Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. Lessons in the exponential function: 25, then 146, now 962. Those were the successive values of the European bailout, in US dollars – from what was asked for to what was delivered. This week, when the second largest currency area, and the very largest area by GDP (collectively), required a trillion dollar IMF Public and Private bailout, the reputation and trajectory of the EU project was altered for a generation, if not permanently. The Global financial community is being propped up, and rather than be liquidated and its assets sold off, it is being inflated into a greater center of risk in the world financial system.
France (primarily banks) holds $911 billion of Southern European debt. Germany 704 billion, and Britain 418 billion (again mainly on bank balance sheets.) We know Tier One Capital Ratios are well below that in the US banking system, with the UK being only slightly better. Thus, even small debt depreciation would cause insolvency. How small an amount? 6-8%. The EU was not bailed out. EU Banks were saved in the name of stability and a return to normalcy. That is now impossible.
Keep in mind the impact on the Chinese balance of trade from a weaker Euro. Realize that the goal of US Dollar independence by that country is postponed by a freshly weakened Euro area. China may be more compliant to US Foreign Policy pressures in this environment. We do not see China leading the world out of recession as some have suggested, and are certainly cautious with that region as an investment theme.
2. “Think Locally, Act Globally” … I know that’s not exactly how it goes, but we witnessed a classic case of national self interest expressed in the North Rhine-Westphalia election in Germany. The most populous state voted the Merkel party out. Unhappy with German politicians giving away German tax dollars to any other EU country, and intolerant of their opinions being ignored, they threw the rascals out. It seems a similar theme has developed in the UK. Cameron comes into office (in a coalition) in a vote that has to be viewed as reactionary. People want change. Political volatility spells market uncertainty, and volatility.
3. Investor sentiment remains frail, and markets have moved to gold with fresh enthusiasm (new highs for the metals this week in the face of a rising Dollar – we are doubly benefitting). Other indicators: Emerging markets are at critical levels and breaking down. China has led the other global markets up as well as down since December 2007 – it has not followed the rise in the DOW, and is now topping out. This is a leading indicator for US and Global markets. Brazil is similar. Australia is similar – particularly with the pending imposition of the increase by 40% in taxes on mining revenue. Summary: World markets are set to move lower.
Meanwhile, earnings are offering an insight into the media hype of a new bull market. Cisco Earnings were up on record revenue. At first glance that sounds good. What’s the context? We saw $1.5-2 billion in sales added from acquisition not organic growth. The difference is that their earnings improvement doesn’t necessarily support recovery. The revenues are from a brand new source.
Staying the course……
Have a great weekend!
VP Investment Management
President and CEO