July 2012 Investment Journal
The dog days of summer have set in, and market trading volumes were predictably low in July, accentuating price trends and money flows. US stocks were up, while bond yields pushed lower. Gold, oil, and other commodities were healthy, especially agricultural commodities, which spiked as a severe Midwest drought decimated the US corn crop for this season:
Markets in July remained tethered to the European bailout drama. The latest iteration has an Iberian flavor, as Spanish politicians pleaded their case for more money to fellow Eurozone members. Meanwhile, their largest state run bank (caja) declared itself insolvent and pleaded for relief from the Spanish feds (isn't this circular begging)? All the while, unemployment in Spain has reached epic proportions - 24%! The bond "vigilantes" were also at work, driving up Spanish yields above 7% for the 10 year variety, considered "unsustainable" by most experts (they said the same thing about Greece, whose 10 year yield is now above 20%).
A lot of time and effort is being spent by market prognosticators on possible outcomes in Europe. To us, it's not that difficult: the Germans will decide everything because they have all the savings and economic firepower. The only question is will German industry win by keeping the Euro in place thus maintaining their export juggernaut (and saddling the taxpayers with new debt), or will the burghers decide to ditch the politicians and return to the Deutschmark?
The answer may come in August, as our old friend Greece literally runs out of money during the third week of the month. France and Italy have already lined up behind Spain, with ECB head Mario Draghi in late July promising to defend the Euro "at any cost". His comments ignited a late month rally, as stock markets took that as a confirmation that more money printing/bond buying ("quantitative easing") lay ahead.
The US Fed is a key player in this global debt debacle, and Chairman Bernanke testified at his semi-annual appearance before Congress in July that the Fed was "not satisfied" with economic progress in the US. Senator Schumer of NY then promptly scolded the Fed for insufficient action and told the Fed-head to "get busy" with more QE. Really? The first two rounds have done little to ignite "animal spirits", and uncertainty over the US tax code and regulatory regime, as well as bipartisan stalemate throughout the election cycle, is probably going to keep a damper on things. Our view is "what you see is what you get", and if Senator Schumer's comment is indicative, it's "Nero fiddled while Rome burned".
From our front row perch, it seems that bold and decisive action is needed soon. In the past several months stock markets around the world (with the exception of the US), have been anticipating a slowdown, especially China, the world's "growth engine":
Our hunch is that global central banks are not going to wait on the politicians to "do something". A failing Europe gives everyone the excuse they need to put in place gargantuan new bond issuance and purchase schemes, which would push stock markets up, but for all the wrong reasons. At the moment, it seems that government intervention is the only leg upon which the stock market can stand, and that is a shaky proposition at best. We'd like to see healthy, sustainable earnings, which are usually a hallmark of larger, higher quality companies with a global footprint and wide "moats". Investors take note.
While August could be a key month for market directionality, the long term solution is still elusive. Stimulus, bailouts, too big to fail, burden sharing and all the other trite slogans being used mask the capital distorting effect of artificial market activity (just look at the Swiss government bond market, where all instruments out to 6 years now offer negative yields!).
In this environment, savers everywhere (including large public and private pension funds) will be challenged to meet return assumptions. (This is a really big deal that no one is talking about. Check out this link to read how CALPERS, the largest and among the most sophisticated public pension fund in the US earned 1.0% last year, versus an assumed rate of 7.5%):
And, given that the US Fed has committed to keep interest rates at zero through at least late 2014, nothing seems to be on the horizon to change that outlook. Which is normally when something comes out of left field to upset the apple cart! Investors always need to consider all the "permutations and combinations" of various potential outcomes, and position themselves accordingly. We'll report back next month to bring you the latest "percolations from the front lines" which may include a return to the Greek drachma!
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