Weekly Commentary June 29th, 2015

The Markets

Not quite as popular as Branjelina and Kimye, ‘Grexit’ (short for Greek Exit) has gained traction as a nickname during the past few months. The British press appropriated a variation, Brexit, when they discovered that the Bank of England was researching the potential risks of renegotiating membership in the European Union, or possibly even leaving the group—but that’s another story.

This is about Greece, and it’s a Grexhausting tale. Last week, The Economist explained the state of affairs this way,

“…euro-zone finance ministers failed for the third time in four days [on June 25] to find a breakthrough in their talks over Greece's bail-out…But four days before its twice-extended bail-out expires and a €1.5 billion ($1.7 billion) payment to the [International Monetary Fund] IMF falls due, Greece and its far-left prime minister, Alexis Tsipras… still have no deal.”

By Saturday, a deal was off the table. After days of negotiations, CNN Money stated, “Prime Minister Alexis Tsipras…could not accept the terms being offered by Europe and the IMF. He said he would recommend that Greeks vote against them in a referendum on July 5.” The move was perceived to be a delaying tactic and, when Greece requested bailout extension, European finance ministers refused.

Greece owes about 1.5 billion euros to the IMF, and a payment is due on Tuesday. In the meantime, the European Central Bank (ECB) has been providing emergency funding—a line of credit currently worth about $95 billion—to keep Greek banks from collapse.

It’s unclear whether Greece will be able to make the payment due to the IMF this week. If it does not, Bloomberg Business reported the country is at risk of joining a rather disreputable club: countries that have failed to repay the IMF on time. Current membership includes Sudan, Somalia, Zimbabwe, Cuba, Cambodia, and Honduras.

CNN Money explained that Greeks are queuing at ATMs, banks are strapped for cash, and the European Central Bank may decide to curtail emergency funding. On Sunday, in an attempt to manage the financial fallout, Greece decided to keep its banks closed on Monday and close the Athens stock exchange.

One expert cited by the International Business Times suggested that a Greek default could make international credit markets unavailable to the country for many years. In addition, Greece may experience rapidly accelerating inflation and economic decline.

If the economic effects of default prove less dire than anticipated, other debt-strapped Eurozone countries such as Italy, Spain, and Portugal, may decide to follow suit. The possibility has many worried about the future of the Euro.

There is a good chance markets will be volatile this week as events play out.

 

 

has Your car joined the internet of everything? Auto buyers have mixed feelings about cars and connectivity.

 

A McKinsey & Company survey found that more than 25 percent of participating car buyers in Brazil, China, Germany, and the United States prioritized automobile connectivity ahead of traditional features like engine power and fuel efficiency. Thirteen percent wouldn’t even consider purchasing a vehicle unless it had Internet access.

 

At the other end of the spectrum, 37 percent of respondents said they would not buy a car that was connected to the Internet — although here were significant regional differences. Concerns about potential privacy violations were highest in Germany (51 percent), the United States (45 percent), and Brazil (37 percent). Just 21 percent of Chinese respondents said digital safety and data privacy was an issue.

 

Of greater concern to respondents was the chance that connected vehicles could be hacked. Fifty-nine percent of Germans and Brazilians were worried that others could take control of connected vehicles and manipulate them. Fifty-three percent of the Chinese shared this concern, and 43 percent of Americans.

 

Hacking is a serious issue. Last summer, a group of automobile engineers, policy-makers, security experts, and high school and college students had a confab. The topic of discussion was the security of connected automobiles. Autoblog wrote that a student was tasked with remotely infiltrating a car; an assignment some security experts predicted would take months of planning. They were wrong. The student spent $15 on equipment, built his own circuit board, and took control of the car.

 

After a technician from the National Highway Traffic Safety Administration laboratory used his mobile phone to switch off the engine of a test car being driven by a representative from Consumer Reports, the magazine cautioned readers against plugging any unknown or unscreened devices—even thumb drives with music—into their cars’ USB or OBD-II diagnostic ports.

 

Connected cars are here, but there are a few bugs to be worked out.

 

 

Weekly Focus – Think About It

 

“Beware of little expenses. A small leak will sink a great ship.”

-- Benjamin Franklin, Founding Father of the United States

 

Weekly Commentary June 22nd, 2015

The Markets

You’re probably familiar with the seven-year itch. Not the movie with Marilyn Monroe, but the concept that relationships can lose their luster after seven years.

That may be what happened last week in China. Investors got itchy and the Chinese stock market suffered its worst week since 2008. The Shanghai Composite lost more than 13 percent during the week, and the Shenzhen Composite was down 12.7 percent, according to MarketWatch. The previous Friday, the Shenzhen had closed at a record high.

