Thursday, June 16, 2011

Economic Condition Review: June 2011

The last economic review I did for the blog was in January 2011. At that time conditions for the US economy felt hopeful with corporations getting ready to announce good to great business results and guardedly optimistic business outlook messages. Food and energy inflation were an established factor in the US and the rest of the world. QE2 was adding fuel to inflation and to the prices for most commodities, especially the money hedges, gold and silver. The US$ was weakening, reaching a recent low near 73 (see graph below). A review of the weekly market data for January 14 is linked here. Company share prices elevated for much of the early part of earnings season before hitting a ceiling in mid February and suffering a March pullback in sympathy with Japan's enormous tragedy trio, earthquake, tsunami and nuclear power plant catastrophe's. The US markets recovered to the year-to-date high at the end of May.

Now in June, the world is captivated with concern about the bank and sovereign debt crisis in Greece. The concern is over the terms by which it will be resolved and when. The political forces are at work, the ECB, the IMF, and the US Fed are all applying pressure. The Financial Times describes the situation as "A Defining Moment for Greek Debt". A play on words since the article is about the definitions given to what everyone perceives to be a 'credit event' in Greek sovereign debt, involving credit default swaps. Eurozone forces feel the resolution is to deepen the austerity of the Greeks putting the problem on the back of labor as well as insisting that the government sell prime assets, such as state owned transportation and valuable land assets. Bloomberg describes the situation here. The proposals are being met with resistance from Greek labor unions. It remains to be seen how the government decides what to vote. Will they shun the political force representing the banking/eurozone interests or will they adopt an Iceland type reform to protect their assets from fire sale and force losses on the financial system. If they choose the latter, the potential exists for wide ranging credit related losses for European banks and possibly other money center banks around the world too.

The US Fed has announced they do plan to end QE2 as planned at the end of June. Until then, they are still in the markets supporting asset prices. A widely held view, that I share, is that there will be some form of market manipulation choreographed by the Fed until they get enough political support for the next QE. It will take a good financial scare to move the political will, so this is the time to be patient, waiting to take on risk. John Hussman writes that more QE will be politically aggressive in the face of a discouraged populace and critical global community. In addition, the lack of evidence that QE has been successful would support its abandonment. But the final decision likely revolves around the determination of Fed Chairman Bernanke to maintain the practice.

Recent data about the employment picture and the residential real estate picture are adding a discouraging tone to the intermediate-term economic condition. The US$ index has been showing strength within a long-term declining trend. The 10Y Note rate is under 3% for the first time in many months.

Developing economies, like the BRIC's and South Africa, are experiencing inflation as a result of hot money inflows to their growing economies. There have been interest rate increases of various degrees, as these economies begin to defend against inflation.


Japan based columnist William Pesek had this to say recently about the yen in his Bloomberg column. "Households are sitting on savings in the neighborhood of $15 trillion; the country holds $1.06 trillion in currency reserves, second only to China; the unique structure of Japan’s bond market keeps about 95 percent of public debt in domestic hands."
"Bonds are the main financial asset held by everyone, from banks to pension funds to insurance companies to consumers. The question is, Where would they put their money if they sold? U.S. Treasuries? Don’t count on it. Japanese have more confidence in domestic assets than anything made in the U.S." Here is a look at the Yen.

On a different tack, Chris Kimble recently posed the question, are bonds a leading indicator for the direction of the S&P500? There appears to me to be a correlation.

Is the 10Y Note a leading indicator for the direction of the S&P500?

Leading indicators are often helpful at supporting conviction of beliefs. In a recent post, Ryan Puplava writes what I consider to be an objective assessment of the current stock market from both a fundamental and a technical perspective. He considers leading indicators, moving averages, and manufacturing utilization as examples of his variety. In this way he is looking at markets from many different angles. Taking care to read the line of a putt on a tricky putting green (to use a golf analogy). He concludes, "The bull market since the 2009 is intact in my eye; however, the damage lately has taken my long-term view down to neutral since the ISM non-manufacturing number decimated investor confidence; so much so, investors completely ignored the non-manufacturing survey later that Friday, you know the other 80% of the economy that’s doing well. Interestingly enough, a poor number from the Philadelphia Fed Survey was ignored by the markets with a positive close on the day for the major indices excluding the tech-heavy Nasdaq."