Archive for the ‘Sovereign Debt’ Category

The Age of Low Expectations

Friday, August 16th, 2013

Observing today’s global economy is like watching Adam Sandler’s best movie.  It’s horrible, but it could be worse.

Consider what passes for improvement today:

Europe is no longer in a recession.  Under the headline, “Eurozone’s longest-ever recession comes to an end,” the Associated Press quoted Eurostat, the European Union’s statistics office, announcing that the 17 EU countries that use the euro saw their economic output increase by 0.3% in the second quarter of 2013.  Over a year, the Eurozone’s growth rate would be 1.1%.

The DJIA is following a familiar pattern.

The DJIA is following a familiar pattern.

That’s the first quarterly growth for the Eurozone since 2011, but it requires some perspective.  China’s growth slowed to just 7% this year and it’s widely regarded as a calamity, signaling that the world’s second largest economy is on the brink of failure.  Europe’s economy is growing at a rate of 1.1 % and the party hats are out because some believe that the Eurocrisis is finally over and we’ll never have to hear the term “sovereign debt” again.

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Two Banks With a Country Attached

Monday, April 1st, 2013

Cyprus?  Really?  The population of Cyprus is just north of 1 million people.

In comparison, the Boston area has a population of 4.6 million.  Greece has a population of about 10.8 million.  Central Massachusetts has a population exceeding 800,000.  Would a financial crisis involving two banks in Worcester shake the financial system the way the financial crisis in Cyprus has?

Of course not.  Then again, Worcester is not a tax haven for Russian billionaires, who use Cyprus as their Cayman Islands.  Russia has kept many Cypriots gainfully employed through the country’s two largest banks, Bank of Cyprus PCL and Laiki Bank.

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Europe – The Weakest Link

Friday, February 15th, 2013

With the election, sequestration showdown and other pressing domestic news, we’ve hardly had time to think about Europe.  Yet the continent is as troubled as ever and is crying out for attention again.

Keep in mind that, in this era of a global economy, our fates are intertwined.  Europe and America are heavy trading partners and our multinational businesses are located throughout each other’s continent.  Our banks own European bonds.  So when Europe is in trouble, so is the U.S.

Well, Europe is in trouble.  We’d say “in trouble again,” but it’s never really gotten out of trouble; at least not since Greece triggered the sovereign debt crisis.  The popular British game show, “The Weakest Link,” could serve as a metaphor for the whole continent, except that what’s happening in Europe is not nearly as entertaining.

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The Good News: No More Election Ads

Friday, November 9th, 2012

In the wake of Tuesday’s re-election of President Obama, the Dow Jones Industrial Average fell 434 points in two days, a drop of 3.3%.

That’s better than when he was first elected.  After a 305-point rally on Election Day 2008, the DJIA fell 486 points, or more than 5%, on the day after, which was the largest post-election drop ever.

In 2008, the housing bubble had burst and we were dealing with the biggest financial crisis since The Great Depression.  Today, we still have not recovered from the financial crisis, but face a “fiscal cliff” and continuing troubles in Europe.

The fiscal cliff, which combines $800 billion in tax increases and government spending cuts, has investors spooked for many reasons.  Unless action is taken:

  • Corporate dividends will be taxed like earned income, increasing the tax from 15% to a top rate of 39.6%.
  • The Affordable Care Act adds a 3.8% on investments, so the tax on dividends could nearly triple overnight.
  • The top tax rate on capital gains will increase from 15% to 20%.
  • Income taxes and estate taxes would also increase, and many more Americans would be subject to the alternative minimum tax (AMT).
  • The re-election of President Obama, who favors tax increases, makes it more likely that the increases will take place.
  • With Republicans controlling the House and Democrats controlling the Senate, Congress is divided and it will be difficult to reach an agreement that would avoid or reduce the impact of the fiscal cliff.

Of course, there’s plenty of time between now and the end of the year to deal with the issue.  But Congress will be on holiday for much of the time between now and the end of the year.

Meanwhile, in Europe

While Europe’s sovereign debt crisis received little attention during the busy election season, it’s not because the crisis has abated.

Once again, Greece is the little country that can’t, as it increasingly appears that “the Greek ‘austerity’ vote was merely theater,” as Zerohedge put it.  The resulting news in Europe this week is that European finance ministers may delay approval of the next bailout payment for Greece from November 16 to late November, when they will hear a full report on Greece’s compliance (or lack thereof) with the terms of the bailout.

The unveiling of the Outright Monetary Transactions (OMT) program in September by the European Central Bank (ECB) boosted market confidence that Europe was doing something about its problems.  But, like America’s ongoing quantitative easing, Europe’s OMT won’t eliminate economic problems.  Lower interest rates just make it less expensive to keep borrowing more and more money.

