We have been asked by several of our advisors why this European Financial Contagion is so important and we are stumped. It shouldn’t be all that big a deal. Whether the Euro stays or goes won’t matter much in ten years time, unless it is still causing trouble for the member states then, too. We have beaten to death the idea that Greece doesn’t really matter on the world economic stage or that Portugal doesn’t matter or that Spain doesn’t really matter all that much.
These are small actors. Even the Euro-zone as a whole is only the second largest economy in the world. The economic repercussions of the worst case scenario for Greece, Portugal, Spain, Ireland, even Italy wouldn’t mean the end of the world, even for them. The recent decline in prices of many global markets is all about fear and risk.
Let’s digress for a paragraph or two and try to remember how the markets work. On a day to day basis, there are buyers and there are sellers. On days when any market goes up, there tend to be a few more anxious buyers than there are anxious sellers. On days when any market goes down, there are more sellers than buyers. On up days, the sellers are in command, think about that for a moment. Really, think about that! When you want to buy a loaf of bread, the market is in command because they have the bread to sell. They determine their price by what buyers are willing to pay. The same goes for stocks. If you really, really want to buy some Apple (AAPL) you’ll have to bribe some current shareholder into selling theirs to you. The sellers are in charge on up days. And the opposite on down days, the buyers are in charge!
The other thing to think about is whether this is a stock market or a market of stocks. That idea is extremely pertinent these days as people who have one of those opinions can be very disruptive in the short-term. The ‘stock market’ people believe that markets are fairly efficient, that you can make sweeping statements about the stock market and that if you’re right in your statements, you can determine where the stock market is going to go. This is a macro-view. The market of stocks people (and you’ll guess pretty soon that we fall in this camp) think that you have to look at the stocks themselves and have a good idea how they will work out and that will tell you where the ‘stock market’ is going. This is the micro-view. We keep asking whether this or that news item or trend will impact sales of Coca-Cola or toothpaste. The reason we do that is to make the point that this or that news item or trend may not matter at all to the stocks themselves.
In this vein, do riots in Greece matter to sales of toothpaste? Maybe, if enough teeth are knocked-out, but probably not. The stocks will go on about their business whether the ‘stock market’ likes it or not. What matters is that we are not as sanguine about the near future when there are riots in the streets, even in Greece. We are more afraid. We are less likely to accept risk, like the risk that toothpaste sales won’t meet expectations. So we aren’t willing to pay as much for the stocks in the stock market. Risk tends to impact the macro-picture, regardless of micro fundamentals.
So, this whole little drama with Greece and its impact on stock prices is all about risk appetites or lack thereof. We were just starting to get our risk appetite back after the last bear market and were just starting to feel like stocks weren’t all that bad after all. Then, bam! Something comes along to wreck our newly found risk appetite. As we indicated above, nothing in the Greek Tragedy will impact the results of very many companies very much. The fundamentals will go on about their merry way regardless. Ultimately, stock prices will follow the fundamentals and the stocks will go up, dragging the ‘stock market’ with them. Our only real question is when?
Crisis of the Week
Its May Day again and the workers of the world are demonstrating, at least the Greeks are. That nation continues to garner more than their fair share of attention for being the poster-boy for excessive public spending in a welfare state. The Greeks have faced their own civil (or rather uncivil) servants across the picket lines. The riots and demonstrations in Athens have now caused several deaths and a great many injuries. Shall we “buy when there blood in the streets” to follow Nathan Rothschild’s advice? We think if you can do that you are more of a contrarian than we are, at least Friday (not so on Monday).
The Greeks were given what appeared to be a very generous bail-out package and then the world wondered if it was enough. Maybe so, maybe not? The real question is whether the same sort of package for Portugal or even Spain would be workable. As we’ve been saying for quite some time, the real point of Greece is that they are the precedent for other bail-outs to follow.
Oddly enough, the European Central Bank had their monthly policy meeting in Lisbon, Portugal this month rather than in Frankfurt. The announcement of no major policy initiatives from Lisbon is one reason why we are back talking about Greece today. Had the ECB decided to put some real muscle into their help for Greece, they’d have met popular expectations and started buying Greek sovereign debt in a bid to stop the raid on Greek sovereigns by hedge funds and other speculators.
