Market Update – June 2

Please forward this email to others who may want to sign up.  If you want to be on my list, there are instructions at the bottom of this email as to how to sign up.


Below is a summary of stories that I read during the past few days.  I think that the most important story is the conflict that we are seeing in the EU.  But, before I get to that, I have updated you on some of the other news about the EU.


1. News From the EU

On Friday, Fitch downgraded Spain from AAA. Apparently, Spain’s fiscal crisis is being worsened by a political crisis, as citizens are very unhappy with the government.  Of course, this will make it very difficult to implement austerity measures.


If Greece can’t solve its problems, they may need to restructure their debt (that’s a fancy way of saying “default”) or leave the EU.  This could create fears about other countries.  Greece needs to cut wages to make its goods more competitive.  There is also need to deregulate parts of the economy that do not have competition and simply protect workers.


France’s budget minister said that France should not take for granted its AAA rating. France forecasts that its deficit will be 8% of GDP this year.  They don’t expect to have it down to 3% until 2013.


Germany’s finance minister said that Germans need to be ready for higher taxes. The government is considering raising the VAT to 19% on certain items that currently benefit from a lower rate of 7%.  Germany’s deficit is expected to be 5% of GDP.


The European crisis is resulting in a slowdown in lending in Europe. Libor has increased and deposits with the ECB have increased (because banks don’t want to loan money to other banks).


The ECB has made clear that they consider inflation to be their top fear.  But, many economists think that they are missing the bigger threat: deflation. When the ECB bought government bonds in May, they simultaneously took in more deposits from banks (showing that they were not adding liquidity to the market) and some economists think that this was a mistake.  Deflation is a big concern because:

1. it causes consumers to delay purchases (waiting for lower prices)
2. delayed purchases (by consumers) can cause a downward spiral of lower demand and production
3. debtors are paying debt back with more valuable currency

In April, prices fell in Ireland.  Inflation was less than 1% in five other euro zone countries.  For the entire euro zone, inflation is running at 1.5%.  Many countries are going to try to cut wages to become more productive (since they don’t have their own currency to devalue).  There is less fear of deflation in the US because we have kept interest rates near zero and pumped large amounts of credit into our economy.


Europe’s banks will have to write of $237 billion of bad debts by 2011 and their ability to sell bonds may be curtailed as governments finance fiscal deficits, the ECB said.




2. Dissension in the EU

One of the things that I’ve been speaking about recently has been the fact that the EU has bailed out European banks, not Greece.  One of the most significant conclusions that central bankers have reached as a result of America’s crisis was that a banking crisis is much worse than a normal recession.  We don’t want any more banking crises.  As a result, if banks own crappy securities, the government will buy them.  Ultimately, that’s what happened in Europe.


This obvious issue (that the bailout is for the benefit of “non-Greek” banks) is felt very strongly by Germany.  It really irritates the Germans that the ECB is buying Greek bonds even though Greece is already getting money from an EU rescue fund.  The Germans believe that this is just a ploy to allow the French banks to liquidate their Greek bonds.  Of course, ECB President Jean-Claude Trichet is French.  This is leading some to believe that the independence of the ECB has been compromised.  Imagine how irritated the Germans are – the German banks had committed to holding their Greek bonds until 2013.


The ECB has already spent $50 billion buying bonds issued by Greece, Spain, Portugal and Ireland.  When Greece’s debt loses value (prices are artificially high because of the ECB purchases), the ECB’s capital will be crushed.  Member nations will need to inject more capital.  That should go over pretty well.


Tensions between ECB and Germany seem to continue to escalate.  ECB executive board member Lorenzo Bini Smaghi said that “in one large euro-area country it was thought that public support for swift action could be achieved only by dramatizing the situation, for instance, by telling the public that the euro is in danger or by considering the possibility of expelling a country from the euro area.”  Obviously, this was a dig at Germany.


Germany and Bundesbank leader Axel Weber have openly criticized the ECB purchase of government bonds.  There is fear that the ECB is simply financing spendthrift countries (or bailing out other countries).  But, Weber has not been as vocal as we might expect.  The reason that he has held back is that he wants to lead the ECB once Trichet’s term is done.  I can’t help but think that Weber replacing Trichet will be like President Regan replacing President Carter (and this is not a dig at President Carter).  The world very quickly realized that there was a new sheriff in town.  I’m just not sure that all of the Europeans can handle a new sheriff.


The bottom line is that Germany is very different than much of the EU.  We’re starting to see the problems from this.  I think that this will get significantly worse over time.




3. BP

Was this the range or simply the lower boundary? On Thursday, the U.S. Geological Survey said that BP’s well was leaking between 12,000 and 19,000 barrels per day.  They said that this was “the overall best initial estimate for the lower and upper boundaries.”  Now, some of the researchers who worked on this are saying that this was simply the lower boundary.


One of the worst stories from the BP debacle is that several newspapers reported that workers were bussed in to clean up the beaches prior to the President’s arrival and then they were gone once the President left.


We hate you…please save us. Americans tend to distrust government, yet we want the government to be able to solve the BP leak.




4. Economy

Consumer spending didn’t increase for the first time in six months. At the same time, personal income rose .4%, as more people had jobs.  The core price index for personal-consumption expenditures rose .1% for April.  On a YOY basis, it’s up 1.2%.


