Beware Greeks Bearing Bonds

We have to thank Mark Hulbert of the Hulbert Financial Digest for regular reminders about contrarianism. The latest consumer confidence and consumer sentiment data are not a reason to worry about the length or strength of the economic recovery or the market advance. He notes that consumer sentiment is very much a lagging indicator and in times past has bottomed well after the onset of bull markets and economic recoveries. The current low for consumer sentiment was way back in May last year, although we aren’t that far from those levels after this past month’s reading. Typically, consumer sentiment turns several months after the onset of recovery and even further after the onset of bull markets. The recent reports are just a couple more bricks in the wall of worry that this bull market must climb.

The idea that everything must be hunky-dory before equities can do well is a fallacy. When everything is hunky-dory, stocks tend to be over-owned, over-believed, and overvalued. High degrees of consumer confidence are actually bad for stocks in the intermediate to long run. Skepticism is what bull markets thrive on.

Think of the examples of great buying opportunities of the past. They have all come at times of uncertainty. When the world seemed to be coming unglued in the mid-70s with oil embargoes, currency weakness, global recession – the worst since the Great Depression, war in the Middle East, and a bunch of other issues too numerous to list. Yet, we survived and we made lots of money for a few years. The picture might have been worse by 1982, interest rates at 20+%, unemployment above 10%, inflation above 10%, the world in chaos, deficits as far as the eye could see, awful, awful stuff. Yet, we survived and went on the biggest rise in stocks since the 50s. What mattered was the part about we survived. These economic issues are transitory. That situation is always changing. The bigger picture is always the same, billions of people trying to improve their lives any way they can. That global urge has been partially thwarted by unyielding religions, political systems, despots, natural disasters and other plagues, but it survives.

As we move into each new year, more and more people are doing better than the year before. We haven’t eradicated hunger, disease, poverty or ignorance, but we are moving ahead. So long as we are better off than before we can keep moving in this direction. We had less to be sanguine about back in the early 80s than we have today. The odds of total annihilation have probably dropped pretty substantially in the last 30 years. I doubt that President Obama could find the big red button in the Oval Office today. No, Bush the elder took care of the Ruskies once and for all (well maybe not for all). China is an economic competitor, but not a military one. Take a second and count your blessings and you’ll see that they amount to more than you thought, maybe not as many as you’d like, but more than you thought.

Crisis of the Week

Okay, this week we’ve had another disaster, not the earthquake in Chile, that’s a natural disaster, not man-made. Okay, so Greece isn’t a new disaster, they just got their debt downgraded by Standard & Poors. Does that come as a surprise to anyone? Maybe it happened a little quicker than most folks expected, but given the history of credit ratings, at least they didn’t wait until after they defaulted to cut it. Any default is at least years in the future according to most folks who supposedly know about these things. Also, a report states that Greece, since its war of independence from the Ottoman Empire in 1832, has spent just about half of their modern history in default on some or all of their foreign debt. A new default would be more in character than for most European countries.

The issue here is really a slippery-slope kind of deal for the European Union. Once the EU starts bailing-out members we’ll get a new, improved definition of moral hazard. Moral hazard today means more of less that society has compelled some group or organization to perform some service or accept some limit on their freedom and thus society has a responsibility to protect the organization against the repercussions of those limits or services. So, once the US decided to make the major US banks the agents of its monetary policy, it felt it had to save them from the repercussions of US monetary policy.

The Europeans are facing a similar problem, once it lets a member state of the EU welsh on its bargain to keep government deficits below 3% of GDP or maintain other requirements of membership in the EU, what do they do? If the Greeks can run large deficits, why can’t the Portuguese? Why not the Spaniards? Why not the Germans? If the rules don’t work, how can you enforce the rules? The EU would prefer to save the Greeks, so long as it isn’t too expensive, in order to save the Euro. But, if the price is too high, do they kick Greece out of the Euro? Does the Euro have to be amended in some major way? Can they continue to grow the Euro-zone? All these questions because Greece broke the rules.