Prior to last week’s correction, China’s stock markets had been VERY popular. So popular, Chinese firms were seeking to delist from American stock exchanges and relist their shares on Chinese exchanges, reported The Economist. Plus, the Chinese government rolled out the red carpet (and waived profitability requirements) for new firms seeking to list on local stock exchanges.

In their enthusiasm to participate in rising markets, some Chinese companies are reinventing themselves on paper. The Economist wrote:

“But the wider trend is clear. At least 80 listed Chinese firms changed names in the first five months of this year. A hotel group rebranded itself as a high-speed rail company, a fireworks maker as a peer-to-peer lender, and a ceramics specialist as a clean-energy group. Their reinventions as high-tech companies appear to have less to do with the gradual rebalancing of China’s economy than with the mania sweeping its stock market. The Shenzhen Composite Index, which is full of tech companies, has nearly tripled over the past year.”

June has been a tough month for China. Earlier in the month, MSCI decided not to add China’s A-shares, which are denominated in China’s renminbi, to its emerging markets index because of issues related to Chinese markets’ accessibility.

Greece hasn’t been faring all that well either. The European Central Bank extended an emergency $2 billion loan to the Greek government. The Greek people, anticipating Greece may not reach an agreement with its creditors, which could trigger default and an exit from the Euro, withdrew more than $1 billion from the country’s banking system in one day.

Ip! Ip! OORAY! Greg Ip, Chief Economics Commentator at The Wall Street Journal, was blogging about business cycles. He wrote, “After a perplexing start to the year, the economy is starting to make sense…[Recently released data] has begun to help solve three puzzles that have hung over the U.S. and global economies in the last year.” The three puzzles were:

1.      There was no surge in consumer spending in the United States. Despite a mammoth drop in oil prices, retail sales were weak and contributed relatively little to first-quarter growth. However, May retail sales numbers were strong and numbers for March and April were revised upward. So, consumers appear to be spending. (The final revision to gross domestic product (GDP), which was released in late May, showed GDP grew by 0.2 percent during first quarter.)

2.      When workers are in short supply, wages should rise – but they haven’t. Unemployment is at about 5.5 percent. Employers have jobs open and are seeking qualified applicants. Yet, hourly earnings had barely improved at all. The Bureau of Labor Statistics’ Employment Cost Index showed private workers’ compensation grew 2.8 percent for the 12-month period ending March 31, 2015. That was a big improvement over the previous year’s growth. Government workers realized a 2.1 percent increase for the same time period, which was a modest improvement over the previous year.

3.      The bond market hadn’t priced in a rate increase. Federal Reserve guidance has been pretty clear. When employment and inflation numbers align, the Fed will begin to tighten monetary conditions by raising the Fed funds rate. Regardless, bond market rates hadn’t moved higher – until recently. Yields on 10-year Treasuries rose from 1.87 percent in early April to about 2.4 percent by mid-June.

Ip summarized, “…in many ways, the world is behaving as it should. If so, then the next stage is for stock and bond investors to finally realize the era of zero rates is coming to an end and re-price accordingly. Do not expect that to be a smooth process… That the world is behaving normally, however, is not the same as saying it’s back to normal.”

 

Weekly Focus – Think About It

“Change is the law of life. And those who look only to the past or present are certain to miss the future.

--John F. Kennedy, 35^th President of the United States

Weekly Commentary June 15th, 2015

The Markets

Sir John Templeton once said: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”

If he was right, investor sentiment seems to support the idea the bull market may be around for a while. The American Association of Individual Investors’ most recent poll indicated investors aren’t feeling very optimistic:

·         20 percent of investors were bullish – fewer than in the previous poll, and far lower than the historic average of about 39 percent.

·         47 percent of investors were neutral – fewer than in the previous poll, and far higher than the historic average of about 31 percent.

·         33 percent of investors were bearish – more than in the previous poll, and slightly higher than the historic average of about 30 percent.

Investors have had plenty to worry about. U.S. economic growth appears to be slowing which has created questions about the wisdom of a possible Fed rate hike. “Liftoff,” as some have called the much anticipated interest rate change, could also affect the global economy. The World Bank and International Monetary Fund have cautioned against a 2015 increase suggesting, “…a premature rate hike in the United States would exacerbate volatility in the world’s currency markets and hurt the global economic recovery.

The Fed isn’t investors’ only worry. Last week, the International Monetary Fund walked out of Greek debt negotiations. The BBC reported:

“Greece is seeking a cash-for-reform deal, to avoid defaulting on a €1.5bn debt repayment to the IMF… The EU and IMF are unhappy with the extent of economic reforms the Athens government is offering in exchange for the release of a final €7.2bn (£5.3bn) in bailout funds. Their bailout deal with Greece runs out at the end of June.”

