Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. EU Deal: It’s Not What You Think: At 4:00 am Thursday morning, the EU and lawmakers in Germany finally agreed to a “number” that made markets giddy. The terms of the deal entail leveraging the EFSF facility (€440 billion base) to somewhere between €1.0 trillion and €1.4 trillion, a bank restructuring to comply with Basel III requirements of €106 billion capital raise, and a 50% haircut on owners of Greek debt.
We assume that the “haircut” means a chop to the par value of a section of the outstanding bonds owned by the private sector – meaning Greece’s government debt burden will be reduced from €350 billion to a hoped-for €250 billion. Greece will still sport a lofty debt-to-GDP ratio of 120% after the reduction. Behind the scenes, the terms of the deal come with a host of increased “policing/surveillance” requirements that are meant to impose fiscal discipline – beginning with the PIIGS – that essentially enforces balanced budgets.
A blank check with no strings attached would have been preferred by those countries in need at the moment. Anything else leads to forced austerity, followed by recession and, in some cases, depression – which is THE political nightmare. Those participating in the deal are more than likely to break the new rules to avoid immediate collapse. In that light, Germany would do well to limit the guarantees it provides. As we have said many times before, inflation is behind the ongoing “pinch” in economic activity and/or rising deficits. This dynamic is still based on monetary crimes of the past that cannot be reversed, and have yet to be fully discounted in the marketplace.
The monetary “fixes” the EU, Fed, or any other governmental body is likely to conjure up at this point will possess only the appearance of permanency. In reality, all are to some degree inflationary and therefore temporary in effect. In our opinion, this particular deal may increase current inflation marginally, and has even less potential to stimulate economic growth among those participating (Italian debt markets fell the very next day).
Instead, as we said a few weeks ago, this is a deal that is meant to restructure/aid the banks. Put simply, the banks in question are being given the chance to refinance their own debt by assuming the cheaper EFSF facility. As a result, we doubt that the retail environment and, by extension, the economies at large will experience much relief from the deal. Merkel herself was quoted as saying, “this money will never be needed because the mere pledge will restore market confidence.” We shall see…
2. Did Someone Say “Leverage”? Even though stocks have been in rally mode since earlier this month, markets immediately began partying in grand style on the news that the EFSF fund would be “enhanced.” Adding to the celebratory mood were two Fed heads, Yellen and Tarullo, who were found chirping about how the Fed may be ready to implement “QE3.” Stocks leaped around the world on Thursday, breaking records dating back as far as 1974 in some cases. You can check the box scores at right for the weekly results.
U.S. economic data was mixed, but market enthusiasts clung to the positives, asserting “recovery” in the wake of the eurozone-induced rally. Consumer spending, new home sales, and inflation all came in better than expected, while confidence indicators, durable goods orders, home prices, and jobs data once again hovered in recession territory. Interest rates have fallen in the wake of uncertainty; consumers have once again reaped the one-time (fading) benefit of refinancing.
In comparison to the aforementioned events, U.S. 3rd quarter earnings (whether good or bad) seemed to take a back seat to the overriding importance of sovereign debt and banking issues that dominate every move in the marketplace. A little over 50% of the companies in the S&P 500 have reported, and are “in line” with expectations thus far. Growth over earnings from second quarter, which ended in June, will be about 4.7%. This growth beats the comparable numbers from last year, when reported earnings actually contracted. On the flip side, insider selling is still running at record levels, contributing to the belief that earnings growth could be fleeting.
As we move forward from the “deals” of today, it will be interesting to see how the markets react. So far, they have been a boon for most everything besides bonds and the dollar. However, it wasn’t long ago that inflation was a concern for stock market investors and a threat to Central Bank tendencies to print (confirmed by FOMC minutes). Given recent market behavior, this dilemma appears due to visit us again soon.
As for the precious metals, they have obviously found some solid ground – responding favorably to central bank support. However, the real engine for a metals advance will be their becoming the “go to” safe haven from the ongoing and growing sovereign debt crisis. This is not yet the case. Technically speaking, if gold can hold above the $1750 level in coming weeks, we may be embarking on a new leg in the metals bull market.
Best regards,
David Burgess
VP Investment Management
MWM LLLP
