Believe me, I would love to talk about something other than Greece and the pain in Spain, but the fact is that they are the big stories from around the world that will have the most impact on financial markets. To deny it is foolish. Between the non-stop caterwauling about Facebook and this ongoing saga in Europe, I’m eager for a change in subjects. But then again, I know the next major subject is going to be the election here in America, and I can’t say I’m excited about that coming attraction either.
The last issue of Worth Considering talked mostly about the warning signs that began to develop in the markets, including the metals markets. Since that issue went out, we have seen steady erosion in prices. I feel the same way now as I did then – that these signals are flashing yellow, not turning red. In other words, it is still a time for a balanced approach to an investment portfolio. There’s no need to be paralyzed by fear, and there’s no need to be intoxicated with greed. Intense bargain hunting is premature and panic is misplaced.
I’ve seen a lot of portfolio managers, newsletter writers, pundits, and supposed ‘smart money’ in general take very steep losses so far this second quarter. And it’s almost uniformly for the same reason. The common mistake was expecting the impact of future inflation to finally arrive in the markets. It hasn’t, and it isn’t about to, either. Eventually it will, which is why I remain solidly bullish about the markets looking out over the next few years. Keep in mind that financial markets thrive on a certain amount of inflation, but struggle during deflationary cycles. And I continue to hope people will recognize the enormous deflationary elements in the system around the world. In the end, I believe the additional money printing that will likely come soon in Europe and then again here at home in the US will dominate and overpower those deflationary forces. But I reiterate my multi-year plea to not bet with both hands on the return of inflation in terms of what investments you choose to overweight in your portfolio. Those that have are suffering mightily under the losses in the metals, energy, and commodity markets and the effects those weak conditions have had on the companies in the mining, manufacturing, and related businesses.
The French (Mis)Connection
In a previous communication I commented on the importance of the French election. In short, it went the wrong way. The new President, Francois Hollande, is a staunch Socialist who is not likely to continue the path of his predecessor, Nicolas Sarkozy. It is still too soon to know how exactly this will impact the broader European progress of the past year, but I don’t see any positives that come from this election’s outcome. I view this as a setback for the region, not just France. If Europe is going to stay under such pressure, there is only so much growth the rest of the world can maintain. Unfortunately, this election outcome means a return to more historically normal global rates of GDP growth is now further out on the horizon. The world will still grow, just at a slower pace for a longer period.
The Greek Waiting Game
The Greeks go to the ballot boxes again on June 17th. The big debate is whether the pro bail-out party will pull out a victory over the anti bail-out party. I just don’t know how much it matters – Greece is going to default either way, it’s just a matter of when and how. I think the markets have moved past all that now and have moved on to the debate about how to avoid chaos and hangover effects of an exit of Greece from the Eurozone. There might be good news here. The investment world is going to be more surprised if Greece doesn’t default; so when they do it might not have a negative impact at all. In fact, it might be the type of event that actually moves markets higher because the waiting game is finally over.
The Real Issue is Spain
To me, the situation in Greece can be considered a type of dress rehearsal for the main event. This main event plays out in the larger troubled nations of the Eurozone, chief among them being Spain. According to data recently reported on CNBC, Spain has 22% unemployment and a staggering 50%+ rate of unemployment for those under the age of 30. Their debt is massive and they, like Greece, are stuck in a currency they don’t have the ability to devalue to create various forms of relief. Something has to give. The confidence in their ability to manage their situation is rapidly deteriorating. One has to wonder that if the Spanish watch Greece’s problems only get worse if the Greeks attempt to leave the Euro, will it help create an attitude of discipline and healthy reforms in Spain. It is possible, and Spain’s debt isn’t at a point where it is too late for them.
