Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
Party. You are invited. BYOW (Bring Your Own Wellies): When you think of Europe, you may visualize Big Ben or the Eiffel Tower; but today, doesn’t the word morass paint a more fitting picture? If you are stuck in a bog, as they are in Europe, you can’t avoid getting dirty, but you can and should avoid being delusional about your circumstances. Yet today, delusions abound.
We finished on a high note this week, but with a difference of opinion remaining between bond and stock investors. Equity investor enthusiasm throughout the week indicated a belief that the EU leaders would (and did) design a solution that addresses long-term European fiscal concerns. We are not so sure. At best, we witnessed a renewed commitment to disciplines that already existed (remember the 3% debt limit from the Maastricht treaty?), along with new penalties for breaching the old rules. The skeptic in us wonders about the enforcement mechanism when the rules are broken yet again. Perhaps Brussels can borrow UN troops on occasion, or give our Guantanamo boys a European vacation to see if European politicians respond well to water boarding … I jest.
The bond markets of Europe were by contrast still under pressure, and not convinced of the results stemming from these “new” technocratic commitments. After all, this is the fifth such meeting. Many of the peripheral (Spanish and Italian) bond yields rose, even with active buying by the ECB. So we are not alone in our skepticism over workable long-term solutions. The good news for investors was that no one was panicked.
The European Banking Authority is suggesting an additional €113 billion be raised by European banks to shore up tier-1 capital, lifting the number to Basel’s expected 9%. These are not huge numbers, but do come at an inconvenient time. Moody’s, S&P, and Fitch have been busy down grading financial institutions (dozens last week), which makes it more challenging to borrow inexpensively. Major French bank credit ratings were all lowered again this week, and now assume some future government involvement (funding or nationalization?). As we recently noted in our audio commentary , the US money market’s willingness to fund the short term borrowing needs of these banks has all but dried up. Compared to one year ago, money market funding has declined by 93%.
Whatever pressure the ECB is under now will be compounded in 2012. The money market funding requirements are an important missing variable, leaving the ECB as the only reliable source of funding for these banks – truly the lender of last resort. French banks (not including your more challenged PIIGS) have increased refinancing deals with the ECB from €22.3 billion in June to €100.6 billion at present. According to Citigroup, there is an additional €490 billion of European bank debt that comes due in the first six months of 2012, heavily weighted in January and February. On this basis, the EU negotiators convinced member states to contribute €200 billion more to the bailout pot, as of Friday.
Have you wondered where the money actually comes from? To appreciate the point, imagine, if you will, a young person going to their father to borrow money, even as the father is in bankruptcy. How do the broke lend to the broke? Enter stage left – the printing machine. We circle back around to the inevitable unwind in the debt markets, which has been and will continue to be fought with all available liquidity (“inflate or die”). The world’s central bankers see no other alternative for getting us back on the Keynesian hamster wheel than via monetary stimulus.
All in all, the economic game of yo-yo continues in Europe: Today, the hopes are high. Simply wait for Monday, and conflicting news releases may again pull markets lower. Oddly enough, the Europeans have taken the opinion that David Cameron is the real yo-yo, for not ceding partial British sovereignty to Brussels. While we can’t count the cost of his decision to stand aside from the morass, it appears the right decision nonetheless, and reminds us of the English fondness for wellies (Wellington boots). For all the wigs and tea (forgive the American impressions), they really are a practical people. May that serve them well.
Turning to the US, we find mixed data with a positive bias. University of Michigan Consumer Confidence figures showed better than expected numbers at 67.7, implying an improvement in economic expectations. Perhaps that improving view is a necessary prerequisite for consumers hitting the malls and spending money they have not yet earned. Looking at consumer credit numbers, we find more upside. These came in 10% higher than the revised October figures, at $7.645 billion, as reported by the Federal Reserve. Our view is that the consumer has already front-loaded retail purchases following the annual turkey feast, and we are likely to find December retail figures, along with consumer credit numbers, back in decline going into January. Noting the inventory figures, we find them increasing again by 1.3%. We don’t like what the build-up in inventories may tell us about the January to March period.
We didn’t mention the employment figure out last week (one more bit of good news). Please consider the political importance of the unemployment number in an election year. Remember that the race goes to the new (or the Newt) in favor of the old, should we find the statistic stubbornly high in the second and third quarter. The cutoff is roughly 7.5%. Remember also that “the number” is improving not via job creation and a return of unemployed persons to the work force, but simply due to the fact that after a certain period of time the unemployed fall off the count and are recategorized under the heading “discouraged workers.” Perhaps you can appreciate our frustration with this blatant manipulation. The most recent employment number of 8.6% had Steven Roach from Morgan Stanley describing it as ‘suspicious,’ and ‘disappointing,’ while Bill Gross questioned the validity of the number’s steep decline on Bloomberg TV. It is not suspicious when you remember we are in an election year. Then, this type of chicanery is expected.
Unable to tie in the wellies theme more effectively to end this missive, I’ll just suggest that you consider what 2012 may be like in our own mud hole, and encourage you to be practical. Actually, one of the best gifts I ever received was a pair of those boots. Outfit the family this holiday season; we may be knee deep in it next year!
Best regards,
David McAlvany
President and CEO
MWM LLLP
