Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. Of Tar and Feathers. Caution is warranted – a clear tell being this week’s behavior in the overseas markets. Recent lows were not revisited, but the weekend sell-off related directly to bank solvency concerns and the fundamental debt plague gripping the US and Europe. Global growth expectations are being revised lower again and again, with each prospective engine of growth encountering its own problems.
Global equity investors were again selling shares in acknowledgment that economic growth is not shaping up as nicely as hoped. A favorite gauge in the Chinese market is now down over 50% in the last year. German economic statistics are softening, and with them ECB interest rate expectations. Chinese markets will face further credit-related pressure, leaving no engine of growth, whether American, European, or Asian.
We suggest a restful weekend for both mind and heart; next week may have them both racing rapidly again. A vote will be taken in Germany on the 7th of September to determine whether the European bailouts are legal according to the German constitution. Should the monetary lifeline in question become a political impossibility, there will be significant reactions throughout the European financial community and financial markets. If there was a thread of hope in the continuing saga of institutional and sovereign bailouts, it will disappear – with global equities reflecting a level of concern last seen in the fall of 2008.
Preview of coming attractions in Europe – incumbent politicians will need to consider new career paths. To summarize: The debt structures being held up by bailout dollars will eventually collapse, and with them the confidence to keep current governance in place. Highlighting the reverberations in the political sphere from the current European fiscal mess (and looking again at Germany), we see continued concern over how much authority the German parliament wants or should have in doling out EFSF funds (the bailout funds made available for financial triage by other European countries). Having a €211 billion stake in the fund, voters won’t appreciate a failed effort.
Understandably, the German parliament wants more of a voice. There is political risk in delegation to a small pan-European committee. Each parliament throughout Europe is answerable to their constituents, but each parliament lacks the control over how the money is spent. An added complexity is that emergency decisions are not quickly made by one parliament, let alone 17 of them. If voters don’t feel represented, they stage a revolt – if only at the polls. If you want an easy bet, go long political volatility calls expiring late 2012. Or just continue to own gold. The saga continues….
News from the Greek isles: Two-year Greek debt instruments now yield 47.2%, up 3% in the last week alone. (Greek debt and Iraqi dinar … all upside from here? Just kidding.) As austerity measures are attempted and taxes increased, the response on the ground is negative. A collection of 15,000 restaurants and hospitality businesses has flat-out refused to pay a 10% increase in VAT taxes. This was a part of the IMF and EU bailout plan to raise revenues. So the Greeks will evade taxes (that‘s never happened), and the government will threaten with fines. This a tough environment for politicians. Global demand for tar and feathers should be strong going forward. Keep a close eye on all your chickens.
2. Bad News Was Good News. Until recently, the markets have been operating on the convoluted notion that bad economic news leads to QE, and QE means higher stock prices. Good economic news has therefore tended to reverse that calculus, resulting in lower stock prices. Today, however, an abysmal jobs report delivered a dose of reality to that absurd reasoning. Stocks tanked, bonds and the metals soared, while the US dollar remained flat – giving a no-confidence vote to the Fed and its extensive set of “tools” to propagate economic growth (more on this below).
For the week, stocks were generally flattish, with defensive sectors (utilities and consumer staples) outperforming. The 30-year Treasury advanced, with its yield falling 24 basis points to 3.30; 10-year yields followed suit, dropping 20 basis points to 1.3%. Again, the dollar was flat, generating zero momentum to the upside, even after “breaking out” above its 50- and 100-day moving averages.
Commodities, on the other hand, remained firm – yet again. The CCI index remained in the green during Friday’s trade, gaining 0.60% for the week. The CCI is now up 29.23% over last year, giving very little ground from its peak in April this year. As for foreign markets the mood was very similar, with German and Asian (believe it or not) bond markets receiving the lion’s share of flight capital.
U.S. economic data was dominated by the jobs report, which saw no change in the unemployment rate of 9.1% for the month of August. Non-farm payrolls gained nothing, producing zero jobs (250K would suggest expansion). To add insult to injury, non-farm payrolls for July were revised down to 85K from 117K. Private payrolls added 17K (95K expected) and manufacturing payrolls lost 3K jobs. Manufacturing payrolls were revised up 12K for the previous month (July) to 36K – the only positive in the report. Factory orders (+2.4%) and total vehicle sales (12.10M) saw impressive gains, perhaps on the heels of the rally in bonds or, in the case of autos, GM could be stuffing the channel ahead of an expected strike by union workers.
Away from home, China continues to exercise responsible monetary policies, increasing reserve requirements once again to curtail frivolous lending and dumping U.S. dollars in exchange for resources. China upped its purchases of copper in the latest month. China will represent 38% of global copper demand this year.
Canada’s GDP unexpectedly declined in the second quarter of this year (following suit with the US), and Switzerland has decided that a strong currency isn’t half bad – allowing it to appreciate. The Swiss national bank issued a stimulus package that was lower than forecast.
Japan may also be adopting a more moderate stance against shredding its currency (we mentioned a higher rate of inflation had emerged there last week). Japan’s newly appointed finance minister, Mr. Yoshihiko Noda, happens to be a fiscal and foreign policy conservative who opposes large scale welfare spending – instead he favors reconstruction financed via a consumption tax.
Central bank attitudes are clearly changing with respect to monetary policies, both here and abroad. The tendency to print is diminishing rapidly because of the threat of rising inflationary pressures – witnessed of late by the solid performance in commodity prices.
We believe this is exactly why the Fed may be waffling on QE3. In fact, the Fed may be pulling away from such a move (at least for the moment) more than the market cares to admit. In the latest week, the Fed balance sheet shrunk by $5.761B (mortgage backed security purchases declined $7.405B). This is in stark contrast to actions taken just a few weeks before, where the Fed monetized aggressively just after Jackson Hole. It could be that in the absence of a dollar rally and a subsequent commodity pullback, the Fed (and others) may be caught trying to strengthen the currencies instead of shredding them to attain the needed contraction in inflation. It makes you wonder if an inflection point has been reached – and if a new Volker era has been born….
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