June 24, 2011: Market Update
Can Icarus Fly Again?
The market looks to finish the week only slightly lower than where it started. For an unusually volatile week filled with market moving stories, this is a reasonably good outcome. The three big events that occurred this week were the vote of confidence for Greece’s Prime Minister, the Federal Open Market Committee (FOMC) meeting minutes and the surprise plan by the International Energy Agency (IEA), of which the United States is a founding member, to release additional oil from strategic reserves.
Following days of anxiety due to concerns over a possible Greek default, investors have been calmed for the time being by the confidence vote early Wednesday in Greek Prime Minister George Papandreou’s government. Investors are hoping this paves the way to the passage of another batch of austerity measures in a vote next Tuesday. Greece’s partners in Europe and the IMF have made the $17 billion bailout (#2) contingent on a positive Parliamentary vote on the austerity package.
So why is Greece important? The Washington Post laid out a very plausible scenario describing how a Greek default could ripple across the financial world. According to them, this is how the dominoes might fall:
- Without an emergency loan from the IMF and European countries, Greece may default on $18 billion in debt it owes between July 15 and August 20.
- Greek banks hold nearly $200 billion of Greek debt, and a default could cause a collapse of the Greek banking system. Germany, France and Britain own another $265 billion and would suffer significant losses as well.
- Because of the Federal Reserve’s zero-interest rate policy, many U.S. money market funds lend money to European banks at favorable rates. The top ten U.S. money market funds collectively have approximately $380 billion in short-term investments with European Banks. If European banks suddenly suffer huge losses due to Greece, U.S. money market funds would shy away from Europe and cause a liquidity crisis much like what happened in the days following the collapse of Lehman Brothers in the United States.
- Lastly, remember AIG? They sold insurance called “credit default swaps” on debt holdings. They went bankrupt when they couldn’t pay out on the claims. There are over $5 billion in credit default swaps on Greek debt. However, since the industry remains unregulated no one knows who holds the contracts or what impact a default might have on their financial health.
The Federal Reserve, the International Monetary Fund and the European Union are all acutely aware of the potential ramifications. Because of recent history, we are confident that Greece will not be allowed to default (at least not in the near term). The stakes are too high.
In other news, the Federal Reserve released the minutes from their latest meeting. It turns out the economy is weaker than they had anticipated with Chairman Bernanke admitting, “We don’t have a precise read on why this slower pace of growth is persisting.” The minutes of the FOMC meeting assigned blame outside of the U.S., pointing at Japan along with rising food and oil prices. With the end of QE 2 next week, we anticipate the Fed will stay on the sidelines for the next couple of months while determining the size and scope of the current slowdown. The earliest we might hear new policy coming from the Fed would be at the Jackson Hole Summit in late August (the event during which QE 2 was announced last year).
For the story of the week we turn to the U.S. Postal Service (USPS). On the same day that FedEx announced a 33% jump in profits, the USPS declared an emergency end to its contributions to the federal pension fund for its workers. This move by USPS, effective today, will save it $800 million by the end of the fiscal year on September 30. The Postal Service reported a loss of $8.5 billion in its 2010 fiscal year. It also reported a widening second-quarter loss, to $2.6 billion, on declining volumes. Here’s the part you probably didn’t hear. The Postal Service claims they overpaid the employee retirement account by some $6.9 billion and has asked Congress to pass legislation to return the money. With several bills in Congress, it is unclear what potential remedies lie ahead. “Right now we don’t believe this decision will have any impact on current employees and it will not have any impact on current retirees” said the USPS this week. The real question is what impact this will have on taxpayers in the years ahead. Now you know.
June 17, 2011: Market Update
Sunscreen Guidance Half-Baked?
If the market holds up into the close today, we look to finish the week higher for the first time in seven weeks. Despite continued weak economic data, two major uncertainties are closer to being resolved. Negotiations between Congress and the White House regarding the national debt ceiling picked up pace this week and progress is slowly being made in the Greek debt crisis. Investors drew a huge sigh of relief and the market move higher.
Vice President Biden and a group of six bipartisan congressional leaders meet at the Capitol on Tuesday for their sixth round of negotiations on a comprehensive deficit-reduction plan. The task ahead for negotiators remains a tall one as Congress faces an August 2nd deadline to raise the $14.3 trillion federal debt ceiling. There are a range of options for a budget deal, including:
- An agreement to raise the debt ceiling for nine months in exchange for $1 trillion in budget savings
- An 18-month extension of the debt limit, along with $2 trillion in savings
- A longer-term agreement to cut the deficit by $4 trillion — a deal favored by Obama’s deficit commission and some congressional Republicans.
Boehner has said the length of a debt ceiling extension would hinge on the amount agreed to in spending cuts.
As for Greece, progress is being made there as well. Despite riots over further austerity measures (i.e. spending cuts), it looks like Germany is backing off its hard line. To date, Germany has demanded that any Greek rescue come with the participation of private bondholders, who would have to take “haircuts” on their investment, as opposed to the French position of paying creditors 100 cents on the dollar. French President Nicolas Sarkozy hinted that a deal to resolve the Greek debt crisis may be near. “We want to go as quickly as possible without fixing a date,” Sarkozy said after meeting with German Chancellor Angela Merkel, adding that the pair had the same position on Greece. This is encouraging news and bodes well for a resolution to this ongoing predicament.
