When conditions change in the investment markets, it's best to recognize the new realities and rescale expectations. The well-publicized fear of Greece's sovereign debt contagion has gained a momentum of its own. In the tradition of Greek tragedian literature, as today's protagonists in the European community seek to avoid their fate, step-by-step they seem to move ever closer to their inevitable, inescapable destiny. To the Greek malaise now must be added the possibility of similar problems with the Spanish, Portuguese and most likely Italian economies.
"To the rescue" last week came the European Community Bank (ECB) and International Monetary Fund (IMF) jointly pledging nearly $1.0 trillion in implied guarantees intended to assure investors that sovereign debt default on the part of these other southern tier EC countries is not a prospect. Alas, the bond markets (as we have pointed out in past letters, the most sensitive of financial market barometers), do not seem to be impressed by the EC bailout package. Taking advantage of the situation, traders and speculators are gaming both the bond and currency markets with borrowed money. So far they have succeeded in trashing the Euro (down 13% this year), and driving concerned investors to the U.S. dollar.
So, for the moment at least, our politicians can hide behind a strong dollar, ignore the consequences of their recent profligate ways, and do what they do best, pass legislation which usually deals with yesterday's crises without confronting the future entitlement expense train wreck so obviously ahead. Arguably, this lack of fiscal probity is the cause of much of the loss of investor confidence throughout the globe today.
"The Take-Away"
For investors, the bottom line effect of all this is that the belt-tightening required to remedy the EC fiscal crisis means reduced economic growth and weaker demand for U.S. exports, the one sector of our economy enjoying renewed strength currently. Further, a strong dollar may curb future U.S. export orders (roughly 11% of U.S. Gross Domestic Product, GDP), dampening our fragile economic expansion presently underway.
Stock markets around the world have taken notice of all this and the first real correction in equity valuations since the rebound which began in March of last year is upon us. Abetted by the yet-to-be-fully-explained "flash crash" of ten days ago (during which some stocks traded at pennies per share), confidence in the integrity of U.S. financial market exchanges has also suffered. The confluence of this rapidly shifting negative news backdrop, not to mention the BP oil spill, along with passage of the Senate financial reform legislation, not surprisingly, has narrowed investor focus to the worst case scenario.
On the Other Hand
At such times it is often fruitful to examine the other side of the coin. First, since our stock market correction has realigned valuations, ours is now more attractively priced than European bourses. Add to this our economy is in the first stages of a modest economic rebound, the effect of which will be a strong rebound in corporate operating earnings this year, as well as throughout 2011. At today's prices, U.S. equities sell at a reasonable 12-13 times projected 2011 earnings; a moderate valuation by most past standards.
Bonds, by contrast, although usually promising stability and current income, today seem caught in a bubble caused by the extraordinary liquidity forced into the global credit markets by the world's central banks. Particularly in the longer end of the maturity range, investors seeking enhanced current income and the security of high grade sovereign issuers seem to be making a bet against what would seem to be inescapably rising inflation expectations and a rising pattern of interest rates. If there is a sovereign debt default, long dated bond holders could be unexpectedly vulnerable, but the recent weakness in the equities markets would seem to be offering a buying opportunity.
Headline Dissonance (What's a Wary Equities Investor To Do?)
ï?§ "U.S. ‘Double-Dip' Recession Odds Now 25%"ï?§ "ECU Sovereign Debt Problems a Preview of Things to Come for the U.S."ï?§ "Offshore Infection Affecting U.S. Stocks"ï?§ "China's Attempt To Achieve A Soft Landing in Housing Problematic"ï?§ "Inflation at 44-Year Low"ï?§ "Mortgage Rates Decline"ï?§ "Slow and Steady Wins the Economic (and Investment) Race"ï?§ "Fear is Here . . . No Time to Panic, But a Time to Buy"
Media headlines, of course, are drawn by editors and journalists to command the reader's or viewer's attention. Those cited above are from but one day of last week's exposure to the financial press. The last comes from Steve Leuthold, one of this country's more respected investment advisors. From his perch on Bailey's Island on the coast of Maine (equipped with satellite dishes and every imaginable electronic communication known to man), he can often see the forest while others sifting daily through what's hot and what's not cannot. Known for his willingness to take the contrary view, Leuthold's position strikes us as the appropriate interpretation of the approach long-term investors should adopt today.
Should you have any comments or questions, please don't hesitate to let me know.
Jim Joslin is Chairman and CEO of TFC Financial Management, a Boston-based money manager.
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