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Markets Can’t Digest Greece-y News Diet
By Louis Navellier
Last Thursday’s free-fall was triggered by a series of negative news events. First, the number of people filing for new jobless claims in the latest week rose 25,000 to 471,000 – the first increase in five weeks and the biggest weekly rise in over three months. Second, the Conference Board reported that the index of Leading Economic Indicators (LEI) fell 0.1%, the first drop in over a year. Then, Professor Nouriel Roubini (the reigning “Dr. Doom”) appeared on CNBC to predict that stocks would decline another 20% as the world economy weakens. Roubini called recent plans to rescue Greece “Mission Impossible.”
Let’s look at these concerns in a less-hysterical light, to see if the world is really in such terrible shape:
Market Can’t Digest “Greece-y” News Diet
I don’t know about you, but I’m getting a little tired of the global news machine focusing on Greece every day. It is a small nation with a small economy. My favorite image of that “crisis” came last Thursday morning, when CNBC showed Greek police on motorcycles in Athens waiting for the daily protestors, whose numbers had been diminishing, and whose protests were becoming more peaceful. Even though public sector services were unavailable, as hundreds of thousands of workers walked off the job to protest austerity cuts, most workers were enjoying a free day off rather than publicly marching in violent protest.
In other words, the news media seemed disappointed that Thursday’s protests in Greece were becoming peaceful. This may be due to the latest cash infusion into the Greek economy. The Greek bailout is taking place, despite taxpayer protests in Germany and France. Greece is enjoying a fresh influx of capital:
(1) First, Greece received 5.5 billion euros (nearly $7 billion) from the International Monetary Fund (IMF) on May 12 as part of the first 20 billion euros ($25 billion) of the IMF’s financing plan.
(2) Then, last Tuesday, Greece received 14.5 billion euros ($18 billion) from the European Commission (EC). Germany contributed the most, 4.4 billion euros ($5.5 billion), with France coming next at 3.3 billion euros and Italy adding 2.9 billion euros.
(3) The European Central Bank (ECB) also bought more than $20 billion in European sovereign debt instruments based in Portugal, Ireland, Italy, Greece and Spain.
My guess is that Greek workers will get back on the job soon, but the cameras won’t cover that event. “Mission Impossible” will quietly disappear from the headlines, as the media move on to the next scare, which will probably be the growing budget shortfalls in several U.S. states. On Tuesday, the Financial Times reported that “U.S. state pensions are becoming a federal issue.” The FT article profiled Illinois as a “foster child of unfunded pensions,” pointing out that it has $78 billion in unfunded liabilities and that $4 billion of Illinois’ $13 billion 2010 budget deficit comes from lower state pension contributions.
The Treasury Department is already helping to keep 32 states afloat. According to the EconomicPolicyJournal.com, 32 states have run out of funds to make unemployment benefit payments and the U.S. Treasury has stepped in with funds for the unemployed. However, an economic recovery will cure many of these ills. The fact that sales tax revenue is now rising in most states, including California, is evidence that comparing California to Greece is mostly just financial media entertainment. California is almost four times bigger than Greece, and it is home to Silicon Valley and other innovative companies, so California at least has the potential to grow its way out of some of its fiscal problems, unlike Greece.
Short-Term Short-Sighted Short-Selling Rules
The market rebounded on Friday after the German Parliament formally approved Germany’s contribution to the euro-zone bailout plan. The lower-house (Bundestag) passed the bill 319 to 73 (with a stunning 195 abstentions). Germany’s upper house, which represents the16 federal states, also backed the bailout. The bill calls for Germany to add 123 billion euros ($154 billion) to the EU and IMF rescue package. Despite the German media calling themselves the “schmucks of Europe,” the debate is effectively over.
However, on Tuesday, Germany also tried to stop speculation in the financial markets by implementing a partial ban on “naked short selling” of certain securities. Bafin, Germany’s financial regulator, said the ban was needed because of the “exceptional volatility” in euro-zone bonds and the widening of spreads on credit default swaps. Additionally, Bafin said that large-scale short selling could “endanger the stability of the entire financial system.” But Hans Redeker, chief currencies strategist at BNP Paribas in London, said that Germany’s move is “foolish, to say the least. The decline of the euro and inner [bond] spread widening has very little to do with speculation, but is the result of excessive debt and deficits.”
In the interim, the euro has rallied significantly from $1.22 on Tuesday to almost $1.26 on Friday, in the wake of the Greek bailout and Germany’s short-selling ban. Interestingly, the European Commission, the EU’s executive arm, suggested that Germany acted unilaterally on a trading ban that should be discussed by all EU finance ministers. French Finance Minister Christine Lagarde said France should be consulted in such moves, adding “France is not considering banning naked credit default swaps on sovereign debt.”
Wall Street & Washington Need to Restore Investor Confidence
Similar moves are brewing in the U.S. On Tuesday, the SEC proposed new rules to introduce uniform “circuit breakers” for all stocks in the S&P 500, in an attempt to avoid extreme inter-day volatility, like the five-minute “flash crash” on May 6 that caused a 99.86% drop in the iShares Russell 1000 Value ETF, careening from $59 to 8 cents in five minutes. Apparently, no one bought shares at that low bid, but that was little consolation for investors, some of whom lost over 60% on that one day in a “stable” ETF fund.