If negotiations fail, Greece may be forced to leave the Euro which the BBC said could make the country a pariah in international markets. U.S. stocks finished the week higher despite losing value when Greek debt negotiations stalled.

and the survey says… September! The Wall Street Journal has been out on the street asking economists when they think the Federal Reserve is likely to begin increasing the Fed funds rate. Unlike Jay Leno’s interviews with average people on the street, not one economist asked, “What’s the Fed funds rate?”

Although a few diehard economists (6 percent) believe a June or July increase is possible, the rest expect liftoff in September or later. The Journal explained the circumstances that have gotten us to this point:

“The Fed has kept short-term interest rates pinned near zero since December 2008 to support the U.S. economy through a financial crisis, recession and slow recovery. Officials have signaled they expect to begin raising rates sometime this year. The central bankers say [they] want to see continued improvement in the job market, and they want to be “reasonably confident” that too-low inflation will soon move back toward their 2 percent annual target.”

Employment has been moving in the right direction and Fed estimates suggest inflation may reach 1.8 percent during 2016, so what’s the hold up? Some Fed officials are concerned the American economy has lost momentum, and they’re not alone.

When the Journal asked analysts to estimate gross domestic product (GDP) growth for 2015, 2016, and 2017, their June estimate was 2.1 percent. That’s considerably lower than their March estimate of 2.9 percent. The Fed’s March estimate of GDP growth in 2015 was 2.5 percent. A revised June growth projection should be out this week. If expectations deteriorate, it’s possible the Fed may decide rates shouldn’t go much higher.

Analysts’ estimates for the 2015 Fed funds rate declined to 0.58 percent from 0.83 percent in March indicating they believe the Fed may not raise rates as much as had previously been expected.

 

Weekly Focus – Think About It

“Public opinion is a permeating influence, and it exacts obedience to itself; it requires us to drink other men's thoughts, to speak other men's words, to follow other men's habits.”

--Walter Bagehot, British journalist

Weekly Commentary June 8th, 2015

The Markets

If it looks like a bond, and it acts like a bond…oh…that’s the problem. Government bonds aren’t acting the way investors expect.

Last week, 10-year U.S. Treasuries – which, typically, are thought to be safe and stable investments – suffered the biggest one-week sell off since June 2013, according to The Wall Street Journal. Treasuries finished the week yielding 2.4 percent, a gain of 0.3 percent. In the world of stodgy, backed-by-the-full-faith-and-credit-of-the-U.S.-government-bonds, that’s a big change.

The performance of U.S. bonds paired with that of German government bonds. BloombergBusiness reported 10-year Bunds delivered their worst weekly performance since 1998. On Friday, the German benchmark bond settled at 0.8 percent after rising to almost 1 percent on Thursday. In late April, the yield on Bunds was at an all-time low of 0.049 percent.

So, what’s going on? Why are bond values fluctuating so much? Barron’s said the problem is a lack of liquidity in fixed-income markets:

“The global financial system is awash in liquidity, created by central banks as they have driven short-term interest rates to zero (or even below) and expanded their balance sheets by the equivalent of trillions of dollars. And so the world is swimming in cheap money. At the same time, liquidity is said to be at a low ebb in the financial markets, especially for bonds… As a result, transactions that once didn’t cause prices to budge now send them lurching from trade to trade… And the advice from central bankers on both sides of the Atlantic about this new volatility? Get used to it.”

One reason for the lack of liquidity is the relative scarcity of market makers, reported Barron’s. In the past, banks made markets – buying and selling for their own accounts – which created liquidity, but new regulations have curtailed those activities.

Looking beyond bond market illiquidity, there was economic good news in the United States: employment numbers improved. However, investors worried that could push the Federal Reserve toward a rate increase sooner rather than later, and U.S. stock markets finished flat to lower for the week.

When a government has a lot of debt, is it better to implement an austerity plan and pay the debt down? Or, take advantage of low interest rates and invest in the country?

Since the financial crisis, countries around the world have racked up a lot of debt through stimulus programs, financial bailouts, and other monetary and fiscal rescue efforts. When Should Public Debt Be Reduced?, a new paper published by the International Monetary Fund (IMF), reported advanced economies currently have some of the highest debt ratios of the past 40 years.

