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@theMarket: Merkel Versus the Markets
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Germany's Chancellor Angela Merkel agrees change is necessary but not the kind the markets want. Her nation insists that good old-fashioned fiscal austerity will solve Europe's problems over time. Investors believe that while that is a laudable goal, it will not do anything to solve the immediate problems of the "too big to fail" nations such as Italy and Spain.
Over the last two weeks the flow of positive comments from European leaders who keep promising a definitive solution has subsided. During that time it has become clear that Germany is unwilling to go along with the majority of EU member nations that want the European Central Bank to act as lender of last resort. As a result, the price of European debt and equities has declined while interest rates have reached untenable levels in Italy and Spain. Even German sovereign debt is not immune. This week's 10-year note auction was woefully undersubscribed with only 65 percent of the issue taken up by investors.
Over the last month I have written that the "she said, he said" strategy of talking the markets up while trying to come up with a solution to the Euro Zone problem would only work for a short time. Without a substantive plan to bail out Italy and Spain, et al, investors would lose patience with Euro Speak. That is now happening and the best that Europe's leaders could come up with is to promise not to criticize each other in public.
The bottom line is that Germany is the largest, wealthiest, most politically stable member of the EU. It owes that success, in part, to the Euro. Its economy has benefited mightily from the currency. Today, without Germany, there would be no European Union and the Germans know it.
As such, the Germans insist that there will be no U.S. Fed–style bailout of European nations with the accompanying risk of hyperinflation. It was never part of their vision. Some believe that they would rather see the EU dissolve first. It appears the markets are intent on forcing Chancellor Merkel into deciding which is most important — Germany's principles or the EU.
In the meantime, the U.S. markets are deeply oversold. So it was no surprise that Friday's holiday-shortened session experienced a bounce in the averages. Investors, after days of Europe mania, focused instead on America and its Black Friday weekend consumer spending spree. The markets are hoping that consumers will forget their woes this weekend and spend, spend, spend.
I do believe there will be a boost to retail spending this year, but after the smoke and hype clears out, the revenue numbers will not be as high as some predict. If spending follows the trend of last year, expect a boost in sales for the holidays now, followed by a decline before picking up again just before Christmas.
I am expecting a nice bounce in the markets into the end of the year. Granted, the averages have gone the other way since last week and have retraced two thirds of October's gains so far this month. Let's hope December lives up to its name as the best month in the year for stocks.
Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net . Visit www.afewdollarsmore.com for more of Bill's insights.
@theMarket: ECB Between a Rock and a Hard Place
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Back in the day when the ECB was first established, its member countries insisted that its role would be confined to controlling inflation through monetary policy. Unlike the U.S. Federal Reserve, there was no directive to manage unemployment in their guidelines. This is important because in this country managing unemployment allows our Fed to goose the economy (by printing money) despite the risk of future inflation to reduce the jobless rate.
The Fed's quantitative easing programs was all about buying U.S. Treasury bonds, reducing interest rates and therefore jumpstarting the economy. Some think it was a useless effort while others argue that without it our country would be mired in a multi-year recession with far higher unemployment.
In Europe "too big to fail" is not about the banks as it was in America. It is about a growing list of countries whose government bonds are plummeting in price as their interest rates rise. If allowed to continue, it will pitch many of the southern tier nations into a recession or worse. In some cases, such as Greece, we are talking bankruptcy. Although that would be negative, Europe could survive it. If the same thing happens to Italy or Spain, it would take down the entire European Community and destroy the Euro.
Although the EU has attempted to head off the contagion, they have done too little, too late. The amount of money that would be needed to calm investors' fears of a European meltdown at this point is not available outside of the ECB.
All week, markets have been hoping against hope that the ECB may find a way to save Europe without violating their charter. There is talk that maybe the ECB could lend money to the International Monetary Fund, which in turn could buy Euro debt. Although that would be technically legal, I doubt that Germany would go for it.
Germany is the major stumbling bloc in resolving the ECB's dilemma. It is diametrically opposed to allowing the ECB to bail out Germany's neighbors. After its own hyper-inflation experience during the Weimar Republic, Germans have a horrific aversion to anything that might trigger inflation.
They believe that by bailing out Italy and Spain, or even the PIGS, via an ECB quantitative easing program it would open the door to inflation throughout the EU. Germany also believes that it would nullify any incentive now or in the future for these spend thrift nations to mend their ways.
If nations feel that the ECB will bail them out regardless of their economic policies, argue the Germans, what incentives do they have to change? The Germans fear that the ECB could become a political football with Southern tier nations continuously issuing more and more debt to maintain their lifestyles while the ECB prints money to buy them up.
