A Brief Primer on the European Crisis
Some reflections on the Greek elections and the market going forward after this “long” weekend, as we await Benny to take on the show tomorrow. Don’t be surprised when they start hitting metals tomorrow, as this has been the trend lately. By Hussman of Hussman Funds.
With Greek elections resulting in a fairly benign outcome that promises to hold the euro together in the near-term, the market may enjoy some amount of relief. The extent and duration of that relief will be informative. Based on broader factors, we don’t expect that relief to survive very long, but we are willing to respond more constructively if our own return/risk measures become more favorable.
Our estimate of the prospective return/risk tradeoff in the stock market remains in the most negative 0.5% of historical instances. That said – and this is important – if market internals improve meaningfully over the next few weeks (measured across individual stocks, industries, sectors and security types), our estimate of the market’s prospective return/risk profile would improve, despite what we view as rich valuations and a new recession. Very roughly speaking, this would require a solid rebound in market internals over a period of 2 or 3 weeks. That sort of outcome might accompany a Fed easing or other event, but our focus is on the measurable condition of market internals, not on Fed policy or other news per se. A positive shift in our measures of market action would likely be enough to ease back from our tightly hedged investment stance to a slightly constructive position. For now, we don’t have the evidence to take anything but a very defensive stance, but we’ll take changes in the evidence as they arrive.
It’s fair to say that we don’t foresee any development that would encourage us to remove a major portion of our hedges at present, and my personal expectation is that conditions are likely to deteriorate sharply rather than improve, but as always, I want shareholders to know where my attention is focused. Our measures of market action – and any meaningful improvement over the next few weeks – will be important in determining the whether we maintain a tightly defensive stance or shift to a slightly constructive one.
The Heart of the Matter
Hussman of Hussman Funds shares some good points on the markets and the central banker’s casino.
Over the past 13 years, the S&P 500 has underperformed even the depressed return on risk-free Treasury bills. Real U.S. gross domestic investment has not grown at all since 1999, and even as a share of GDP, real investment remains weak.
The ongoing debate about the economy continues along largely partisan lines, with conservatives arguing that taxes just aren’t low enough, and the economy should be freed of regulations, while liberals argue that the economy needs larger government programs and grand stimulus initiatives.
Lost in this debate is any recognition of the problem that lies at the heart of the matter: a warped financial system, both in the U.S. and globally, that directs scarce capital to speculative and unproductive uses, and refuses to restructure debt once that debt has gone bad.
Specifically, over the past 15 years, the global financial system – encouraged by misguided policy and short-sighted monetary interventions – has lost its function of directing scarce capital toward projects that enhance the world’s standard of living. Instead, the financial system has been transformed into a self-serving, grotesque casino that misallocates scarce savings, begs for and encourages speculative bubbles, refuses to restructure bad debt, and demands that the most reckless stewards of capital should be rewarded through bailouts that transfer bad debt from private balance sheets to the public balance sheet.
What is central here is that the government policy environment has encouraged this result. This environment includes financial sector deregulation that was coupled with a government backstop, repeated monetary distortions, refusal to restructure bad debt, and a preference for policy cowardice that included bailouts and opaque accounting. Deregulation and lower taxes will not fix this problem, nor will larger “stimulus packages.” The right solutions are to encourage debt restructuring (and to impose it when necessary), to strengthen capital requirements and regulation of risk taken by traditional lending institutions that benefit from fiscal and monetary backstops, to remove fiscal and monetary backstops and ensure resolution authority over institutions engaging in more speculative financial activities, and to discontinue reckless monetary interventions that encourage financial speculation and transitory “wealth” effects without any meaningful link to lending or economic activity.
Spain joins the “B” Club
Although not overly unexpected, S&P delivered another downgrade of Spain. Leaving the fine A club and joining the B club, this only shows how badly run the world’s 12th largest economy actually is. The Trader still believes majority of the analyst community still underestimate the bad loans, the state of bank’s balance sheets and the mentality of dealing with economic reality in Spain, from politicians, companies, down to the average person. The boom has ended, and the hang over is just starting. Despite all this, the top news in today’s version of El Pais, is regarding king Juan Carlos and the status of his hip after the big game safari in Botswana.