As things stand today, the Greeks can pay their current debts, but they are approaching the limit of how much debt they can shoulder. The point may come where Greece can’t service their debt but they still need to borrow. That day will be real interesting. Any package of EU fixes will be directed at maintaining Greek access to credit markets and postponing the day when the Greek crisis becomes the Greek tragedy (come on, you saw that one coming a mile away).

Also, the EU would like to create a template for how to handle all the other miscreants in the EU, Ireland, Portugal, Spain, and Italy. Whatever they come up with, it had better be flexible, fair, effective and affordable. Yeah, there’s nothing they can do but kick them out.

The new wrinkle in this whole sad affair is the attack on the Euro by hedge funds. Because of the Greek tragedy, many people in the hedge fund world think the Euro is overvalued and needs to come down. If enough hedgies sell enough Euros, can they make that happen? The Euro is a huge market and there is some question as to whether the hedge funds have enough ammunition to take it down. This will at least cause a lot of volatility in the Euro over coming weeks and maybe months. It could also mean that many hedge funds are going to have a lot of eggs in the Euro basket. If the attack on the Euro fails miserably, it could cause a lot of bleeding for a lot of hedge funds.

Economic News

GDP revisions – It was interesting looking for the GDP revision statistics. We must have gone by at least half a dozen other economic reports before we got to the GDP numbers. The common theme was that bad numbers got top billing while the relatively benign GDP numbers were an afterthought. That is fine with us. It means that the collective psyche is still focused on bad news and not much good news is imbedded in stock prices.

Speaking of good news, the GDP revision was good news. The GDP was revised higher in the fourth quarter, to 5.9% from 5.7%, which comes as a bit of a surprise to us. Real final sales were revised lower and inventory adjustments were revised higher. The adjustment to final sales took the number from 2.2% growth to 1.9% growth, still growth. The inventory revision means we depleted even more inventories that originally thought.

Final sales can come from one of three sources, current production (that is what we are trying to measure here), inventories (production from a previous period), or imports (production from somewhere else). When inventories fall, all other things being equal, this means that production had to be higher to meet demand. Since inventories continued to fall in the fourth quarter, our economy produced more stuff than the final sales number indicated.

Exports and business investment still were major parts of the fourth quarter gains. Consumer spending was tepid, but positive. The quarterly numbers will be revised one more time before they are put in the record books. And even then, further revisions are likely.

Case-Shiller home prices fell again in December. After a few months of mixed results, there was some hope that the worst was over in declining home prices. That belief was evidently premature at least. Oddly, it was some of the worst home markets the either fell the least or gained in December. Los Angeles, Las Vegas and Phoenix all gained, though marginally. For the twenty-city index, prices fell (0.2%) in the month of December and (3.1%) for the year ending December. Competition from foreclosures was blamed for some of the price weakness. There is a wave of further foreclosures sweeping the nation as many of the longest teaser rates are now running out and mortgage payments are rising for the folks who had those loans. It was one thing to watch the value of your home fall by a third, but when that payment goes from $900 a month to $1500, that’s a killer. Actually, that is often exactly how it works. People put-off making a big decision until they absolutely have to. So long as the low mortgage payment was very affordable, it didn’t matter that the house value was in the toilet. Now that it isn’t so affordable, well when in Las Vegas, do as the Las Vegans do.

New home sales fell for the third straight month, this time by 11.2%. The consensus of economists was looking for a very small rise in this series. The drop puts this series at the lowest point in its history, which goes back to 1963. The population of the US has at least doubled since 1963, which shows just how out of whack the housing situation is these days. Home sales do not necessarily translate into home closings as a decent percentage of sales fall-through these days. The pace of an annualized 309,000 new homes is a far cry from the 1.7 million new household formations in a typical year these days. It is also interesting to note that more homes sold for below $200,000 than above. Even at a mere $200,000, that price would be a stretch for the average family in the US that earns roughly $59,000 a year. Remember that’s a family and more than half of families have more than one wage-earner. Unusually cold and snowy weather in the Northeast likely had something to do with the poor showing.