So, should they be paying off their debts? It all depends on how much ‘fiscal space’ your country has, according to the IMF. The Economist explained it like this:

“This concept [fiscal space] refers to the distance between a government’s debt-to-Gross Domestic Product ratio and an “upper limit”, calculated by Moody’s, a ratings agency, beyond which action would have to be taken to avoid default. Based on this measure, countries can be grouped into categories depending on how far their debt is from their upper threshold… It is a decent measure of how vulnerable a government’s finances are to a shock.”

The IMF report concluded countries already at the upper limit – like Japan, Italy, Greece, and Cyprus – are out of luck. They must take action to reduce debt levels. However, for countries that have fiscal space, there may be merit to the idea of “simply living with (relatively) high debt and allowing debt ratios to decline organically through output growth.”

In other words, if the country’s economy grows faster than its debt, the debt will become a smaller percentage of GDP, resolving the debt issue gradually over time. Given enough time and economic growth, the problem could resolve itself.

The IMF cautioned these conclusions do not constitute policy advice. The paper was intended to fuel debate about the proper course of action for rich, but indebted, countries.

 

Weekly Focus – Think About It

“You have brains in your head. You have feet in your shoes. You can steer yourself in any direction you choose. You're on your own, and you know what you know. And you are the guy who'll decide where to go.”

--Dr. Seuss, American writer and cartoonist

Weekly Commentary June 1st, 2015

The Markets

Is it possible to have an economic optical illusion?

On Friday, the Commerce Department reported the U.S. economy contracted at an annualized rate of 0.7 percent during the first quarter of 2015. The Federal Reserve sees things slightly differently.

Previously, the Commerce Department had reported our gross domestic product (GDP), which is the value of all goods and services produced in the United States, had increased at an annualized rate of 0.2 percent during the first quarter. The estimate was weaker than economists had expected and caused some analysts to wonder whether the economic recovery was stalling.

Weak first quarter GDP has caused other analysts, including those at the Federal Reserve Bank of San Francisco who penned an article entitled, The Puzzle of Weak First-Quarter GDP Growth, to wonder whether a statistical anomaly is causing first quarter GDP growth to appear weaker than it really is. Barron’s explained it like this:

“Since the expansion began in mid-2009, there have been six calendar quarters that have included the January-March quarter; for those six quarters, the average rate of growth has been just 0.4 percent. For the other 17 calendar quarters, growth has averaged 2.8 percent. One reason for this pattern seems to be faulty seasonal adjustment in the first quarter… In any case, if the same pattern persists in 2015, expect a rebound in the current quarter and through the second half of this year. And, based on data released so far, one source of the rebound would be a pickup in housing.”

The San Fran Fed report concluded, “There is a good chance that underlying economic growth so far this year was substantially stronger than reported.”

While GDP was revised downward last week, the core consumer price index (CPI), which is a measure of inflation that excludes food and energy, showed inflation increasing for the first four months of the year. If it continues apace, by year-end the CPI will rise above the 2 percent inflation target set by the Fed and will probably set the stage for an increase in the Fed funds rate.

Investors weren’t thrilled with last week’s news, and markets generally moved lower.

IF America’s Growth is slowing, the United States was The Little Engine That Could during 2014. We added three million jobs, unemployment fell to 5.6 percent, and GDP grew by 2.4 percent for the year. Unfortunately, despite the contentions of the San Francisco Federal Reserve’s report, we appear to be losing momentum.

So, what happened?

The Economist reported a variety of factors have contributed to the slowdown. The U.S. dollar has gained 20 percent in value against the euro during the past year, which made exports more expensive. In fact, exports were down about 3 percent, year-over-year, in March. Also, oil prices fell, which knocked 0.8 percentage points off economic growth as investment in mining structures shrank. Finally, American consumers didn’t spend as much as experts anticipated they would, despite lower oil prices. Lower-than-expected spending may reflect weak wage growth.

While growth in the United States shows signs of slowing, the Eurozone’s growth is accelerating. The region emerged from a double-dip recession in the spring of 2013, according to The Economist. Many large country’s economies, including those of Spain and France, delivered relatively strong GDP growth during the first quarter of 2015. As a whole, the Eurozone grew by 0.4 percent during the quarter, outperforming the United States.

Why is the Eurozone doing so well?

The European Central Bank took a page from the Federal Reserve’s playbook and began a round of quantitative easing (QE). QE has contributed to the euro losing value against the U.S. dollar, which has helped Eurozone exports. Also, consumers in the Eurozone have been spending the windfall created by lower oil prices.

Will the United States and the Eurozone be able to sustain positive economic growth? Only time will tell.

 

Weekly Focus – Think About It

“There is nothing noble in being superior to your fellow men. True nobility lies in being superior to your former self.

--Ernest Hemingway, American author