As the Greek election returns began to filter in as Fathers’ Day drew to a close, the results whispered on Friday from private polling sources(public polling is banned in Greece prior to the election) appeared to be confirmed. The New Democracy party together with the PASOK Socialist party hadsecured sufficient votes to form a governing coalition. Since both parties have been backers of a continued Greek presence in the European Union (EU) andits enforced austerity policies, the financial world breathed a collective sigh of relief.
While this outcome seemed to quell the latest “death of the Euro” talk, the election returns are not ascomforting as the mainstream media have been playing them. The two parties, which have alternately controlled Greek politics for over 40 years, securedonly 40% of the vote. While this was enough to form a government (with a 12-seat majority in Greece’s 300-seat ruling body), the nationalistic Syriza party and its allies increased their share of the actual raw vote to 46%. They oppose EU cooperation and would pull the country out of the Union.
With Greece running out of cash by mid-July, there is not much room for error. PASOK and New Democracy will have to put aside their four decades of disagreements to not only form a government, but also to develop some effective strategies to meet EU insistence on real reforms and a Greek populace tiring of five years of recession.
…but who will jump on the grenade.
It’s just very difficult to see a positive end game in all of this. Sometimes you win even when there is a small margin of error, but when you face such odds over and over again, sooner or later you are bound to come up short. And as we stated last week, Greece is just the beginning of this tragedy-in-waiting. Spain and Italy stand in the wings about to take center stage. The Spanish “solution,” announced last week, will not prove to be anything of the kind. The EU pledged 125 billion Euros, and committed €100 billion of that, but the banks probably need a total of €400 billion. And while the early reports suggested that the money would be infused via equity purchases of the Spanish banks, it instead came in the form of lending senior to all the other creditors, pushing everyone else to the back of the line in a much less secure position than when they started.
And in this country, we have upcoming presidential elections, the end of the Bush tax cuts, the end of supplementary unemployment compensation, the endof the emergency payroll tax cut, the still-to-be-felt spending cuts “required” by last summer’s fiscal crisis, and, of course, Obamacare. While the Supreme Court may eliminate the last of the litany, the rest will pose a challenge to an economy already in a stalling recovery.
Now mind you, I’m not saying that all of this means that financial Armageddon is just around the corner. On the contrary; I know that economic events move in cycles, and when the sky is blackest, the most likely future is a brighter day. Back in 1982, most of South America (led by one of our major trading partners, Mexico) defaulted on all of their debts to us. It was disrupting, but we carried on, and one of the greatest stock market rallies in history soon commenced.
The safest place to have one’s money at the present time is the US. Dollars are becoming hot commodities, so the currency risk remains low. At the same time, the US equity markets, while suffering the usual May swoon along with everyone else, has been the least affected. US market indexes remain higher year to date, while those of most other countries are down for the year. The primary props under the US markets have been the low interest rates (aided by Federal Reserve cash infusions through multiple methodologies) and the positive earnings recovery by US domestically oriented companies. The former remains firmly intact.
Last week’s inflation reports at the import, consumer, and wholesale levels showed declining prices. Gasoline prices, for example, are down around 18% and are expected to stay low for the summer.
Freed of inflationary concerns, the Federal Reserve is meeting on Wednesday, and expectations for continued easing of monetary policy are running rampant. The only negative here is that the expectations may precede the execution by a number of months causing disappointment and a negative market reaction. Still, in the intermediate to long term, it is hard to envision any degradation in this positive underpinning.
There is concern on the earnings front. Analysts have been issuing revisions to their earnings expectations like a waiter serving up baklava at a Greek wedding. Since earnings reporting season ended in May, analysts have issued revisions for around 1000 of the S&P 1500 Index companies and the downward revisions have outnumbered the positive ones by a margin of two to one.
This is primarily the result of disappointment in the numbers being reported on the health of the US economy. Despite the Federal Reserve’s efforts and massive increases in Federal Government spending, most reports, as we have been reporting for months now, have disappointed. That means that while many have shown improvement, they have not lived up to the levels being predicted by our nation’s corps of economists.
This may merely indicate that we have economists that are poor prognosticators, or it could be that this recovery is weaker than advertised when the President said that “… the private sector is doing fine.” The recent uptick in both the unemployment rate and the number of new unemployment claims suggests the latter.
Hopefully, analysts will be proven to have overreacted when earnings reports commence again in July. After all, as we reported last week, earnings of those out-of-sync companies that report after earnings reporting season have been outpacing analysts’ predictions by near record levels. But if they are right, then a late-summer nosedive by stocks may emerge like last summer.
Until then, I would side with the current market momentum to the upside, aided by some positive pronouncements from European leaders and the Fed.
Whether I am right or not, our quantitative strategies were designed to try to dodge the bullets that are not one-time occurrences but rather are a constant part of the economic environment in which we coexist. Without them, how else would you attempt to get out of the way?
All the best,
Jerry
