhooed rallies in stocks suspect. Monthly upside volume averages haven’t been convincing, being in steady decline since “QE” speculation began last year September. US corporate earnings and revenue growth have flatlined in the 2nd quarter, with nearly 50% of all companies thus far issuing negative surprises on revenue growth (despite record low interest rates for US consumers). And with the prospects of “infinite QE” priced into these markets, it’s not hard to see stocks dislocating (deleveraging) sometime in the near future. That said, however, markets can and usually do what they want in the interim.

Best regards,

David Burgess
VP Investment Management