Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. Unstoppable? Eurozone markets may be stuck in an uncontrollable and perpetual state of motion – to the downside. Insolvency has led to higher rates, higher rates have equated to lower economic activity, and lower economic activity has exacerbated insolvency and so on and so on.
ECB monetization efforts to halt the slide seem to produce mixed results at best. Italian, Spanish, and French bonds rallied, while related equity markets fell during the week. US Fed officials Evans, Dudley, and Rosengren joined the ECB, jawboning about the virtues of QE. This kept US stock markets from hitting the skids on Wednesday (in response to the breach of the crucial 7% level in Italian debt), but it only slowed the decline in stocks as they finished the week with heavy losses.
The indifference shown by stocks to actual QE (by the ECB) and or prospective QE (by the Fed) may be suggesting that inflation (i.e., $100 oil) remains a formidable threat. Perhaps it reflects an erosion of confidence in Central Bank abilities to restore economic and fiscal balance – but it’s too early to draw that conclusion.
2. A Brief Overview: Stocks worldwide gave up some considerable territory to Treasuries, German Bunds and the dollar. The metals struggled, rising and/or maintaining their ground overseas, but again lost ground to Treasuries as the safe haven of choice in US markets. Please refer to the box scores for results.
Favorable US economic data was trumped again by sovereign debt issues abroad. Consumer spending was strong as retail sales advanced 0.5% vs. expectations of 0.3%, while inflation moderated with both the PPI and CPI falling below expectations for the month of October. Both inflation indicators actually turned negative in comparison to September, reflecting the recent cooling of commodity prices from mid-year levels. The benefit of lower rates at the expense of stocks obviously remains stimulative to the economy – however dysfunctional that may be.
Overseas, the situation still remains hopelessly “uncontained,” and is spreading. French sovereign debt spreads to German Bunds still hover in record territory. However, Moody’s has now fixed its gaze on the German debt markets as well, downgrading 10 German lenders (not including Deutsche Bank), targeting their senior debt and deposit ratings. The BoE has promised a third round of QE in the coming months, but, similar to euro and US markets, the effects have been mixed. Bond prices have firmed, but stocks have yet to gain any meaningful traction to the upside.
We almost titled this section “Bond for Gold Swap, Part II,” but noticeable indications that Europe has joined in Asia’s appetite for the trade are still too infrequent to emphasize here. We would like more hard data before reaching this conclusion. However, we are not alone in the expectation. Bloomberg ran an article titled “Gold Top Pick at Morgan Stanley as Europe Debt Spurs Demand.” We are not terribly fond of the word “pick” as it pertains to investing, but the article contains some insights into the near future for the metals. In the meantime, the metals may grind a bit higher into year-end on the heels of performance gaming and/or Fed QE prospects.
3. It’s Their Density: George McFly approaches Lorraine Baines in the movie Back to the Future and, as any good nerd will do, stumbles over his words at the critical moment. “Lorraine, my density has brought me to you.”
I can’t help but feel a Back to the Future moment as we encounter the density of elected officials putting their best foot forward in an attempt to woo the crowds in an election year. Maybe they are thinking tough talk with numbers that are above the comprehension of the average income earner (for example billions, trillions, quadrillions) will make it seem like they are doing their jobs? Let’s put together a “super” committee of “super” people to do a “super” job of cutting 1.2 trillion dollars from what we spend over the next ten years. Laudable on the surface, but laughable if you dig a little deeper.
Keep in the mind the difference between the words “each” and “over.” CBO reports show our current budget trajectory and the increase of nearly 1 trillion (actually 976 billion – do you mind if we round up?) a year EACH year for a decade. Now, with that in mind, consider the target of cutting 1.2 trillion OVER 10 years? That’s 120 billion per year, while the deficit projections are over 8 times that number each and every year.
The bottom line: If the “super” committee is successful over the next few days in implementing a US version of austerity, they will spend an average of 856 billion dollars each year that they don’t have, instead of the 976 billion previously mentioned.
Next time you get the chance to meet your elected official, perhaps you’ll recall McFly’s second verbal miscue as the words, “I’m your density, I mean … your destiny!” come out of your congressman’s/woman’s mouth. Our political elite indeed is charting a scary destiny; and much of it does hinge on their density.
Let us remember that government spending (beyond the necessities) is no more than a redistribution of and usurpation of spending which we individually could have controlled. Political promises to pay if elected and reelected merely serve to take money from the many and redirect money to the few (via lobbying).
We would suggest that too many promises have been made for such political support. To try and increase the tax take assumes that those political payments are legitimate and/or necessary in the first place. I have acquaintances that financially flourish (we are talking about very wealthy individuals) because they have been able to creatively siphon off tax dollars for special projects, contracts, grants, and the like.
Why this is irksome, if it’s not obvious, is because it’s MY money and YOURS that is doled out. We have a budget based on graft and whitewashed corruption. I see hundreds of Berlusconis in DC, and am fairly convinced that unless they all resign the real work of austerity implementation and recovery cannot begin.
To date, the US has failed to implement austerity, even as Europe begins the gradual process of restructuring its super state, under fresh leadership (more to come in 2012). Let’s see how far they are willing to go. More austerity equals less monetary madness (inflation), and vice versa.
By allowing government to spend money we don’t have, we have burdened future generations with debts that we would never obligate ourselves with individually. Every constituency group that receives federal dollars should ask themselves, not if they like receiving a handout, but rather, if they mind enslaving their children and grandchildren for the pittance of a handout received. Perhaps we need to embrace an increase in taxes to bolster revenues. But before we do, we should know that each dollar spent is a dollar well spent, and not just more political graft.
VP Investment Management
President and CEO