May 16, 2010

A Greek Tragedy

A Greek Tragedy

May 17, 2010

“If healthy economic systems require taxing the responsible and debasing the currency to bail out the profligate, the EU’s rescue package should be a raging success.” --Kevin Duffy

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: 2.31%
SPX: 2.23%
COMPQ: 3.58%
RUT: 6.28%


Volatility has exploded over the past two weeks (see chart below courtesy of Bloomberg) as the markets reacted to an IMF/EU bailout of the PIIGS. The correction of 2:45, which saw the Dow fall by 1000 points in a matter of minutes due to inconsistencies in the circuit breakers amongst the various exchanges, has investors on edge. Rumors of a trading mistake (isn’t it funny how trading mistakes only seem to occur on down days?) have proven to be false and seemingly unlikely.

The market staged an enormous bounce back Monday after the announcement of the big bailout package (also known as ‘Tarp, Part Deux’). David Rosenberg notes that big bounces (400 Dow points or more) typically have occurred during or near the beginning of bear markets. Personally, I have maintained this market has been a cyclical bull in a secular bear market, and right now we may be experiencing either a normal correction or the beginning of a down phase that could take the S&P down to the low 1000’s.

The Euro also staged a one day rally Monday before continuing its retreat (see chart below courtesy The Euro now stands at a four year low, and seems destined to continue falling over the intermediate time frame. Some traders are expecting a short lived bounce due to the crowded short position in the currency. I would use any strength to add to short positions.

The results have been predictable as US Treasuries and the dollar have both rallied given Europe’s problems and a potential slowdown in China (more below). Commodities have recoiled on the strength in the dollar and concerns about demand coming from both Europe and China. Finally, gold has ripped to a new high amidst concerns about not only the Euro, but also most currencies which have been debased in response to the recent financial crises.

From a stock standpoint we have been suggesting staying focused on mid-cycle stocks since the beginning of the year. Doug Cliggott, strategist at CSFB and a very astute market observer, suggested moving to late cycle stocks this week. Doug may be a tad early, but given weakening demand coming from Europe (20% of US exports); the potential for a rate increase in China; and tougher earnings comps in the back half of the year, the burgeoning economic recovery may be peaking this quarter. As a side note, Doug was right on the mark with his market calls heading into the 2000 peak and eventual bear market.

One major area of concern may be liquidity in Europe. The chart below shows the jump in one month LIBOR rates over the past year. Banks across Europe are significant holders of Greek, Portuguese, and Spanish debt. You may recall that spiking LIBOR rates in the middle of 2008 were an outgrowth of the financial crisis, and contributed significantly to the bank liquidity problems at that time.


Actual Consensus Prior
Wholesales Inventories 0.4% 0.5% 0.6%
Continuing Claims 4627K 4570K 4615K
Initial Claims 444K 440K 448K
Export Prices ex-ag 1.4% 0.7%
Import Prices ex-oil 0.5% 0.2%
Retail Sales 0.4% 0.2% 2.1%
Retail Sales ex-Auto 0.4% 0.5% 1.2%
Capacity Utilization 73.7% 73.9% 73.1%
Industrial Production 0.8% 0.8% 0.2%
Michigan Sentiment 73.3 73.5 72.2
Business Inventories 0.4% 0.4% 0.4%

The IMF said this week that this is the first time Asia has led a global recovery while the US and Europe lag. Europe may have destined itself to another decade of slow growth with their most recent bailout package, joining the US as underperforming economies over the next decade due to overly leveraged balance sheets.

Employment rose the most in 4 years last week, but the unemployment rate jumped as more people began looking for jobs. Job gains are still needed to sustain the recovery. Employers increased payrolls by 200,000 workers in April. ISI estimates 750K jobs were created last month, 550K from the government hiring census workers and 200K from the private sector.

March Business Inventories rose by 0.4%, in line with expectations and up for the 5th month in the past 6 after 13 months in a row of declines. Because sales rose 2.3%, the inventory to sales ratio fell to 1.24 months, matching the lowest level on record dating back to 1980. The historically lean inventories is a reflection of business caution to the still uncertain economic environment but also provides a great backdrop for a pick up in production if confidence in the outlook grows and end demand improvements become longer lasting

Oil Spill Good for the Economy

Outside of the obvious environmental disaster, should we be looking at the BP oil spill as a boon to the regional economy? Remember that the rebuilding of the south after Hurricane Katrina was a major boon to the area’s economy.

More on Taxation without Representation

Last week we discussed the UK usuriously taking bonus money while an unnamed US based bank clipped employee bonuses by 7% globally to pay the tax. This week both BofA and Citi announced they would pay $465 million and $400 million respectively due to the UK tax. The UK government had hoped to raise 500 million pounds via the tax, however, it appear that figure may be closer to 2 billion pounds.

I just want to clarify this one. BofA and Citi, among others, operate their businesses so poorly that they require the financial assistance of the American taxpayer, helping to push the country into a recession. Then, after some favorable accounting changes, they begin to pay bonuses again. The UK decides to zing them for their “profitability” for 2 billion pounds.

So the net is that the US taxpayer just subsidized the UK by 2 billion pounds!

Am I missing something here? Don’t they still owe us for helping them a few decades ago when it was apparent they’d be speaking German and doing the goose step?

