Central Banks Underwhelm – July 6, 2012

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

Central Banks Underwhelm

Markets responded favorably to the conclusion of the EU summit last Thursday, although we have a hard time seeing why.  In terms of the monetary impact, not much has changed.  Money (€100 billion) will be lent to ailing Spanish banks and corresponding austerity measures relaxed.  In exchange for the bailout, Germany effectively bargained for greater (almost absolute) control over a proposed fiscal union – a single banking supervisor (possibly the ECB), which may be in place by year-end.  As previously stated, the EFSF will be phased out and replaced by the ESM’s €500 billion facility, from which loans and or refinancing will be made.

A change in treaty will be required for the ESM to lend directly to banks.  For now, credit will continue to be extended to sovereign entities, albeit it be with greater ease (red tape visa via the Troika), private sector recourse, and with an “off balance sheet” accounting privilege.  We could go on about the details if we had any confidence in their relevance, but we don’t, as the rules and conditions have had a tendency to change.  As far as current market impact is concerned, aside from the hoped-for fiscal union, there wasn’t much to get excited about.  Rallies in stocks then faded into this week as the focus shifted back to reality with lackluster US corporate earnings and a softer global economy (See the box scores).

It’s hard to say exactly how this earnings season will end.  By that we mean that we wonder if the markets will play the QE card on bad earnings and rally, or instead discount negative realities.  Of the majors, Alcoa will kick things off with its report at the close next Monday.  At that time, we’ll get an idea of how the markets want to respond.  In the case of Alcoa and others, expectations have been set rather low – setting the stage for an easy game of “beat the number.”  We have already heard from Bed, Bath & Beyond; Nike; Ford; and Seagate Technology. Each has disappointed, and seen its shares punished as a consequence.

US economic data went largely ignored up until the rather ugly jobs report on Friday.  Of note for the month of June, the ISM manufacturing index slipped into recession territory with a reading below 50 (actual 49.7).  Domestic vehicle sales came in a bit better than expected at 11.05 million (vs. expectations of 10.89 million; we’ll see next month if the dealerships can unload the inventory), while non-farm payrolls disappointed with only 80,000 jobs created – far short of what’s needed.

Overseas, central banks were found easing in the face of worsening economic conditions.  Benchmark interest rates were cut by the ECB (1.00 to 0.75%, overnight deposits to 0.0%), PBOC (6.31 to 6.00%), and Denmark (0.45 to 0.2%).  Incidentally, Denmark will now penalize its banks (by charging for money on deposit) for not lending money to the public.  All of this is to say that the markets wanted a whole lot more to maintain positive momentum. Spanish and Italian bonds eradicated recent gains and advanced once again into critical territory.  Stocks (i.e. the Euro Stoxx 50) also failed to break major resistance levels, reaffirming the bearish trend. The euro fell to new lows against the U.S. dollar, subsequently pressuring the gold price in dollar terms.

Gold continues to show signs of stabilization, regardless of the rally in the dollar.  Said a different way; while the dollar makes new highs, gold is struggling to make new lows.  This doesn’t mean we won’t see some additional consolidation in the metals, but it may be suggestive of a subtle shift in sentiment regarding the fate of the dollar. Beneath the surface, the dollar isn’t much better than the euro; both are flawed. Therefore, buying the dollar simply because it’s not the euro may prove a fool’s errand.  As the US economy worsens, we suspect that pressure to inflate the dollar will build – subsequently reducing its attractiveness as a port in the storm.  For now, the level of denial regarding our precarious condition remains relatively high.  Ultimately, though – and soon, we think – insolvency issues on both sides of the Atlantic should lead to much higher prices for the metals.

Best regards,

David Burgess
VP Investment Management
MWM LLLP

2014-10-02T18:41:32+00:00