The Germans have a point. But at the same time, if nothing changes soon, the Euro will be kaput, (something the Germans would hate to see) since their economy has benefited mightily from its inclusion in the EU.
Until there is some clarity on this issue, expect the markets to continue to swoon one week and celebrate the next. We are getting dangerously close to the recent bottom on the S&P 500 trading range, around 1,200. If it breaks there, we could see further declines. I'm betting we hold. There is an increasing stream of good economic data coming out of the U.S. that investors are ignoring. I think that is a mistake.
Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net . Visit www.afewdollarsmore.com for more of Bill's insights.
@theMarket: The Italian Massacre
Unlike Greece or Portugal, the Italian bond market is the third largest in the world. So when interest rates on their sovereign debt skyrocket overnight, the world's stock markets pay attention. It was a massacre.Wednesday's decline was breathtaking with all three U.S. indexes declining over 3 percent, giving back in one day what it took a week to gain. World markets followed suit taking a huge bite out of investors' recent stock gains. As I wrote last week, volatility is here to stay and maintaining a defensive investment posture is a good strategy.
Readers should be aware that I am writing this column on Thursday, which is the 236th birthday of the Marine Corps. As a Marine (no ex's allowed) and a Vietnam vet, I will be taking off Veterans Day. Usually, I wouldn't worry about missing one day in the markets, but these are not ordinary times.
The financial contagion that began with Greece almost two years ago has inexorably spread through the PIGS nations to the more dominant economies of the EU. Italy is the current target of investor concern, but I have noticed that even French interest rates have started to climb. Why does that matter to the stock markets?
Let's use Italy as an example. Its debt load at $2.6 trillion is the second highest in Europe (after Germany) and the fourth largest in the world. That is nothing new. The Italians have always lived above their means but have made their debts payments on time each year, thanks to a fairly strong economy. The Italians pay off the annual interest owed by tapping the debt markets for more money. As long as they can continue to borrow at a low rate of interest everything is copacetic.
It would be similar to you paying your minimum monthly credit card payment by borrowing more on the card. Because interest rate charges on credit card balances are north of 20 percent, you would soon find the minimum payment getting larger and larger. At some point, even that minimum payment would overwhelm your ability to pay. What's worse, the credit card company would then refuse to lend you any more money.
Because of the concerns over finances in Europe in general, and high debtor nations in particular, investors are demanding more and more interest to refinance government debt. They are not demanding credit card rates quite yet, but they don't need to.
In Italy this week, interest rates on government debt rose to above 7 percent. Granted it is a long way from our credit card's 20 percent, but it is high enough when you are a couple of trillion dollars in debt. At that 7 percent level, investors believe the Italians might have trouble paying off their minimum payment due. As these worries increase, buyers will demand higher and higher interest to compensate for the perceived risk. It becomes a vicious spiral. If allowed to play out, no one will lend to them, Italy goes bankrupt, which could trigger a domino effect throughout other debtor nations around the globe.
At its center, the problem is not that Italy's economy is in trouble. It is an issue of confidence. Let's face it, Silvio Berlusconi, the nation's recent prime minister, is considered more of an Italian Stallion than a Julius Caesar. But his agreement to resign has left a leadership vacuum at the worst possible time.
At the same time, the EU has still not provided the confidence or the plan necessary to stop these "runs on the bank." In Italy's case, the "too big to fail" slogan aptly applies. Nothing that the EU has proposed so far is large enough to bail out Italy, if push comes to shove.
It appears European leaders are still playing catch up, always one step behind the latest crisis. They are unwilling (or unable) to come up with a truly comprehensive plan to resolve the on-going crisis. I believe that the structure of the European Union is largely to blame for this problem. Unlike our own country, where the Federal Reserve, in combination with our Treasury, can (and did) intervene decisively in the financial markets, Europe has no such mechanism. It may well be that such powers will be developed as the crisis deepens. One thing is for sure, investors worldwide will keep their feet to the fire until a solution is found.
I hope all vets everywhere have a great Veterans Day; as for all you Marines, active or otherwise - Happy Birthday and Semper Fi.
Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net . Visit www.afewdollarsmore.com for more of Bill's insights.
@theMarket: Paid to wait
So here we are again. Another G-20 Summit, Greece on center stage, the Euro trading like a seismograph and you, my dear reader, simply trying to cope.Earlier this week we had the pullback I was expecting with the S&P 500 Index dropping about 5 percent in two days. Then we rallied back into Friday when traders dumped stocks again before the weekend. Along the way, we had the bankruptcy of MF Global, an on-again, off-again Greek Referendum and mixed signals on the viability of the Euro zone bailout plan. Who said it would be easy?
