Asian equity indices were weaker in overnight trading (note the SENSEX doesn’t close until 0600 EDT) responding to the sell-off in Europe and the US (more on this below)…European indices are trading to the “+” side in the morning session (around + ½% so far)…domestic futures currently indicate a negative opening again today although much more muted than yesterday’s straightaway 2% drop.
It’s [still] the [global] economy stupid – James Carville’s (whom I like to refer to as Skeletor) words used at the time against George HW Bush remain pertinent for markets around the world…yes, there was much wailing and gnashing of teeth on the talk show circuit yesterday following S&P putting the US Treasury’s AAA rating on outlook negative (there’s a difference between an outlook and an actual downgrade although that fact appeared lost on much of the populace yesterday). Did this represent the culminating event that has focused the attention of the markets on the plight of the world’s economies? Nothing to do with the markets is ever that simple or that linked to a single event (short of it being a cataclysmic event…although given the events of the last year, I’m not sure what represents cataclysmic anymore). This is the proverbial “wall of worry” and the market’s have been scaling it for some time now. Take a moment to look at the chart below and you can see the “consolidation” moves that the S&P 500 has made following the upward runs over the last 16 months. Now let’s think back…what were the events surrounding the sell-off moves?
• March 2010 – The EU threatens to come apart at the seams as the weaker southern European economies appear to be collapsing under the weight of their own socialistic largesse…the “panic” culminates in bailouts for Greece and Ireland as the IMF and EU stepped in with the first debt support from the so-called EFSF (European Financial Stability Facility)… volatility spiked to levels not seen since the March ’09 lows. fears of a “double dip” were on everyone’s mind…crude oil (West Texas Intermediate) collapsed from $86 to $65 in the span of three weeks. The market oscillated around these events until late summer when it became apparent that the EU would do whatever necessary to bail the PIIGS out because if they went under, the banking systems in Germany and France would follow as they held much of the sovereign paper in these profligate member states.
• March 2011 – Japan…the world’s 3rd largest single-state economy has the northern 1/3 of Honshu (the big island) rocked by a 9.0 Richter Scale quake (strongest ever officially recorded)…the effects were quickly felt in a violent sell-off in the S&P 500 and the commensurate spike in VIX but the change in each paled in comparison to the occurrences following the initial EU “PIIGS crisis”…so the real question is why, and why might the tragic events in Japan take longer to play out and be more of a stealth growth inhibitor? Well, the simple answer is that it isn’t as obvious…I mean every investor out there can instantly imagine what the impact of a EU collapse could be…everyone trades with the EU, they have a 12 year old infrastructure set up to deal with international and intra-EU trade a collapse would’ve had a devastating impact on the world economy. Japan is a large economy but this wasn’t a potential structural shift in the very fabric of the world economy, it was a natural disaster followed by a manmade disaster (Fukushima) but now we get to the insidious details and it all is driven by global trade and inventory practices…I don’t believe that we’ve seen the extent of the impact on global trade that the aftermath of the quake/tsunami will ultimately cause…it’s been 5 weeks, a lifetime for cable news (when’s the last time you saw significant time devoted to Fukushima? Is the situation under control? No) but the blink of an eye for supply chains that transit the world on cargo ships linking far flung industrial operations that in turn link to other industrial operations all depending ultimately on their weakest link…in this particular case the northern 1/3 of Honshu.
Now back to yesterday…so we’ve been scaling this wall, knowing that plenty of other events are bubbling just below the surface:
• “Cairo Spring” in the Middle East…how far can this spread…could another Palestinian uprising be right around the corner…could such an event throw all of the area into an uproar as besieged governments use that event to focus the minds of their people away from their problems at home and once again toward Israel? The current perception of the US Administration exhibiting patient decision making at best, indecisiveness at worst does little to help stabilize the situation. All of this makes the oil market a very volatile market indeed.
• Portugal needs/gets a bailout…Spain invests billions in 4 Cajas (land banks) taking majority stakes after claiming that the market would provide capital to these banks…Bank of Spain says bad loans continue to climb…Greece now appears poised for a restructuring little more than a year after the bail-out would supposedly fix the situation…Ireland continues to struggle under the debt owed and bad debt owned by their banking system.
• China raises reserve requirements (now over 20%) and indicates that short rates will be raised once again (5th time this year) as the government continues to battle inflation (fears of a potential insurrection if food and energy prices continue to spiral upward have to be front and center for the communist government).
• Oil prices surging to levels not seen since ’08 (remember ’08…proper response is “don’t remind me”)..gasoline hovering just below $4/gallon nationally, already over $4 in the high gasoline tax states (one of which I manage to live in)…this has typically been a growth killing level.
• Currency crises from Argentina to Vietnam…
Bottom line, it’s all about global growth and all of these issues existed before S&P came out with their outlook for the full faith and credit of the US Government’s debt…none of these issues seem to indicate to me that a stable growth trajectory awaits us but I don’t think that a crash is out there waiting for us either (barring some cataclysmic event) but we could clearly see a consolidation phase which is probably well deserved after the run that the S&P has had since late last summer.
• On the domestic economic release front we get housing starts and building permit data for March out at 8:30…the consensus expects that we should see improvement over the weather impacted numbers from February. Home ownership is losing its luster in many areas of the country…
• Yields on two year Greek debt now exceed 20% as the country sells 13-week bills (€1.625 billion)… Credit spreads have stabilized in Europe after yesterday’s widening…the SOVX index is just inside 190 basis points
• Treasury rates continue to hold steady with yields near their lows for the year even after the S&P comment yesterday…this is more indicative of problems elsewhere and the fear of credit and equity market risk than the quality of the US Government…
• It appears that the Fed will likely move to maintain the Open Market Operations balance sheet at current levels (around $3.5 trillion) by reinvesting any maturing securities in the portfolio…this will be mostly T-bills, agencies and mortgage backed securities.
• NATO planes hit HQ of units leading attacks on Misrata…oil lower in early trading at $106.32 per barrel for WTI, Brent at $120.00
Phillip Pennell, CFA
Turnberry Capital Management
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