Friday, June 24, 2011

Worried about Greece?


I don’t often write commentaries on a daily basis, but the developing saga and fear based market moves related to the current Greek credit crisis deserves your attention and a bit of understanding.

It is estimated that the total amount of Greek debt is well above $300 billion. That would make a default there one of the largest in history for one country. Larger than Argentina in 2002. And, Greece is not the only European country that has more debt than it can repay. It is a big deal.

Defaults like this (but not necessarily this large) however are not as uncommon as the average person thinks. Between 1998 and 2004, there were 15 governments that defaulted on their debt. Between 1976 and 1989, there were more than 40!

One of the things that I thought we learned in the past is that in most cases, by the time default is contemplated, the situation is usually so bad that a large part of the loans need to be written off. Here are some quotes from the EMTA’s site (link below) “The Brady Plan, the principles of which were first articulated by U.S. Treasury Secretary Nicholas F. Brady in March 1989, was designed to address the so-called LDC debt crisis of the 1980's…..From 1982 through 1988, debtor nations and their commercial bank creditors engaged in repeated rounds of rescheduling and restructuring sovereign and private sector debt, in the belief that the difficulty these nations experienced in meeting their debt obligations was a temporary liquidity problem that would end as the debtor nations' economies rebounded. However, by the time the Brady Plan was announced, it was widely believed that most debtor nations were no closer to financial health than they had been in 1982, that many loans would never be entirely repaid, and that some form of substantial debt relief was necessary for these nations and their fragile economies to resume growth and to regain access to the global capital markets.” Read more at the site:


What I thought we learned from past was that some sort of market based solution is necessary. Repackaging and reselling the debt. Something similar to the Brady Plan has been proposed by Daniel Gros, Director of the CEPS and Thomas Mayer, Chief Economist of Deutsche Bank. You can download their plan at the link:


One thing that is different this time is that those same pesky Credit Default Swaps we learned about during the mortgage bond credit crisis here in the US are involved in this crisis too! Seems like the French and German banks bought “insurance against default” on Greek, Irish and Portuguese debt—from US banks! So, it gets a bit more complicated. And, it is logical that a possible and probable default in Greece is creating a “not this again” fear in stock markets. i.e. 2008 all over again.

What is probably different however is that companies have prepared for this storm with strong balance sheets. And, hopefully, the US banks have prudently “reserved” for losses from their CDS "insurance" they have issued, with more capital. The Greek people vote on June 29 and June 30 on whether they will accept more “austerity”—a condition placed by lenders for more “bailout” money. It appears that markets are getting ready for the possibility that they will refuse and the crisis escalates. (Think Wisonsin.) Be prepared for volatility, risk and great uncertainty in this case. My best guess is that a temporary solution will be implemented, and then, sooner or later, the losses will be recognized and the crisis will end. We are at the end of the beginning of a resolution. I think this issue will be in the news for quite some time. I do not think that this week’s actions will merit any major portfolio changes, yet, as markets are likely to snap back very quickly. Be sure all of your present investments are long term oriented--the bottom of this may be a very good entry opportunity.


This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

















Thursday, June 23, 2011

Borrowing Money is Fun! Paying it back--Not so much.



Graph of Household Debt Service Payments as a Percent of Disposable Personal Income
Ben Bernanke (06/22/2011).......“We don’t have a precise read on why this slower pace of growth is persisting,” Bernanke said. Referring to “frustratingly” slow job growth and weakness in the financial and housing industries, Bernanke said “some of these headwinds may be stronger and more persistent than we thought.”

You have got to hand it to a man who is honest and straightforward, but markets get spooked when the man who “should know what to do” tells us that the Fed does not know why growth is so slow and that they underestimated the headwinds holding back the economy. Add this to continued worries about the fiasco in Greece and it is no wonder that markets trend down.  (Remember that markets are driven by fundamentals and sentiment.)  Mr. Bernanke is a good man and a great economist--perhaps he is not the best at inspiring confidence.

The chart above is one illustration of the biggest problem: Too much debt and the consequences of debt reduction. Borrowing money is fun—paying it back—not so much fun. (Sort of like gaining and losing weight.) Households in the US took on too much debt—in fact you might say we went on a debt binge from 1994 until 2008. Since then, we have been paying off debt—fast and furiously! The good news—we are rapidly approaching a “sustainable” level of 10-11% of our income.

Oil prices had been rising rapidly for a year. But, recently they changed direction and have been falling. Today, the US and other nations agreed to release a lot of oil from strategic storage reserves. This will tend to accelerate the drop in the price of oil and is a big stimulus to global economic growth.

The one thing out there that is not necessarily “about to turn the corner” with certainty is the debt problem in Europe. Banks lent too much money to homeowners in the US. In Europe, banks lent too much money to governments. When a homeowner can’t pay the loan back, there is at least some collateral that can be sold in a foreclosure. Lending to governments is like a signature only loan or credit card debt—you can’t exactly foreclose—your only collateral is government revenue from taxes. When governments continue to run deficits, spending more than they take in from taxes, there is no surplus left to pay back the loans.