Tic tac tic tac as PIIGS yields spike further.
Remember the non HFT days?
S&P pit 30 years ago. Courtesy CME.
Offense is the best Defense-Spain attacks S&P
The Trader has written extensively on the mountain of problems Spain is facing. With unemployment at 23.5%, a property sector in implosion mode, competition from other tourist nations increasing and a huge corruption problem, Spain is up for a rogue ride. One of the bigest problems Spain needs to fix, is the mentality of how stop losses are treated. With many in total denial of what is going on, the decisions made, might just be a little to late. The collapsing property market is simply not being dealt with. Banks, institutions, individuals etc all still live in a fantasy world just waiting for the property sector to come back to those record levels. That will simply not happen, in out life time. The speculative buyers are still leaving, and the over hang of unsold properties valued at record levels will eventually cause big problems, when they start taking the big stop. One thing is for sure, cheap properties are coming up, just like we saw in Florida, where you still buy double the property for half the price compared to sunny Spain.
Meanwhile, the politicians continue the rhetorics. From El Pais;
Prime Minister Mariano Rajoy says he knows exactly what Spain needs to improve its reputation with international credit rating agencies as well as to create jobs and stimulate the economy. Speaking a day after Standard & Poor’s downgraded Spain’s sovereign rating along with that of eight other European nations, Rajoy said Saturday that he plans to go before the European Commission on January 30 “to tell them what I believe needs to be done as a clear response to defend the euro, control deficits and introduce economic reforms.”
Europe (still) hung over- What to do?
So, S&P “shocking” people by the (un)expected European credit downgrade on Friday Evening. The downgrade, is nothing more than a sober and objective look at the European situation. France should not have the same credit rating as Germany, Italy is in great problems, and yes, Spain’s unemployment (hitting 23.5%!) and the property bubble are just some of the problems facing (old) Europe.
With the huge administration where people can’t agree on the size of the cucumber, the political Euro project is going into an intensified mode with the Friday evening downgrade. It is time for Europe to sober up and deal with the situation practically, not just politically. From Spiegel;
Following the decision by rating agency Standard & Poor’s to downgrade the ratings for nine euro-zone countries, pressure is likely to increase on Germany, the country long viewed as a model during the crisis, but also the one that holds much of the money that is needed to solve it.
S&P downgrade could be major game changer
Guest Post by Steen Jakobsen of Saxo Bank on the S&P Downgrade.
Market impact
S&P’s report is the most honest, politically incorrect report on the Eurozone debt crisis I have seen in a long, long time. It could increase the focus on how the policymakers continue to throw liquidity at a solvency issue and also underline how focus on austerity can leave us all worse off, as we can not save ourselves to prosperity.
In practical terms this means the European Financial Stability Facility is 90 percent dead – its leverage is now so small it makes no sense, hence the European Stability Mechanism will be moved further forward on the agenda in the March EU Summit, but it will also mean huge pressure on Germany to pay more, and to increase the EUR 500 bn. limit in place for the combined EFSF/ESM.
This will not go down well in German domestic politics and it will create an even bigger gap in the Franco-German alliance.
The downgrade of France changes the relationship from one of equals to one of older sister to younger brother. The dynamics could mean Sarkozy has to fight harder in the upcoming French election. I could easily imagine Marie Le Pen gaining momentum in the next few months on a strong anti-EU and anti-Sarkozy platform.
EUR/USD should open lower on the uncertainty and everything being equal (the favourite economist speak): it will put upward pressure on yields in Spain and Italy.
The main effect though could be more honest dialogue about the real reasons for the crisis in Europe and hence leave us better off as talk finally centres on reality rather than hope. Effectively S&P did what it was supposed to do: It ignored the “Powerpoint presentations” from the EU and looked only at the accounts. The accounts speaks clearly for temselves – no progress, no real plans and only savings making the board meetings.
Two conflicting views of where the market should go in 2012
According to Dent the Demographics effect is about to kick in. Dent predicts S&P to fall 30-50% in 2012.
Jim O’Neill of GS is slightly more positive, and expects the market to go up 20%. Two rather different views below;
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