Financial Market UpdateStrategicPoint of View®
May 31, 2011
LAST WEEK
Data continues to be uninspiring. Unemployment claims stayed above the 400,000 mark for the seventh week in a row. Durable goods orders dropped a disappointing 3.6%. GPD growth for Q1 2011 was reaffirmed at a sluggish pace of 1.8%. Consumer spending, which constitutes 2/3rds of GDP growth, is on target to deliver sub-par growth for the second quarter.
On a positive note: consumers seem a bit happier now that oil prices appear to be stabilizing (albeit at a higher level), according to Thompson Reuters/University of Michigan consumer sentiment survey. One component of the survey - expectations – rose significantly and could help boost the economy later in the year. Meanwhile, new homes sales jumped, providing a brief respite for the struggling housing market.
S&P 500: 1331 (down 0.15% for the week and up 5.89% on the year)
NASDAQ: 2797 ( down 0.21% for the week and up 5.47% on the year)
Dow: 12,442 (down 0.56% for the week and up 7.47% on the year)
US Treasury 10 yr: 3.07% (from 3.15% last week)
Crude Oil (July): $100.59 (from $99.49 last week)
Gold (August): $1538 (from $1,508 last week)
USD/Euro: $1.4297 (from $1.4157 last week)
THIS WEEK
The week will provide a slew of data for investors. We tap into many corners of the economy including: housing, consumer confidence, productivity, factory orders, motor vehicle sales and the all important jobs number. Good news early in the week could be overridden by a less than respectable jobs report on Friday.
COMMENTARY
This Side of the Atlantic
Consensus is forming on how to handle Greece’s debt issues. The trouble is the consensus is building outside of Europe. Inside the euro-zone, disagreements are still raging.
It is easy for us, in the United States and other parts of the globe, to tire of the European debt crisis and offer tidy solutions. After all, the fallout from any resolution hurts parties in the eurozone much more than it does elsewhere in the world, although we too will suffer if Europe can’t solve its debt problems. Concerns over slower global economic growth and shades of another banking crisis – this one in Europe – tend to drag our stock indices down. As much as anyone else, U.S. investors want to see the current “muddle through” approach by the European Union replaced by strategies that will work, even if pain is a by-product.
There are three broad approaches to addressing Greece’s looming insolvency.
1. Let the Greeks handle it themselves through cuts in spending and hikes in taxes. This is a popular remedy if you aren’t from Greece. Some austerity measures have already been instituted by the government, but these are dragging the local economy even further into recession. 2010 Greek GDP was (-4.5%) while 2011 growth is estimated at a (-3.5%), and resistance amongst the populace is rising. Even draconian measures won’t be sufficient to stabilize the country’s debt balances. Conclusion; the Greeks can’t do this one alone.
2. Give Greece more money – beyond the $155 billion the country received last year from a special euro-zone rescue fund in concert with the International Monetary Fund. The difficulty here is that any bailout is likely only to be a stop-gap measure. If, one year after the first bailout, Greece has already returned to the brink, it is hard to imagine a revived Greek economy a year from now. At what point do the handouts end? And equally important, what other countries will demand assistance? Not surprisingly, Germany, France and other strong European economies, which would ultimately be the source of these funds, are resisting this approach. Conclusion: Greece can’t count on the super-generosity of friends.
3. Restructuring debt. This is the most popular solution if you aren’t a private creditor, or the European Central Bank (ECB), holding Greek bonds. Restructuring means that banks and other lenders, as well as investors, are required to take a hit on their holdings. Restructuring often comes in the form of stretching out the loan payments and cutting the value of the principal. In short, it means the face value of a bond might be written down by 50% (Barron’s estimate).
Restructuring has potential broad consequences. Exposure to Greek debt and potential write-downs is concentrated in European banks, which would have to raise more capital to cover their losses. This is similar to what happened to U.S. banks when their mortgage loans imploded, although the situation in Europe is not nearly as treacherous as the 2008 crisis. In the European Union’s case, Germany and France would likely be the provider of last resort for the European Central Bank’s balance sheet, while some banks might need to fail (not necessarily a bad thing as some of these could be absorbed by other more profitable institutions).
An additional consequence could be further downgrading of the debt in other troubled European Union countries, such as Ireland, Spain, Portugal and Italy. Since restructuring is considered by rating institutions to be a default, the European Central Bank is hesitant to advocate for changes in debt provisions.
Restructuring is the most popular solution proposed by non-Europeans (and increasingly by some in the European Union). This weekend the Financial Times reported that European leaders are negotiating a new bailout deal for Greece, utilizing some aspects of the above strategies – austerity and restructuring predominantly - and imposing the changes from outside the Greece itself. The Greek populace and the private investors are bound to fight back, but we may be moving closer to some tentative resolution.
Any agreement with Greece, however, is unlikely to end the European sovereign debt drama, and impatience over piecemeal solutions is growing. This week’s cover story in Barron’s advocated for a major debt restructuring now, arguing that a little move here or there will result only in band-aid solutions that can compound critical consequences.
Easy for us to recommend. We live on this side of the Atlantic.
*Past performance is not indicative of future results. Indices are unmanaged and you cannot directly invest in them. The Nasdaq Composite Index measures all NASDAQ U.S. and non-U.S. based common stocks listed on the Nasdaq Stock Market. The S&P 500 index is based on the average performance of 500 industrial stocks monitored by Standard and Poor’s. The data referred to above was taken from sources believed to be reliable. StrategicPoint Investment Advisors has not verified such data and no representation or warranty, expressed or implied, is made by StrategicPoint Investment Advisors.
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