Existing home sales fell again, even after the record decline in December. The fall of 7.2%, to an annual rate of 5.05 million homes, gets us back to the level of sales before the first-time home buyer credit was instituted last summer. Some of the shortfall could still be the shadow of the first-time home buyer credit. But the new credit for both first-timers and repeat buyers has kicked in since then. So, what goes?

Durable Goods orders rose in January by 3.0%, much stronger than expected. But, were it not for aircraft orders, the number would have been down. That was a bit surprising to the economics community. The decline of 0.6% for non-transportation durable goods was about as surprising as the 15.6% gain in transportation orders. Many people thought that business spending would accelerate in this quarter. Maybe it will, but it had better hurry.

Consumer Confidence swooned in February from January. The drop from 56.5 to 46 was far sharper than economists were expecting. The drop was largely due to changing attitudes about the jobs market and the pace of economic improvement according to the Conference Board. (Not to editorialize (but we will), the people they interviewed to reach this conclusion must have been nuts. This is a period in which we saw that the economy was growing rapidly, where job destruction nearly came to a halt, and where the major concern in markets was when all the stimulus would end. This is rear-view mirror stuff and will probably be reversed next month.)

Consumer Sentiment fell a little bit from 74.4 in January to 73.6 in February. This doesn’t really concur with the Consumer Confidence report above. This is a different survey, with different questions and reported by a different organization, so the difference should be expected. But the trend in both was down, just nowhere near as radical a move in the Sentiment index as the Confidence index.

Weekly Stuff

Did it seem like last week was a good week to own bonds? Well, it was. Bonds of virtually every stripe were higher by Friday than they were to start the week. The Greek Tragedy was good for US Treasuries as crises usually are. Other bonds followed the Treasuries higher, even high yield bonds. But, after the last few weeks of generally better bond prices, maybe this is the blow-off of that rally. We have gotten back to the low yields for Treasuries for the year to date. Next stop would be the lows from early December or early October (before we knew the recovery was on).

US stocks were down, the bits and pieces of bad economic news may have helped on that front. Oddly, when bonds go up and yields go down, that makes stocks more attractive in the abstract, dividend discount model sense. But, so too does the price going down, even if that decline is only a fraction of one percent. The major US stock indices were off from three-quarters of one percent to only a quarter of a percent. The Dow got hit the hardest, but then when you only have 30 stocks and one of them, Coca Cola, does something stupid, it has more impact. Coke is buying up its largest bottling company with the aim of improving its grasp on the health drink market. When sales growth in Coke are slowing and growth in flavored water or vitamin water are growing, Coca Cola wants a bigger piece of that. Surely, there were other underperformers last week, but KO was enough to make a difference.

The MSCI EAFE was higher, with a falling dollar helping a little no doubt. In local currency terms, most developed markets were down on the week.  The news environment was worse in the developed overseas markets than in the US. The crisis atmosphere seems to permeate everything in the media reports. But then, why should we be any more trusting in the news from overseas than we are of the local talking heads? A good crisis makes for better news than the dreary improvement in container shipments or corrugated paper box sales. Emerging markets were mixed with China up and Latin America down.

Foreign bonds were generally higher, following the trend that bond markets like bad news and the badder the better.

Real estate securities markets were broadly higher last week. Gains of a percent were common. Why? We haven’t a clue. But, with the news environment shifting from commercial real estate as the boogeyman to sovereign debts, maybe that was all it took.

Gold usually reacts positively to crisis, but not this time. Gold in Euros had a nice rally, but in dollars it was down. Among other commodities there was a general decline. Energy prices slipped. Agricultural commodities were also largely down. Industrial metals and the other precious metals trended lower.


Have a great week.


Karl Schroeder, RFC

Investment Advisor Representative

Schroeder Financial Services, Inc.