Maybe that’s why economic confidence in Europe has sunk to a three-year low.

So the economic misery continues, but at least we won’t have to see or hear any more election ads.

The Other QE

Friday, September 7th, 2012

It’s not QE3, the Fed’s highly anticipated and much discussed quantitative easing program, but the European Central Bank’s (ECB) bond buying program is having a similar impact.

Stock markets worldwide rose announced its bond-buying program yesterday.

Bond buying is Wall Street’s version of crack … it costs money and has a negative long-term impact, but it creates a temporary euphoria and makes everything seem just find for the those who want to live in the moment.

As The Wall Street Journal put it, “we suppose the good news is that it isn’t as sweeping as it might have been.”

To receive money from the ECB, countries that want help must first apply to the eurozone’s bailout fund.  Countries that receive assistance must consent to reducing government spending and debt.

In reality, though, countries like Spain, Italy and Greece are under pressure from citizens who don’t want austerity.  They’re protesting in the streets of Spain because the government would like to reduce their generous benefits … and politicians who want to survive had better take heed.

The program also has the potential to send bond yields soaring, not to mention causing higher inflation.

Conversely, one reason the markets responded favorably is that the program reduces the risk of a Eurozone break-up – at least for now.

Dancing With A Cow

Tuesday, July 17th, 2012

While Europe’s sovereign debt crisis has beaten down the U.S. stock market, it has helped the bond market.

Because the European bond market is in such poor shape, U.S. bonds are a relatively healthy investment.  Investors have been buying U.S. bonds, because they look good relative to European debt.  But that’s like dancing with a cow because your only other option is a pig.

U.S. yields are at record lows, even though U.S. debt has now reached $15.9 trillion, up from $9 trillion in 2007.  The 10-year Treasury yield, which has averaged 4.88% over the past two decades, hit a record low of 1.44% on June 1, down from its high for the year of 2.4% percent on March 20.

Regardless, the cow may be turning into a pig.  Robert Auwaerter, head of Vanguard Group’s fixed-income group, predicted that unless the U.S. gets its debt under control within the next four years, U.S. bonds will become about as popular as the bonds of the five European countries that have seen borrowing costs soar as investors boycotted their bonds.

What Bloomberg called a Treasuries Doomsday isn’t on the Mayan calendar, but it could be as grim as those end-of-days predictions, at least from a financial perspective.  If yields were to rise back to 3.8% by December 2014, which is their average for the past decade, investors would realize loses of 10.8%.

Demand for U.S. bonds has enabled the Federal Reserve Board to keep borrowing costs low, and President Obama and Congress to fund a budget deficit that’s forecast to exceed $1 trillion for the fourth straight year.

However, Auwaerter said, “In the absence of a long-term credible plan, we are somewhere around four years away on where the markets are going to say ‘enough is enough.’ ”

Finally – U.S. Drags Down European Market … Japan Falls, Too

Wednesday, July 11th, 2012

We’ve been writing about Europe dragging down the U.S. stock market for more than a year now.  We, of course, take no satisfaction in it, but it’s kind of a “man bites dog” story to report that U.S. jobs data moved European markets lower at the end of last week.

Germany was down 1.9%, Spain was down 1.5% and the UK market was flat.

Meanwhile, while bailouts all the rage in Europe and the U.S., debt-laden, over-spending Japan is intent on joining in the fun.  Japan’s Finance Minister suggested the government could run out of money as soon as October if a bond bill is not passed.  Japanese stocks fell in response.

Even Germany’s Credit Is Slipping

Friday, June 29th, 2012

Greece.  Italy.  Spain.  Ireland.  Even France has experienced a wavering credit rating.  But Germany?

Germany has been Europe’s voice of reason, a financial pillar among a creaky, malfunctioning continent with the financial foundation of a sand castle.

We previously asked whether Germany would have the stamina to lift up the rest of Europe or be dragged down by its bailout-addicted brethren.

One sign that Germany is being sucked into the European sinkhole is that Egan Jones just downgraded Germany’s credit rating from AA- to A+.  Granted, Greece is unlikely to see anything near an A+ rating in our lifetime, but for Germany, it’s a stumble, if not a fall from grace.

It’s not that Germany is being irresponsible.  It’s that its debtors are not paying up.  According to zerohedge.com, “Germany is owed EUR700B of which perhaps 50% is collectible … Germany’s debt to GDP was 87% as of 2011. However, increasing Germany’s debt by EUR700B to EUR2.9T for its indirect exposures raises the adjusted debt to GDP to 114%.”

We can only hope that it’s not a sign of things to come.  Yet, as an increasing number of European nations decide that they’ve had enough austerity, without so much as trimming a few vacation days, it’s unlikely that socialism will give way to pragmatism anytime soon.