Demonstrations have been rampant in Greece as the citizenry, primarily government unions, are showing their unhappiness with the plan to cut back on government expenditures in exchange for IMF funding. The protest is aimed at Prime Minster Georgios Papandreou, who was elected in October based on promises to raise wages for public workers and increase stimulus spending. The budget deficit of 14% of GDP is twice the estimate of the prior government and more than 4 times the limit of the EU, tying the Prime Minster’s hands on doling out the goodies.
The surge in the budget gap as the economy contracted fueled investor concern about Greece’s ability to finance the deficit and sent borrowing costs to the highest level since before the start of the Euro in 1999. Papandreou has pledged to lower the shortfall to within the EU limit of 3% of GDP in 2014. With reductions in wages and increases in taxes, the Greek economy is forecast to shrink 4% this year and 2.6% in 2011. Unemployment has risen to 11.3%, a six- year high.

Europe’s Debt Problems

The chart below, courtesy of the NY Times, shows the breadth of the problems facing Europe. In addition to the PIIGS, Britain, Hungary, France and Belgium all have debt levels exceeding EU limits. It’s ironic that the Eastern Block countries, historically unable to issue debt, are now more fiscally sound than their Western neighbors. I’m wondering how much of this Western European debt problem can be traced back to the cost of integration and support of Eastern Europe after the fall of the Berlin Wall?

Identity Theft Gold Mine

Every digital copier since 2002 has been shipped with a hard drive. This means that every document that has been copied on those machines is stored inside. A used machine could have up to 300K stored copies on it. Check out this link to CBS news:

If you have any concern for your financial privacy, this will scare you.

Marge Simpson and Europe

Enough said?

Thanks to the Big Picture.

China’s property market is a bubble looking more and more like the one that preceded it in the US. An estimated 60% of GDP in China comes from construction related activities. James Chanos (who is short Chinese developers and building related materials suppliers) said China is “Dubai times a thousand. They can’t afford to get off this heroin of property development. It’s the only thing keeping the economic growth numbers going.” “China is on a treadmill to hell.”

Property prices in China rose at the fastest pace in almost two years in February even after officials this year re-imposed a tax on homes sold within five years of their purchase to curb speculation and ordered banks to set aside more funds as reserves to cool lending. The boom in China’s real estate has fueled concern that China may face a collapse like that in the US and Dubai.

China’s Reserves
Chanos was also negative on China’s enormous foreign currency reserves, $2.4 trillion, of which nearly $900 billion are US government debt. China’s foreign currency reserves will be “one asset” that can be used to fund a cleanup of the banking system, he said. If that were to occur it could be the end of the 30 year bull market in US Treasuries.

China Part 3

The Chinese market is now down 20%, which qualifies for a bear market. The market has been pressured by concerns about the government raising rates to slow the economy and cool the housing market, rising inflation, and an increase in bank reserve ratios.

Andy Xie on the US Recovery
“I think the current recovery is merely based on government stimulus and low-base effect. And given the amount of stimulus spending, this is not a strong recovery. More importantly, structural problems exposed by the financial crisis were merely covered up, not resolved, by stimulus spending. This is why the recovery is not sustainable.

Since stimulus will eventually lead to inflation, interest rates will have to be raised. That will lead to another dip in the global economy. I expect this second dip in 2012, which means we are en route to a W-shaped economic phenomenon, not a V-shaped recovery.”

People in Glass Houses Just Shouldn’t
An unlikely advisor to Europe regarding their debt problems has emerged- Barack Obama.

I have nothing more to say.

The International Energy Agency scaled back its forecast for growth in global oil demand this year. The revision cut the forecast by 50K barrels a day to 1.62 million. Analysts said the reduction reflects a shaky world economy.

Inflation in Afghanistan?

Bloomberg is reporting that up to one-third of Afghanistan’s poppy harvest this spring has been destroyed by a mysterious disease, according to estimates revealed by the UN, which could hinder the American military offensives this summer in the country’s opium-producing heartland. It seems the Taliban’s public relations strategy against the offensive includes trying to convince local residents that Western troops will destroy their poppy crops, and in recent weeks Afghan farmers have started blaming the American and NATO militaries for spreading the disease. In many places, the blight has wiped out more than half of individual poppy fields.

Besides fueling the propaganda war, the blight might also help the insurgency by forcing prices up. Reduced production is causing prices for fresh opium to soar as much as 60%. The price increase is also raising by hundreds of millions of dollars the value of opium stockpiles held by traffickers and insurgents. The opium trade is believed to provide the Taliban with a large portion of their budget.

Real Estate
Data from the National Association of Realtors indicate that the housing rebound is losing steam and that housing prices in the U.S. might slip into the second part of a double-dip downturn. Core-Logic, a real estate analytics firm, forecast that prices will be 4.2% lower by February. Economists said the next downturn likely would be less severe, in line with our outlook for another 10-15% decline.


With the dollar rising 6% this month and the Euro falling 5% this week, commodities have been hurt while gold and treasuries have risen. The charts below, courtesy of, show the moves in gold, west Texas crude, and the dollar.

As a reminder I am now sending out the morning economic data via Twitter. I’m not saying I won’t forget some mornings, but if you are interested in receiving them, just click on the “Follow Me on Twitter” button on the upper right of the website. It’s easy to join (just requires an email and password), and more importantly it’s easy to unsubscribe.

The market has some tough sledding in front of it. We are advocating a defensive posture, and would use the market weakness to move into stronger, higher quality holdings and away from higher risk, lower quality holdings. There seems to be very few values in the bond market after a 14 month run, and would use any strength or liquidity in that market to take profits.

Have a great week.


“You have the great problem of a potential disintegration of the euro. The essential element of discipline in economic policy and in fiscal policy that was hoped for has so far not been rewarded in some countries.”-Paul Volcker

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