Interestingly, the SEC report said “We have found no evidence that these events were triggered by ‘fat finger’ errors, computer hacking or terrorist activity, although we cannot completely rule out these possibilities.” The Commodity Futures Trading Commission (CFTC) and SEC are meeting today to discuss a “possible linkage” between cash equities and index products in the futures market, creating a “severe mismatch in liquidity” due to different trading conventions across the main trading venues.
In the meantime, these new circuit breaker rules will kick in if the S&P 500 swings more than 10% intra-day. In that case, all trading will be halted for five minutes. This rule will be in effect on a pilot basis until December 10, while the SEC solicits public comments. One thing is for certain: The SEC and other regulators ought to figure out what actually happened on May 6 before they set out to “fix” the problem.
Investors pulled $2.8 billion out of U.S. stock market mutual funds in the week of May 6 to May 12, according to Lipper FMI. Lipper cited “risk aversion,” calling this “an about-face which suggests that investors have lost confidence in the direction of the markets.” Investors also pulled $1.8 billion out of high-yield corporate funds. While those are not large percentages of total market capitalization, they represent a growing fear that market quotes are not as reliable as investors once thought they were.
Stat of the Week: 0.1% Deflation
Now for some good news: On Tuesday, the Labor Department announced that the Producer Price Index (PPI) declined by 0.1% in April, due mostly to lower food and energy prices, which fell 0.2% and 0.8%, respectively. The core PPI, excluding food and energy, rose 0.2% in April, a bit higher than economists expected, but the PPI is expected to plunge again in May due to plummeting commodity prices.
Then on Wednesday, the Labor Department reported that the Consumer Price Index (CPI) also declined 0.1% in April and that the core CPI, excluding food and energy, was flat. In the past 12 months, the core CPI has risen only 0.9%, the smallest annual increase in 44 years! This represents almost perfect “flation” (neither DE-flation, nor IN-flation, but almost perfectly flat prices, which we can call “flation.”)
This is good news for several reasons: (1) First, 0.1% deflation puts a new light on the 0.1% decline in the Leading Economic Indicators (LEI). The LEI are just reflecting flat prices, not necessarily an economic slowdown. (2) Due in part to the lowest 12-month inflation in over four decades, I anticipate that bond yields will continue to decline, especially on corporate bonds, thereby lifting the bond market. (3) The Fed can keep interest rates low for several years, as long as inflation stays low. This keeps the cost of interest on the national debt as low as possible; and finally, (4) as investors get frustrated with near-zero interest rates, they will increasingly turn to stocks, potentially lifting stocks out of their current sideways malaise.
In brief, I expect that corporate bonds will lead the next stock market surge, just like they did in 2009, setting up the stock market for an explosive rally. Besides, politicians in an election year know that the “easy way” to fix the pension mess is for stocks to rise and interest rates to stay extra-low, extra-long.
I should add that serious (1% or more) deflation poses a long-term risk, creating an environment where prices are declining so fast that consumers will postpone their purchases, which can cause economic growth to contract. A strong dollar also lowers the price of imports. So essentially, one of the negative consequences of a strong U.S. dollar is that deflation can push commodity prices and imports down far enough to create a Japan-style long-term deflation. I see little chance of that happening, since the dollar can’t stay strong for long, and core inflation rates are rising in Europe, Asia and many other regions. For instance, Britain’s inflation rate in April reached its highest level (3.7%) since November of 2008.
Bottom-line: U.S. Dollar Assets are Popular Once Again
As a result of Europe’s sovereign debt crisis and low U.S. inflation, the U.S. Treasury Department announced on Monday that foreigners bought a record amount of U.S. assets in March. Specifically, their total holdings of bonds, notes and stocks increased by a net $140.5 billion in March, triple the size of the $47.1 billion net gain in February and higher than the prior record of $135.8 billion in May of 2007.
Foreign purchases of U.S. corporate debt rose for the first time in a year and purchases of agency debt surged at the strongest pace since June 2008. Foreign governments also bought a net $28.2 billion of Treasury securities, which represents a sharp increase from just $1.1 billion in February. Additionally, private purchases of Treasury securities also rose, reaching $80.2 billion for March, up from $47 billion in February. Even China was a net buyer of Treasury securities for the first time since September, 2009. Net international purchases of U.S. stocks rose by $11.2 billion in March, nearly matching the $13 billion in February, so U.S. stocks and bonds are benefiting from the rush out of European debt.
This recent inflow has solved a lot of short-term U.S. problems, but long-term debt solutions require a continuing combination of low-interest rates and high economic growth rates, thereby helping to solve the state and federal pension shortfalls while returning millions more Americans to work (and tax-paying).
Looking Forward
Today, markets are closed in Canada, Switzerland and Greece, among other nations. Next Monday, U.S. markets will be closed for Memorial Day, so I’ll send you the next Market Mail on Tuesday, June 1. At that time, I hope to report on some marginal improvement in this week’s key U.S. economic statistics:
Monday: April existing home sales
Tuesday: May consumer confidence
Wednesday: April durable goods and new home sales
Thursday: A revision in first-quarter U.S. GDP
Friday: April personal income & consumption; and May sentiment (U. of Michigan survey) and manufacturing (Chicago PMI)
I’ll see you in June...