From a technical perspective, the market is beginning to look a bit oversold. We hit a high of 1,363 on the S&P 500 on April 29th. Since then, the market has been in decline due to all the reasons we’ve talked about these past seven weeks. However, baring a major setback, it looks like there should be support for the S&P 500 around its 200-day moving average. In addition, the relative strength index (RSI) is at 36 signaling that perhaps the market is approaching oversold territory. While we don’t solely base investment decisions on technical indicators, it is nice when they begin to indicate that we may be nearing the bottom of this short-term decline. We are encouraged that the support levels will hold and that the market will reverse course in the third and fourth quarter.
For the story of the week we turn to the FDA. The Food and Drug Administration announced new regulations this week designed to enhance the effectiveness of sunscreens. Under the old regulations, the FDA only required testing for ultraviolet B (UVB) rays that cause sunburn. That’s what the familiar SPF measure is based on. The new regulations require testing for the more dangerous ultraviolet A (UVA) rays, which are most commonly linked to premature aging and skin cancer. Turns out they’ve been thinking about this for some time now. The FDA announced its intent to draft sunscreen rules in 1978 and published them in 1999. The agency then put the plan on indefinite hold until it could address issues concerning both UVA and UVB protection. Despite the 30 year delay, we suppose it’s better late than never.
June 10, 2011 – Market Update
A Crack In The Cartel?
The summer doldrums seem to have set in. Markets ended another week down as concerns over a slowing economy weighed on the major averages. We continue to see corporations sitting in very good positions with revenue, profitability and cash on hand. However, they continue to be stubborn about hiring as they appear to be waiting until the very last moment before bringing on new employees. We may see this start to change as we move later into the year as productivity increases appear to be topping out. Basically, if a company cannot squeeze any more productivity out of machinery or employees, it will have to spend money to get these – either one being good for the economy.
The Fed Beige Book report this week indicated that “economic activity generally continued to expand since the last report.” The translation: The economy is growing but at a slow pace. We are seeing the economy and the market take a breather currently but we believe there is a possibility that better economic numbers are in store for later this year that could lead to a recovering market as well. Could this be a repeat of last summer? I will cover more on this in my quarterly newsletter coming out in early July.
The biggest story of the week happened with OPEC. As most of you have probably heard by now, Saudi Arabia wants to increase oil production because they have excess reserves they can put on the open market. However, in a contentiously divided meeting, the other ministers were flat against it – predominantly because they cannot increase production. Their concern is over the price of oil going down and their inability to make up for that loss with increased production. It was announced today that Saudi Arabia will go ahead and increase production anyway in defiance of the wishes of the other OPEC countries. This is a bold step that could impact the cartel and the price of oil.
In news you may not have heard this week, the government ran a much lower budget deficit than expected in May. The primary reason is because the Treasury Department gave lower estimates for TARP costs. The Treasury Department says it now expects the bank bailout to cost $48 billion – down from earlier estimates of $341 billion. Don’t get too excited yet. For the first 8 months of the fiscal year the deficit totaled $927 billion – $8 billion more than at the same point last year. Now you know.
June 3, 2011: Market Update
State of the Economy: Mid-Year Review
If you were hoping that last week’s economic data was an anomaly, you would have been disappointed by the news this week. Two weeks does not make a trend, but perhaps a couple of months do. The shock this week was a very poor jobs report which had the optimists scratching their heads and the pessimists questioning their optimism. The market tried to shrug off the news but in the end it finished lower for the week.
The silver lining, as mentioned last week, is that as the economy deteriorates, it is more likely that the Federal Reserve will be forced into further quantitative easing. While quantitative easing is widely seen as a failure in curing the ailing economy (particularly labor and housing); it has been very successful at inflating financial asset and pumping up commodity prices. We’re neither sure what form the stimulus will take nor when it will happen, but with each passing week it appears more likely.
Let’s not forget that corporations are sitting on huge piles of money. Some of it is parked overseas where it will probably remain, short of an income repatriation tax holiday. However, a lot of it is right here in the United States and is waiting for the right opportunity to buy a competitor, expand into new a market, repurchase stock, pay down debt, expand infrastructure or put into research and development. Earnings trends remain positive and productivity is higher. While inflation pressure has begun to work its way into materials costs, it still has not created an issue for most industries. Companies are in better shape today then they have been in a long time.
What’s ailing is middle-class America. We learned this week that housing prices fell another 4.2% in the first quarter of 2011, bringing them down to mid-2002 levels. To a large extent this drop is driven by the large number of foreclosures than continue to wind their way through the system. However, an even more sobering number was that the unemployment rate headed higher again for the second month in a row. We learned today that the unemployment rate is now 9.1% and that only 54,000 jobs were created last month (there are 8.5 million people unemployed). Consumption makes up 70% of our Gross Domestic Product (GDP) and to the extent that people remain unemployed, worried about their jobs, or unable to make their house payments, the economy will continue to struggle.
We’re in difficult times. We’ve been navigating these waters with financially strong companies who have excellent growth opportunities. We’re also focused on companies that have strong international sales and fixed income with an international component. Eventually, this cycle will turn around and the market will head higher. Until then, we remain positioned to weather both the good and bad that undoubtedly lies ahead.
While the news may be less than rosy at the moment, rest assured that things will get better. After all, the world didn’t end on May 21st right?
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