Of course, life can be a bit easier in the stock market if you are willing to ratchet down your expectations and "settle" for a 4-5 percent return. I guess right now, with the S&P 500 Index slightly negative for the year, 4-5 percent would look pretty good. The problem is when markets skyrocket, like they did in October, gaining 18 percent in 18 days, no one wants to settle for a measly 5 percent return. Am I right?
Now don't get down on yourself simply because you are greedy. We all feel this way. When markets drop, fear reigns supreme. We all become conservative. The opposite occurs in up markets. The secret is finding that middle ground where both fear and greed are manageable.
As regular readers know, I have urged investors to stay defensive for the most part even through this rally. That means keeping a large part of your portfolio in dividend and income. Sure, there is always room for a few aggressive investments such as technology, precious metals, etc. but they should not be the majority of your portfolio.
Granted, you won't perform as well as the market on those ripping up days nor will you lose as much on the dips. And if you step away from the daily, weekly and monthly gyrations of the markets and look at the longer term results, you will find that after several months of gut wrenching volatility, we are just about where we were at the beginning of the year.
Consider if your portfolio had been invested defensively since January? Your average return could have been 5-6 percent this year, way ahead of the market right now. This type of strategy really works in volatile times like these.
I am somewhat bullish on equities through the end of the year but I'm not expecting any big upside moves like we had in October (although I'll be happy to take them if they come). I do expect a continuation of the volatility we have been experiencing throughout the year. Therefore you can expect 1-2 percent swings in the markets on a daily basis. By the end of the year, however, I would be surprised if we rallied more than 5 percent from the October highs.
That will be okay with me since I am being paid to wait out the markets' volatility with a portfolio weighted heavily in income and interest. As more and more investors realize the nature of this market, they too will gravitate to this same strategy providing price support for my funds and your stocks. It may not be the most exciting way to play this market. But that's OK; I could do with a little less excitement right now.
Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net . Visit www.afewdollarsmore.com for more of Bill's insights.
@theMarket: She Said, He Said
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A week ago, France and Germany announced they had a deal that would be all but completed this weekend and signed, sealed and delivered by Nov. 3, the date of the next G-20 meeting. Markets rallied. Then word came down that this weekend may be too soon for a definitive agreement. Markets fell.
Markets both sold off and then rallied when both French President Nicolas Sarkozy and Prime Minster Angela Merkel indicated that, while no definitive agreement would be completed this weekend, both countries were in agreement on the broad outlines of a deal. The markets here have been up or down 11 days in a row based on this "she said, he said" soap opera.
In a negotiation of this size, with so much at stake, one should expect plenty of starts and stops, contradictory statements and, yes, even some back tracking. It is natural given that this new "comprehensive" program must be sold to 17 nations. A period of consensus building must occur while behind the scenes deals are cut between the players. All this takes time. The fact that the lead players gave themselves such a short deadline in the first place has me scratching my head in puzzlement.
But the real insanity is in the market's reaction. All the historical tools that normally govern the direction of the market have been cast to the winds. The inmates are running the asylum for now and there is little we can do about it.
Granted this crisis has been going on for a long time and has contributed to investors' schizophrenic behavior. The longer things are left to atrophy, the higher the chances of some great meltdown occurring, such as a default by Greece or maybe even one of the larger countries like Italy or Spain. Then, too, the markets have grown increasingly impatient with delay after delay and could force the crisis (and a solution) by selling Europe and global markets en masse. It was exactly what occurred in the U.S. after the first TARP bill failed to pass.
To date, the Europeans are playing a smart game of poker. Every time the markets threaten to swoon in dissatisfaction or frustration, one or more statement is leaked or announced via a newspaper or official, which keeps the markets hoping and investors buying in anticipation of a deal. There are still significant issues to be overcome and the international press has gone over the negatives ad infinitum. By promising a solution in the near future, "next Wednesday" or the "Wednesday after next," they are succeeding in pushing world markets higher, staving off a run on their banks and their markets while giving them more time to negotiate a final solution.
In the meantime, on this side of the Atlantic, quarterly earnings are not as bad as some feared. The macroeconomic data is coming in stronger than expected and there are a proliferating number of stories concerning a plan by the administration and the Federal Reserve to address the housing market. Readers should pay attention to this.I first wrote a column ("What the Markets Missed") explaining that the Fed's latest move in targeting long-term interest rates had much more to do with the mortgage markets, refinancing of troubled homeowners and providing a stimulus to what really is ailing the economy: housing. The troubles in Europe, the "he said, she said" headline grabbers are focusing investor's attention on the forest while a tree may be growing over here in America.
I'm still riding this rally higher but have my finger on the trigger. The game Europe's leaders are playing with the market have a finite lifeline. At some point, they either have to deliver and show their hand or face the consequences.
Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net . Visit www.afewdollarsmore.com for more of Bill's insights.