Okay, the news today is the ECB, several European nations, the IMF and to a small effect the Fed have put together an aid package worth nearly a trillion dollars to help the flailing peripheral economies in Europe. That may not put an end to the problems within the Euro, but it should push this crisis to the back burner for a couple of years. We hope. (We are loathe to undo any of our thoughts just because they are made obsolete by history as it marches by. It does show how quickly today’s concerns turn into tomorrow’s solutions. Remember this the next time you believe it truly is time to jump out of a window due to some goofy thing the market is doing. Tomorrow is another day it will probably be more reasonable than today. Then again, maybe not.)
The employment report was terrific! We added 290,000 workers to payrolls across the country. Only 66,000 of those were temporary census jobs. We created about 100,000 more jobs than the consensus expectation of the economics profession (and we use that term loosely). We also saw that March’s employment was revised higher, to 230,000 workers from 162,000. And, February was revised from a loss of 14,000 jobs to a gain of 39,000 jobs. This report was fantastic! Oh, and the unemployment rate went to 9.9% from 9.7% as a lot more people rejoined the workforce now that jobs seem to be growing.
We’re not going to go over the two survey thing again, you’ve heard that way too often, but, the household survey is now saying that the US economy has added 1.66 million jobs since December. That is the fastest pace of job growth in that survey since 2000. The household survey tends to capture gains in small businesses and self-employment that are generally missed by the establishment survey.
The vast majority of jobs added this year have been in the private sector. This contradicts what many see as a recovery built mainly on government spending. State and local government hiring has essentially stopped and in many areas declined recently. Manufacturing jobs increased as did most other categories, construction, mining, utilities, and the old stand-bys of healthcare, professional services and leisure & hospitality. Transportation and warehousing employment fell, however.
The average workweek increased by 0.1 hours to 34.1 hours and average wages rose by $0.01 an hour to $22.47. (Works out to roundly $44,500 a year, not for a household, but for one worker.)
Personal income grew by 0.3% while consumer spending grew by 0.6% in March. The gains in consumption were focused on autos. With the higher rate of spending than income our savings rate fell to 2.7%. The income gains came largely from higher transfer payments (unemployment insurance, etc.), while hours worked and pay per hour hardly budged. Incomes from assets (rentals. etc.) fell for the second month in a row.
ISM manufacturing gained to 60.4% in April from 60.1% in March. The actual gain or loss of a few tenths of a percent don’t matter all that much, it’s the level of the index that matters. The ISM asks all their questions so that the only responses are increasing, decreasing, or about the same. They add together all the increasing and half the ‘about the same’ responses and that is their index value. So, that 60% could be 60% see an increase and 40% see a decrease, or 40% see an increase, 40% are about the same and 20% see a decrease. There are a whole bunch of other permutations. But, the further above or below 50% the more important the number becomes. Staying at 60% or moving to 65% or 70% would be nice, but as the economic cycle ages, further improvement gets harder to achieve. Staying north of 50% is the important thing.
The ISM services index was unchanged at 55.4% in April. The expectation was that we’d see a small gain in this index, but evidently not. The pace of 55% is nothing to sneeze at, but some improvement wouldn’t hurt either.
Car sales fell in April. While economists had expected a small drop, they got a bigger drop. We sold 11.2 million cars (seasonally adjusted at an annual rate) in April versus 11.8 million in March. It was pretty widely believed that the huge incentives that Toyota was offering and that were matched by many other car makers would attract a lot of buyers. Oops, that didn’t work out so well. (Note above we mentioned that consumption was focused on car sales, that was in March, not in April. This is about car sales in April. Keeping all this straight with different series on different timetables is tough. Try to keep up.)
Productivity gained in the first quarter by 3.6%. That means we grew the economy essentially without any increase in employment. That pace of productivity increase is well below the rates of the last half of last year, which were around 6% each. (This also probably means that the first quarter GDP statistics might get revised higher as there actually was some labor force growth during the quarter.)
The Bank of England and European Central Bank left their respective rates unchanged at policy meetings this week. The ECB unveiled a new program to increase liquidity for Europe’s struggling economies (quantitative easing). The ECB has a tough job ahead of it as the big economies in Northern Europe don’t mind high unemployment and slow growth so long as they don’t have to worry about inflation. The Southern European states are more concerned with growth and access to capital. The ECB probably can’t keep both its constituencies happy at the same time. (Most of this last little bit also got obsoleted by the ECB actions. Que sera, sera.)