Straight from the Economist (and similar to some of my recent speeches):  Consumer spending seems unsustainably strong given weak income growth, shrunken wealth and tight-fisted banks.  It will be hard to rely on exports as Europe weakens (austerity measures and weakened currency).  We have used all of our bullets and we could be in trouble if the economy weakens again.  Most importantly, we continue our longstanding tradition of having no direction for solving our long-term deficit problem.


Scary news for consumer spending:

1. consumer spending didn’t grow in April
2. Target and Gap described spending at their stores as volatile and unpredictable
3. The stock market has gyrated, partly because of Europe, and this has made consumers less certain

A possible explanation as to why consumer spending has held up?  The NY Times had an interesting article describing people who are not paying their mortgage and are simply waiting to be evicted.  The average borrower in foreclosure has been delinquent for 438 days before actually being evicted, up from 251 days in January 2008.  This is all consistent with a theory that this is what has supported consumer spending – the millions of homeowners who are not paying their mortgages.  Apparently, this is particularly prevalent in states which require judicial foreclosure.  Other states (such as Texas and California) allow lenders to pursue foreclosure outside of the courts (call in the sheriff).

http://www.nytimes.com/2010/06/01/business/01nopay.html?th&emc=th


Consumer sentiment rose from 72.2 in April to 73.6 in May according to Thomson Reuters / University of Michigan.


Both Bernanke and Trichet (the leader of the ECB) said that emerging markets are the key to the world economy.  That should make you feel good.


The chief economist at China International Capital Corp. (CICC) said that China’s inflation would peak at 4% this summer.  Last week, the government said that they would monitor prices, punish “irregular” trading activities and increase supply to agricultural markets.


China is now signaling that they will levy a tax if you hold more than one apartment – in order to stop speculation.  The tax may be .8% of the market value of second homes.  Of course, they will need to build the infrastructure necessary to collect this tax.




5. The US Problems

The Economist blasted Congress:

1. Congress has been unable to pass its annual budget resolution, which sets out deficit and spending totals with which individual bills must comply.
2. Earlier this year, Congress passed a “Paygo” rule prohibiting new spending or tax cuts from widening the deficit.  But $79 billion of the latest stimulus bill is deemed “emergency” spending and is exempt.  Suspension of scheduled cuts to Medicare reimbursement rates is also exempt.
3. With taxes, Congress closed foreign-income loopholes for multinationals and taxes carried interest for fund managers.  But, they haven’t addressed the expiration of the Bush tax cuts.

The Economist says that our long-term fiscal challenge is huge – maybe bigger than Europe’s.  The IMF says that by 2015, we will have a structural deficit (one that will prevail at full employment) of more than 6% of GDP, compared to 4% for the EU.

We are being saved by favorable demographics (we still have time before the baby boomers kill us) and the fact that crazy people see the dollar as the safe reserve currency.  But of course, that is allowing us to continue our horrible habits.


The NYT had a great piece recommending some questions to ask the credit rating agencies in Wednesday’s government hearings:

1. given the obvious failures, why should the major ratings companies retain the competitive advantages bestowed upon them by the SEC?
2. what changes to your policies and procedures have resulted from the financial crisis and your role in it?
3. How can you defend the issuer-pay model?
4. In 2004, the FBI issues a warning of “an epidemic of mortgage fraud coursing across this country.”  Were you aware of it?  What did you do?
5. William Ackman (hedge fund manager) suggests a “wait to rate” policy where agencies wait 60 days to rate a bond.  This would require early investors to do their homework.  What do you think of this?
6. Ackman also suggests a pay-for-performance model that would reward accurate ratings.  What do you think of this?
7. What do you think of each issue being randomly assigned to a rating agency, so that they conflict of interest is eliminated?
8. Why did Moody’s wait two months before revealing that they had received a Wells notice from the SEC?
9. On the day that Moody’s received the notice, Moody’s CEO sold $4.3 million of shares through a previously scheduled plan.  Did he consider not selling?

10. Did Moody’s alert Mr. Buffett of the Wells notice?  He sold $30 million of shares the next week.


The Washington Post asked what will happen to mutual funds and pension funds if they are wrong about their purchase of Treasuries?

http://www.washingtonpost.com/wp-dyn/content/article/2010/05/31/AR2010053103456.html




6. Random

This was the worst May since 1940 for stocks. The Dow dropped 7.92% this month.  (In 1940, stocks dropped 22%.)


An AP poll found that 46% of Americans said that they’re suffering from debt-related stress and half of that group described their stress as a “great deal” or “quite a bit.”  The other 53% of Americans said that they fell little or no stress.


Telemarketers take 75 cents of every dollar they raise.  This is according to an investigation done in Oklahoma.   This is very consistent with what I found when I researched this in the past.  The bottom line is that we all want to help groups like veterans and retired police and firefighters, etc.  But, I NEVER give money to anyone that calls on the phone.  If you won’t send me information, I don’t believe that your legitimate.  I have zero interest in providing income to a telemarketer.




7. A Teaser For Friday

I’m often asked “what would make you optimistic?”  While I won’t tell you what I said when Jenny asked me that question, I will give you my economic answer on Friday.  It’s a very simple idea that I read last night.

Have a good week.

_______________________________________

If you want to be on my email list:

1.      go to www.leedsonfinance.com

2.      toward the top right corner is a place to click on for email service—click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.