Last week was simply stunning. Only one quarter of the investing public is now cautious over the market outlook! Well, why not? Gross domestic product rose 2.5%, and we're told that there is a plan to save the euro. Phew.
Since I'm a numbers kind of gal, let's look a little deeper, just for fun. Consumer spending drives GDP in the US, making up more than 70% of it. Between the end of the second quarter and the end of the third, consumer spending rose at a whopping 3.9% annual rate. But real income dropped 1.7% at an annual rate. Making less, but spending more? What gives? Savings.
The savings rate fell from 5.3% in June to 3.6% in September, the lowest level since December 2007. Savings dropped and spending rose, because households had to use their savings to buy the necessities: housing and utilities real expenditures up 2.9% annual rate; healthcare up 5.4%; gasoline prices up 32.7%; financial services and insurance expenditures up 3.3%.
Even more telling, real expenditures on motor vehicles declined 3.3%, and clothing and footwear declined at an 8.4% annual rate. Employment is not recovering. Housing prices are not improving. Interest rates on savings are negative, and consumer credit is nearly flat. Clearly, GDP growth was not driven by an expanding economy, so I'm calling trick here.
What about the eurozone and the European financial stability facility (EFSF) bailout? EU leaders have now come up with the third rescue plan this year, and the equity markets rallied impressively on Thursday, but the bond markets aren't convinced. On Friday, the euro fell as Italian government bond sales met lower demand than at previous auctions and the country paid the highest premium since joining the euro. Yesterday, Italian yields started the week off at 6.12%. Keep in mind that at 6%, Italy's debt starts to become unsustainable.
I have just a few concerns (and yes, you did hear a sarcastic tone, exacerbated by excessive candy indulgences over the weekend -- I'm a weak woman when faced with individually wrapped Reese's Peanut Butter cups):
European banks need to improve their finances to reach the minimum core Tier 1 ratio of 9%. Many of the larger banks have stated that they intend to accomplish this by reducing lending, retaining earnings, and selling assets. For those giddy bulls that pushed equities up last Thursday, how is this credit contraction going to help grow an economy already on the brink of a recession?
The plan hinges on "voluntary" haircuts. How the heck this is going to work is beyond me. For those who bought credit default swaps (CDSs) to protect against just such an event, this is ridiculously painful. The idea is that no one is going to go to the International Swaps and Derivatives Association (ISDA) and petition for a default ruling, which could then trigger payment on the default insurance. (The ISDA, in a statement yesterday, noted, "it does not appear to be likely that the euro zone proposal will trigger payments under existing CDS contracts.") How is a 50% haircut not a default? Talk about form over substance. What if a bondholder balks? This deal could very well destroy the CDS markets. How can these contracts be viable when a (wink-wink) "forgiveness" is used to avoid the reality of a default? Dangerous territory.
Now we've got a moral hazard. Greece gets to walk away from 50% of its debt. If you're Ireland, you're thinking that sounds like a pretty good deal. What about Portugal, Spain, and Italy all raising their hands saying, "What about me?" Why should Greece get preferential treatment?
Not to be picky, but even Angela Merkel has said, "We don't know how this works yet." Umm... if she doesn't know, who does? So we have a market rally on the promise that these guys are going to figure it out later? This isn't exactly a group with a track record of sustained success. Anyone recall the Dexia bank bailout in 2008 that unsurprisingly blew up a few weeks ago?
If we put Greece into perspective, it only accounts for 1.74% of the eurozone GDP. But look at what havoc it has caused. Italy is on the precipice, and it accounts for 12.6% of Europe's GDP. It's the eighth largest economy in the world, with the world's third largest bond market. Italy's debt ratio is second only to (drum roll, please) Greece. With the rise in Italian bond yields after Thursday's announcement, it seems clear to me that we have a long way to go before the "all clear" can be announced. I'm calling trick on this one, too.
It's good for Greece to 50% haircut from their debt. But this 50% deosn't just go away. The lenderd still need to find this 50% money, otherwise they themslves will go to default. We know those debts are mostly deriatives and swapps, it's very difficult to figure out where they are, and who shall pay for what. But overall our whole global economic system still need to pay for this 50%, even Greece is forgiven from that.
So I can't agree more with you people there, there is no good reason that we can cheer from this deal. It's really strange that stock market rallied after this news.
I think cautious is an understatement with a market that is behaving completely erratically there is no confidence in most investors. I am not selling but I am certainly not buying right now. Unfortunately, with the election year, politicians will be hesitant to make any changes for fear of a mistake before the election and we will all be left in an economic purgatory that feels more like hell.
While the rate cut is positive for the currency in the short term because the ECB is trying to help stabilize markets and boost economic growth,I wonder if it willl be perceived as advantageous in the long term. It seems like there are conflicting factors at play here in the near and far term.
The European Central Bank lowered its benchmark interest rate from 1.5% to 1.25% today-- just two days after Mario Draghi took over as president. What do you think: good move or an action that is likely to result in inflation in the name of growth and economic stability?
Jacob, anyone who is focused on long term returns but fails to consider the impact of the short term -- and very significant -- global issues is either a masochist or a fool.
“Only one quarter of the investing public is now cautious over the market outlook”
You are right. Most of the investors are looking for long term returns and hence they are not that much bothered about the ups and downs in market. I think the regular traders are much bothered and concerned about the fluxuations in market.
Greeks are very unwilling to take on the stricter conditions being demanded of them to win fresh funding and avoid default. Greeks are clearly questioning whether there might not be an easier way out of their crisis. Default is much more attractive now than a year ago.
Germany can't save Greece, French can't either. Let's face the reality: Greece will default within a year. You can not save a patient who does not want to follow the doctor's perscription
Dear Tenacious: You are not alone! As I research on a daily basis I get more and more nervous. The bright side to all this though is that often during times of great upheaval, when the future looks most bleak, deep, fundamental changes often occur in society that set it up for decades of success. I believe we are in just such a time, as the decades of incorrect economic policies and ideology are coming to their natural consequence, thus fundamental beliefs are at last being questioned. I have great faith that the spirit of American entrepreneurialism (which is a state of mind to me rather than an actual nationality) will survive and be made stronger by this painful time.
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Forget about business growth as long as the future of tax rates remains unclear, regulation continues to expand in unpredictable ways, and legislation keeps creating increasingly onerous burdens.
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