In fact, Germany’s resistance to printing money as a way out of the sovereign debt crisis is increasingly making the country the odd man out in Europe, even though printing money is a sure path to hyperinflation.

Maybe Germany should leave the Eurozone instead of Greece.

Bad News Boosts the Market

Tuesday, June 12th, 2012

In the strange world of investment management, bad news is often good news.

That was the case last week, as the S&P 500 gained a hefty 3.7%, more than reversing its 3% loss from the previous week.

The market rose 2.3% on Wednesday alone – its largest single-session percentage gain so far this year – amid signs that the already tepid economic recovery is slowing further.

So why did the market rally?  Because traders speculated that the Federal Reserve will react to the slowing economy with additional stimulus.

Fed Chairman Ben Bernanke didn’t even hint at any immediate plans for a third round of quantitative easing or any other steps to stimulate the economy.  The European Central Bank (ECB), likewise, left its benchmark interest rate at 1.00%.  However, ECB President Mario Draghi said that actions would be taken if needed.

So the chance that another round of stimulus may take place is enough to boost the market 3%.

S&P 500 Chart

Given that economic growth remains anemic and the unemployment rate is at 8.3% and is generally creeping up, not down, previous rounds of stimulus have had virtually no long-term impact.

Short-term, though, markets love quantitative easing, which makes investments in stocks appear desirable by making investments in other assets undesirable.

So if quantitative easing doesn’t help the economy and provides only a short-term boost to stock prices, maybe the Fed should just float a few rumors … plan a faux round of quantitative easing to give the markets a boost without any cost or harm to the economy.

The Pain in Spain, Part 2

 Spain added to the good-bad news last week, as Fitch downgraded Spain’s debt rating from A to BBB after the country held a successful debt auction.

A teleconference last week between G-7 finance ministers to discuss Spain’s banking system, along with other Eurozone problems, failed to yield any specific plan for addressing the crises, and Fitch followed up yesterday by dropping ratings on two major Spanish banks, Banco Santander S.A. (STD, SAN.MC) and Banco Bilbao Vizcaya Argentaria S.A. (BBVA, BBVA.MC).

The downgrades, from A to BBB, came in spite of a weekend agreement by the Spanish government to a European Union bailout of up to EUR100 billion, or about $125 billion.

Spain joins Greece, Portugal and Ireland in the growing list of bailees.  Soccer anyone?

Compared To What?

Tuesday, June 12th, 2012

The U.S. dollar is the strongest it’s been in a year-and-a-half.  Is this renewed strength a sign of American economic strength?

In a way – but it’s all relative.  The euro broke to a new low recently, and the dollar and the Japanese yen were both stronger, because of a flight to quality.

Japan, which is still recovering from last year’s earthquake and tsunami, has enormous debt, as does the U.S.  So if the dollar and yen are strengthening, it’s a sign that the euro is in deep, deep trouble.

The yield on 10-year U.S. treasury bonds hit a new low recently, at 1.45%, as did the 10-year German bund (1.18%) and the 10-year British gilt (1.53%).

 Is Europe Burning?

Even the ever-bullish MarketWatch was noting a swoon in global markets, due to “fresh concerns that the European currency union is nearer to dissolution.”

As MarketWatch’s David Callaway noted, “Investors are rushing to safe havens in preparation for financial Armageddon, the long-feared run on European bank deposits that is expected to develop once Greeks awake some Monday morning this summer to find out the euros in their bank accounts have turned into devalued drachmas.”

 The Pain in Spain

In addition to growing conjecture that Greece is going to exit the euro, there is growing conjecture that Spain’s banks will need to be bailed out.

Recently, the S&P 500 broke below 1300.  Not coincidentally, at pretty much the same time, the yield on Spanish bonds went much higher.  Shortly afterward, the International Monetary Fund made a statement that it is considering bailing out Spain.  Shortly thereafter, the IMF made a statement denying any potential bailout.

So what’s really happening in Spain?  The answer is anyone’s guess, but if you’re considering investing your life savings in Spanish bonds, you may want to reconsider.

At least the price of oil is dropping.

 

Key Indexes

YTD (As of 5/30)

S &P
500 (SPX)

-6.1%

Nasdaq
Composite (COMP)

-6.9%

Crude oil (NMN: CLN2)

-16%

Spain Ibex 35 (XX:IBEX)

-12.3%

Japan Nikkei 225 (JP:100000018)

-10.3%

Hong Kong
HSI (HK:HSI)

-11.7%

Russia RTS
(RTG: RTS)

-20.3%

Euro vs. dollar (EURUSD)

-6.2%

U.S.
Treasurys (return) (10_YEAR)

+1%

Dollar
index (DXY)

+5.1%

CBOE Market
Volatility Index (VIX)

+41%