Europe at Center Stage

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I wanted to wait until we had some news out of Europe before writing this message. After all, it has been almost exclusively the issue that the markets have fixated on for months now. This past week we got those much anticipated big European headlines in the form of a 1 trillion euro ($1.4 trillion USD) ESFS package.


This is a potential game changer. Perhaps my expectations were very low, but I admit that I am slightly impressed that the Europeans were able to reach this sizeable and coordinated agreement. Don’t think I’m naïve enough to believe it will unfold precisely as planned, but this is a big first step nevertheless. In time, I would expect more moves will be necessary and it wouldn’t surprise me to see the US getting involved in various ways as well – either directly or through our role in the IMF.

As I mentioned in the last edition, my personal preference would have been to take a harder line with Greece; but I don’t make the rules and I would have been shocked to see the Europeans take that route. As it is with this plan, I’m content to be pleasantly surprised to see that they have demonstrated a little forward thinking about their bigger problems on the continent. They’ve also shown a little spine in requiring investors to take haircuts of 50% on Greek debt and banks to comply by tighter standards (9% core capital ratios) as well as begin recapitalization efforts totaling nearly $147 billion. Each of these figures may rise in the future.

From the financial market’s perspective, this is good news in the sense that it takes the immediate Armageddon scenario off the table. It is bad news, however, because these measures almost certainly limit the growth rate of the European economies in the coming years. In the short run, the good news will likely outweigh the bad.

Some quick background for the sake of perspective: The expectations around the world were that the Europeans would craft some sort of plan to avoid a complete meltdown of their financial system. These expectations were calling for a package worth roughly 800 billion euro on average. Back in September there seemed to be no plan; hence the wicked market downturns. With October came these expectations of a rescue package and along with those expectations came a powerful market rally. When the figure moved from starting with a “b” to a “t”, the market rally intensified.

For example, one report I heard last week is that the Dow might set a record for the most points gained in any single month ever this October. That’s incredible. It is an illustration of how things move most powerfully as conditions shift from bad to less bad, not from good to better. Incidentally, I believe there is too much attention given to the 30-company Dow as a benchmark, but it is still what most news outlets focus on.

Those that took a pure stock market (aka “risk-on”) stance this past month have had the month of a lifetime. Of course, these are almost certainly the same people who are still reeling from similar past speculations gone horribly wrong. It is important to remember just how badly October could have gone. If the Europeans didn’t coordinate some sort of plan, imperfect as it is, the losses of the third quarter would have been expanded, possibly severely. It’s a bit like the gambler who tells the same worn out story about his big score, but never tells the stories about how putting himself in position for that big score jeopardized his future. More often than not he’s speechless hiding all the stories he really doesn’t want you to hear.

One of my favorite phrases is “all anything is all wrong”. It applies throughout most of life, investments included. These past several months in the financial markets have been no exception. As we move beyond the day-to-day headlines and volatility we see yet again that being entirely invested in any one way – be that cash, stocks, bonds, gold, whatever – is not the best path to long term investment success. It’s probably not the best on your heart, either…..

Since “all anything is all wrong”, let me comment on things outside Europe. They’ve had center stage, but there has also been a small supporting cast on stage with them.

It is no secret that Asia and the emerging markets are arguably the key drivers to global growth. As most S&P components have reported their earnings we’ve seen this theme over and over again. Growth in Europe has been weak, US hasn’t been all too much stronger, but Asia in particular has been very strong. Other emerging economies in Latin and South America have also been highlighted.

By far, the most important ‘developing’ market is China. The laws of numbers dictate that eventually their growth rate will slow as their economy becomes more developed. The question isn’t that their GDP numbers will slow; it is simply at what pace? The fears in the markets were that China’s GDP was going to slow greater than expected due to the malaise around the rest of the world. Good news came in the form of a 9.1% GDP growth rate in China as opposed to forecasts as low at 5%. (We in the States recognize 9.1% as our persistent rate of (reported) unemployment – more on that in a moment.)

