August 5, 2011
Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. Catch “US” if you can. We live a world that at times has no objective referent, and without a reference point we are left to make relative appraisals. Let’s begin with the fascinating movements in the currency markets. “Relative weakness” aptly describes the comparison of currencies in today’s market. All currencies are said to be “floating” with values measured against each other. The challenge with seeing the dollar as remarkably weak or strong is that you are measuring that strength against other marginally stronger or weaker currencies.
This week witnessed the intervention in the currency markets of both the Swiss National Bank and Japanese Central Bank in attempts to support their export industries via currency devaluation. Thus, spitting into the wind appeared to be the week’s central bank sport of choice. We are not sure how to judge the event except to say that everyone participated and found that nature sometimes abuses even the best and brightest monetary minds; the Swiss Franc finished the week strong – not exactly the intended outcome, and the Yen gave up an inch but not a yard, which forced Japanese authorities to issue a statement that they may intervene again.
The dollar moved lower this week until dollar negativity was eclipsed by concerns over Spain and Italy with a focus on larger bailout dollars needed from France and Germany alongside a greater commitment from the ECB. (As we’ve suggested, the ESFS fund was only adequate in size for a few of the smallest peripheral countries.) Spain and Italy, previously at the periphery of the crisis, now are more central, like waters circling the drain; what was at the edge is now in the middle of the vortex. By Friday, the ECB was monetizing again, buying Portuguese, Irish, Spanish and Italian paper. European QE2 is here! The Bundesbank is furious, and rightly so in our opinion, accurately viewing the choice not simply as a “provision of liquidity” but rather as fuel to an inflationary fire.
Monetization should best be thought of as a market intervention when things are falling apart; it is supposed to stabilize prices and prevent panic. To our minds, monetization begs the question, “Are things so bad as to warrant a propping up of the market?” Because the simple answer is, “Yes,” the swoon in the market Thursday comes as no surprise as investors adjusted to the possibility of unmet expectations. The recovery, which in our opinion was always elusive (asset prices moved higher with QE, but economic fundamentals languished), is now in question amongst the general investing public. The knee jerk response of “sell equities” “buy bonds” was a classic example of conditioned behavior, even in the face of U.S. insolvency!
Debt crisis resolved? The stock market understood this one immediately, even if our political class did not. The embarrassing moment for both Republicans and Democrats was when the removal of the unknown (to default or not to default) didn’t remove stress from the market place. There is a growing awareness that debt is nothing more than tomorrow’s growth borrowed and used up today. The debt ceiling debate is a red herring for the larger issue of unsustainable entitlement spending based on a perpetually growing economy. In their Friday report, the Council on Foreign Relations (CFR) suggests that no structural reforms have been set in motion, leaving our global credibility and credit standing vulnerable to downgrade. We agree. Essentially nothing has changed. We do take note when the political elite openly critique the behavior of their own pawns; real trouble is brewing.
Although European issues (where billions are owed) captured the attention of traders, we see the US debt issues (in the trillions) as a far greater concern, perhaps with a slower burning fuse. Like cleaning up after horses or cleaning up after elephants, we don’t mean to minimize the billions, but we are well behind the curve on the elephant, and shovels are no longer adequate.
2. Old habits die hard. Making sense out of what is happening as the markets unwind is almost impossible. In situations like this, panic (or mindless computer trading) takes over, while patience and rational thought are thrown out the window. It is also equally difficult to determine what exactly triggered the selloff in equities (producing a loss of $4 Trillion in global market capitalization), even though the economic and fiscal negatives have been brewing for months. Moreover, why did investors flock toward the soon-to-be-bankrupt US Treasury market for refuge? What can be said is that stocks appear to be oversold; but this does not mean they can’t continue their slide to more significant support levels (i.e. Dow 11,000). Yet on the other hand, one could also argue for a relief rally, most likely following what will be damage control on the part of the Fed in next Tuesday’s FOMC meeting. In any case, ascertaining a directional heading across any asset class will remain difficult until the volatility indexes take a hiatus.
For the week ending August 5th, the Dow lost 6.33%, the S&P 500 7.48% and the Tech-heavy Nasdaq Composite 8.04%. Real Estate was pummeled the most, with most REIT indexes shedding 11% on average. European stocks followed in sympathy, with the Euro STOXX 50 off 10.43%. Chinese markets finished with more modest losses, but then again, they have been in a more controlled state all year due to more responsible central bank policies – unlike our own. On the flip side, the U.S. struggled to eke out a small gain of 1.31%, while bonds screamed higher with the 30 year Treasury shedding some 28 basis points. It gave back 17 basis points by Friday’s close – more on that below. The Continuous Commodity Index (CCI) fell 2.17%. This performance was a mixed showing with agriculture and precious metals offsetting losses in most other areas.
U.S. economic data seemed to exacerbate the downside in the markets. Of note was the personal income and spending figures along with the jobs reports that disappointed the Street. Personal spending actually declined in June by 0.2% while incomes rose less than expected. As for the jobs, or the lack thereof: Challenger job cuts rose 59.4% year over year, ADP Employment for June produced a meager 114K jobs, and the US unemployment rate fell 0.1% to 9.1%. Non-farm payrolls rose by only 114K, a far cry from the 250K or more needed to reflect healthy economic growth. The remaining data for the week was better, such as car sales and mortgage applications – obviously benefitting from the recent drop in interest rates.
Intervention seems to be the order of the day overseas. Italian and Spanish bond markets are the subject of recent deterioration – along with stocks across the continent. In response, the ECB is active in monetizing debt to stabilize. Even though ECB remains pat on rates, we do believe ECB QE2 has officially begun. German, French, Swiss, Swedish and Dutch bond markets all held their gains for the week and continued to marginally outperform US bonds in the race for “safe haven.”
Old habits do die hard – the ongoing party in the US Treasury market is a typical chapter and verse drawn from the Wall Street recession playbook. Unfortunately, there is nothing normal or usual about the current situation. It’s clear, perhaps for the first time in US history, that monetary stimulus has failed while record debts and deficits remain – all at the forefront of what may prove to be a major downturn in US economic activity. We won’t bother connecting all the dots in the equation today, but the gist of the matter should evident even to an untrained eye. If you couldn’t pay your debts when business was “good” how can you pay them when business gets much worse? It goes without saying that we have a hard time seeing the insatiable appetite for Treasuries having any real legs. Instead, with the metals holding in a bullish pattern, despite this week’s turmoil, the market may be gradually rewriting the aforementioned playbook.
Have a great weekend.
President and CEO
VP Investment Management