Okay, we waited until this section to comment on last Thursday’s wild market action. We have to keep this whole thing in perspective at least a little bit. Even if the direct cause of the meltdown in equity prices were some erroneous trades, and even if this got exaggerated by thousands of automated ‘algorithmic’ trades (trades that follow a mathematical rule), that isn’t all that was going on that day. We are constantly amazed that even when times are relatively benign, Wall Street and investors in general will find something to worry about. The current case of Greece is a reasonable example of this. So what if the Greeks are rioting? Do you think that matters at all to investors in Sri Lanka? Why should it? Until fairly recently, they had an insurrection going on that had lasted for over twenty years. They have massive poverty, disease, lack of infrastructure – real problems. Two years ago, when most of the developed world was perched on the edge of the abyss (as the popular media proclaimed it) would the situation in Greece have mattered to anyone? Heck no! We had real problems then. So, what do we think is the problem? People are anxious.
As we alluded to in our note last week, we have a lot of fully invested bears out in the markets these days. People who are leery of the market and concerned about valuation or sentiment or lack of momentum or whatever, but are fully invested nonetheless. This undercurrent of anxiety means they will seek any excuse to sell. They have been hard-up for excuses lately with the market near recovery highs, fantastic earnings, expansion of employment, better economic growth, etc. But, they are willing to adopt any idea that validates their pre-conceived notion that stocks are extended and due for a pull-back. If enough people believe the same thing, it might as well be true. Like the Japanese say “if we all cross the street against the light together, no harm can come to any of us.”
There is a lot of fodder for future missives in that one day of trading. We’ll be talking about that one for months. So, one more little bit and we’ll leave it alone for the time being. Just as we were beginning to get the least bit sanguine about the equity markets, sentiment was just turning bullish after the former little correction; this debacle has set sentiment back for months. It also makes it easier to believe we will have a better summer and fall. The ‘wall of worry’ is being rebuilt, another story to top that off.
Stock prices fell precipitously last Thursday and followed up with a another drop on Friday, probably as much as anything people getting around to selling after they got the ‘news’ Thursday night. The drops in US markets between 5% and almost 9% were indicative of the wild change of mood. To think that we are always just a couple of whacky trades away from something just as bad and we don’t even think about it. The small caps got the worst of it, probably because they were overvalued, over-owned, over-believed, while the Dow did relatively better. Some of the highly cyclical areas, materials, industrials, technology, got hit the hardest. Areas nearer the consumer tended to do better. No area that we saw was actually spared, even utilities went down.
Foreign stocks fared much worse. Not only did the Europeans have some relatively more direct risks to face, Greece is in their backyard, but they also are being compelled to take steps that will probably slow down their nascent recoveries. Europe got the worst of it, but Asia and Latin America suffered as well. The Greek market was down about 20% on the week. The broader DJ Euro Stoxx index was down about 12%, including most leading European stocks. London was off 7.6%, Paris 8.6%, Frankfurt 6.9%. Tokyo was only off 6.3%, those lucky guys, but they have their own problems. The rest of Asia was down less but not a lot less. Latin America was hit as well with Brazil down 7% and Mexico down 4%.
Bonds did not reflexively rally, except Treasuries. Most high grade sectors held fairly steady, at least by comparison, while high yields got hurt pretty badly, down 2.5%.
Foreign bonds were hurt more by the run in the dollar than anything else. The dollar gained over 3.3% against a basket of leading global currencies, 4.8% against the Euro. Otherwise, the stronger European credits gained as did Japanese Government Bonds. The UK was hurt by an inconclusive election.
Real estate securities acted more like financials than usual. The index for US REITs fell 6%. Foreign REITs fell even further.
Commodities were hurt by declines in energy prices. Crude oil fell by 12% as panic overtook the pits. Many other commodities fell in sympathy with stocks. It was quite apparent that many arbitrages were coming unglued, especially if they used dollar-based leverage to make them work. The dollar-carry-trade was coming unhinged. When are these bozos going to figure-out that betting against the greenback is risky? Because every time there is any kind of hiccup, anywhere in the world, the dollar rallies on the safe haven trade.
Post script – Think of this, if it hadn’t been for that snafu last Thursday, we’d be sitting at new highs right now. Image what the world would look like were it not for a few errant trades and a huge, miscalculated mistake on top of the original sin of a couple of bad reports. We could be off to the races with nothing clouding our horizon. In that kind of rapturous scenario, your punditry team would probably be out telling you that things really aren’t quite that good and that maybe we ought to take some time to ponder just how much good news was under our belts already.
You’re lucky last week happened, because your punditry team can continue to be bullish and likely be right. When we get through 12,000, it will be despite the fear accompanying the hiccup last week and no one else will believe it. It feels great to have a consensus to bet against again!
Have a great week!
Karl Schroeder, RFC, CSA
Investment Advisor Representative
Schroeder Financial Services, Inc.