This Chinese economic data was perhaps the second largest story in the markets in recent weeks. Taking the bronze metal was the aforementioned earnings season for the majority of US companies. In short, earnings season was very solid. To this point, roughly 70% of companies have exceeded their earnings estimates and a large percentage of them also raised their guidance for the year ahead. It should be noted that a wild card in most forecasts was progress in Europe.

I mentioned unemployment a moment ago and let me say that I don’t see any reason for that figure to be coming down anytime soon. In my view, there’s simply no reason for it to drop. Corporate America is running along just fine at the current level of employment and companies are still facing far too much uncertainty about the cost of new employees to take the unnecessary plunge. I rather respect the CEO who focuses on responsibly protecting the thousands of jobs he or she currently oversees and not putting them at risk by

making new hires that can’t really be justified. How can it be expected that a new hire will add to the bottom line with only so much global demand for goods and services at the moment? On a humanitarian level, I’m sure we’d all like to see unemployment back to 4% or less. There just isn’t any economic rationalization for that hope, however. As the era of the New Normal unfolds I believe we’ll need to expect 6-8% unemployment to become standard.

In recent weeks things around the globe have gotten less bad. Unfortunately there is still a backdrop that includes the capital of Pennsylvania declaring bankruptcy and news of a Super Committee deadlocked about how to cut the federal deficit as they head toward a critical deadline. It’s funny how when you “kick the can down the road” it never goes as far down that road as you’d like. Doesn’t it seem like just yesterday the US was doing all it could to avoid default in the 11th hour? Part of that solution was that this Super Committee would come together with the benefit of some time to properly strategize and make some meaningful cuts – $1.2 trillion is their target. Instead we might see more drama like we saw earlier this year. Already there are rumors of another possible S&P downgrade. Can we really be surprised by this?

This reminds me of a Warren Buffett quote I’ve laughed about with a few you recently. His quote in a CNBC interview was: “I could end the deficit in 5 minutes. You just pass a law that says that anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election”.

I know I said that I’d steer clear of political commentary in these messages, but this quote from Buffett was attached in many emails to some other thoughts about Congress that I enjoyed. Since they speak more to the political construct itself rather than any political party – and since I wholeheartedly agree with every single word of it – I thought I’d attach it as well. See the attached for a common sense take on what being in government should look like.

The takeaway:

The investment landscape will always have things to fear. The old adage that “Wall Street climbs a wall of worry” is true. Knowing that the investment landscape is never perfect, we need to recognize that recent weeks have seen some positive developments. I’m still of the belief that the global economy does more muddling that it does genuine growing; but the odds of a substantial setback around the globe are less today than they were in months past. If Europe doesn’t go forward and implement their plans as promised, it will be a trillion euro wasted and much of the better picture I’ve painted here goes away quickly. Europe’s leaders have claimed victory before. They described their plan in March as a “comprehensive” strategy, and Luxembourg’s Prime Minister went so far as to say that the July 21st accord on a second bailout for Greece and more power for the rescue fund was the “final package, of course”. And yet here we are today. I will still be monitoring that situation very closely and I won’t abandon a more balanced approach to the markets for the overly optimistic view that “risk on” is here to stay.

Congressional Reform Act of 2011

1. No Tenure / No Pension.
A Congressman* collects a salary while in office and receives no pay when they are out of office.

2. Congress (past, present & future) participates in Social Security.
All funds in the Congressional retirement fund move to the Social Security system immediately. All future funds flow into the Social Security system, and Congress participates with the American people. It may not be used for any other purpose.

3. Congress can purchase their own retirement plan, just as all Americans do.

4. Congress will no longer vote themselves a pay raise. Congressional pay will rise by the lower of CPI or 3%.

5. Congress loses their current health care system and participates in the same health care system as the American people.

6. Congress must equally abide by all laws they impose on the American people.

7. All contracts with past and present Congressmen are void effective 1/1/12. The American people did not make this contract with Congressmen.
Congressmen made all these contracts for themselves.

Serving in Congress is an honor, not a career. The Founding Fathers envisioned citizen legislators, so ours should serve their term(s), then go home and back to work.

* Includes congresswomen

Commentary by Jeff Winn, Financial Advisor – Orlando FL


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