So, the problem in Greece specifically and with European government debt in general is yet to be resolved. I have no sure idea what the final outcome will be, but my understanding of history (specifically in Latin America) tells me that a great deal of the debt in Greece, Ireland and Portugal will have to be written off and restructured. Will that hurt the stock market? In the short run—you are seeing it today as this scenario is being “priced in”. In the long run, reducing debt and getting back to being “fit and trim” economically is probably very good for the economy and the stock market.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.
























Saturday, June 11, 2011

Who Moved My Cheese?



Who Moved My Cheese? An Amazing Way to Deal with Change in Your Work and in Your Life, A best-selling motivational book by Spencer Johnson in 1998 was written as allegory. The moral: Change Happens (They Keep Moving the Cheese); and Anticipate Change (Get Ready for the Cheese to Move).

After many months of better than expected economic news, accompanied by a rising stock market, there has clearly been a recent spate of “disappointing” economic news. Over the past week, we have seen a significant reaction by stock markets to that “worse than expected” data. Somebody moved the cheese!

As most of my clients already know, I study and monitor certain economic data that I call Reasonably Reliable Leading Indicators. One of those indicators is particularly applicable to the present situation. It is known as the Citigroup Economic Surprise Index. It can be viewed at Bloomberg: http://www.bloomberg.com/apps/quote?ticker=CESIUSD:IND# (under the ticker CESIUSD:IND) A negative reading of the Economic Surprise Index suggests that economic releases have on balance failed to meet consensus expectations and have “disappointed”.

As I have indicated in the past, markets are determined by fundamentals and sentiment. When the Citigroup Economic Surprise Index falls, sentiment falls. When the Citigroup Economic Surprise Index is negative, sentiment is negative. When sentiment reaches an extreme (within it’s normal cyclical up/down range) it usually indicates a turning point. The Citigroup Economic Surprise Index reached an all time high (100+) around the first of March, and then fell like a rock to near an all time low (100-) this past week. The bottom line—in general, people had become too optimistic. Reality has returned. A quote from 2010 that we display on our website:

“Ever since Adam and Eve were cast out of Eden, Life has been uncertain, difficult and dangerous. Uncertainty, difficulty and danger will continue to exist. Some will be able to recognize opportunities despite such danger and difficulty and will prosper mightily. Others will simply adopt proven strategies to survive and prosper reasonably in a changing world where the future will always be uncertain. In the longer run, the future is seldom as bad as the pessimist believes, nor as good as the optimist predicts.”

Another Reasonably Reliable Indicator is the Investor Sentiment Survey published by the American Association of Individual Investors. http://www.aaii.com/sentimentsurvey  It is considered a contrarian indicator as the vast majority of individual investors misread the markets. (According to historical data.) The normal “bearish” prediction is 30%. Last week it was a much higher than normal 47.7%.

Again, markets are determined by fundamentals and sentiment. Fundamentals (corporate earnings) are strong. Sentiment (expectations about future earnings) is very negative. When sentiment reaches an extreme (within it’s normal cyclical up/down range) it usually indicates a turning point. It is impossible to predict market movements so it is possible that we could see continued market declines as sentiment falls further and fear begins to spread. On the other hand, fear and pessimism is pretty high and history teaches that we are most probably near a turning point. Or, at least a “treading water” period, waiting to see what the next round of earnings reports tell us about fundamentals.
 
Please remember that sentiment changes rapidly based on current news and information. What we don’t yet know, we don’t know. As I have stated “Life has been uncertain, difficult and dangerous. Uncertainty, difficulty and danger will continue to exist.” In times like these, it is important that any money invested is truly long term—then these short term up/down movements are much less important to you. It is also important to keep the emotions of fear and greed out of your thoughts as these emotions generally lead to bad decisions.

Although unemployment and housing information has been disappointing, other information is quite good, or at least not bad. A) According to a government advisory panel in Japan: “Spending to rebuild Japan's tsunami-hit northeast will spark an economic boom later this year”; B) The US Commerce Department reported: “American companies sold more computers, heavy machinery, and telecommunications equipment in foreign markets in April--exports have finally returned to pre-recession levels"; C) The Institute for Supply Management said its services sector index rose to 54.6 last month from 52.8 in April. The reading came in just above economists' forecasts for 54.0, according to a Reuters survey. (Service Sector employment according to ADP is much larger than the Good Producing Sector.); D) According to the Association of American Railroads: “U.S. Freight Rail Traffic: Not Seasonally Adjusted: intermodal in May 2011 up 7.5% over May 2010, Seasonally Adjusted: intermodal in May 2011 up 0.8% over April 2011.”

History teaches, and indicators tell us that there is a possibility of further declines; But, there is a higher probability that markets will turn back up or at least stabilize. One should always remember the moral: Anticipate Change (Get Ready for the Cheese to Move).

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.