China Check
The Chinese are considering another large stimulus package to boost their flagging economy. One current rumor calls for 2 trillion yuan, or roughly 4% of annual GDP, as a shot in the arm to their economy. Most economists call for more than 40% of all world GDP growth to come from China, so if they fall too far behind estimates of domestic growth it would be a particularly strong blow to the global growth story. But keep in mind; they are still growing above 8% without stimulus. Remember also that the Chinese have a war chest of reserves, so we’re not talking about the types of debt spending as what we see around the rest of the world.
If China’s growth stays at a subpar albeit still strongly positive rate, the industries likely to feel the most negative impact would be agriculture, commodities, energy, and metals. The demand for these assets would still be positive overall, but would be curbed substantially. Here again we see the primary suspect areas for investors playing the inflation card too soon.
Here at Home
Meanwhile, here in the United States, our plow horse of an economy continues to slowly meander forward. As I’ve written before, our domestic economy appears to have moved into a painfully slow yet self sustaining recovery mode. We are far from full cylinders; but the plow horse isn’t on the way to the glue factory just because it isn’t a threat for the Triple Crown. It’ll most likely continue to put one foot slightly in front of the other and lumber onward. The question is how well it might be able to defend itself against weakness elsewhere in the world. My answer is that it can only do so much growing under the current political weight and global pressures it must endure. I do, however, believe it will continue to grow. Let’s not lose sight of the fact that corporations are performing well, holding a historically high level of cash, and are by no measures expensive in terms of stock valuations. Interest rates will be kept low for quite a while still, and this is another positive input for the financial markets. So while I think the global economy will grow at a modest rate, investments on the whole appear to be priced properly for that expectation. I would love to say they are cheap, but they aren’t. Slightly under historical valuations can’t be honestly described as cheap. Likewise, things are not expensive and shouldn’t be seen as highly vulnerable to steep declines.
The Presidential Election
As I said earlier, I’m not looking forward to this circus coming to town. Nevertheless, the tents are being raised and the clowns are in full costume. I promised that Worth Considering wouldn’t ever spend much time on politics, and I will happily keep that promise. But from time to time there is no avoiding the important subject – though I do plan to avoid using these communications as a ‘soap box’, so to speak.
To get to the bottom line quickly, my fear both as a citizen and an investment advisor is a clean sweep by either party in November. The President might control the direction of things, but the House and Senate control the pace. The world, not just the US, is in a difficult position at the moment. I don’t personally believe it is best served by growing the size of government; not at all. However, I also don’t believe it can withstand a sudden shock of a complete withdrawal of programs that have been supposedly put in place temporarily. In simple terms, I believe we’d be best served by government getting smaller – but in the right places and over the right timetable. Go back to my comment above and you can see that I want a President that seeks to streamline government and make it more efficient and fiscally responsible, not more ever-present; and ideally this President will be forced to make this progress at a gradual pace to promote stability. I’d love to think this could be done by either political party, but history and common sense give me no reason to believe that. Sadly, neither party has a right to brag about their track record. That’s perfectly fine with me – I’m looking for leaders who have a long range plan for stability, peace, and growth for our country much more than life-long party-labeled politicians. This is true of all elected officials, not just the President.
The takeaways:
- The financial markets are likely to stay under pressure a little longer. The coming weeks will shed light on developments throughout Europe. With so many things still unknown, it makes sense to remain cautious short term; but there’s plenty of reason to maintain optimism for the longer term.
- Yogi Berra might put it this way – Europe is 80% of the story, China is 20%, and then you add the rest of the world. In other words, economic data from the US is essentially meaningless at the moment. Much more impact will be felt by developments in Europe and China in the coming month or so.
- Deflation remains every bit as much a concern as inflation, if not more.
- Be patient with the investment process. Expect volatility to be on the rise in both directions. Do not let your emotions get the best of you on the big up or down days. This volatility is fueled mostly by either “good” or “bad” news out of Europe; and this is news that really matters only in the short term but might have very little to do with how their economies will be doing a couple years from now.
Commentary by Jeff Winn, Winn Advisory Orlando FL
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