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Stocks were up last week based mostly on the idea that Europe and the US were finally addressing their debt issues but anyone placing buy orders based on that are likely to be disappointed. Europe approved a new loan package for Greece that in my opinion makes further contagion more likely rather than less. The fact that Greece was able to hold a gun to the rest of the EU’s head and gain better terms will merely encourage the other PIIGs to adopt a similar obstinate stance. Why should Greece get better terms than Ireland or Portugal? The EU ideologues are determined to see their project through to its logical conclusion - a central European government with taxing power - and Greece just proved they’ll pay just about any price to prevent any current members from becoming former members.
Personally, I think the EU should tell Greece and the other deadbeats to not let the door hit them in the rear on the way out but that doesn’t seem to be an option - yet. If, as I suspect, this does nothing to protect other countries from the bond vigilantes, the EU may soon face the choice of letting some members leave the Euro or seeing the entire United States of Europe project go down the toilet. Frau Merkel may not even be able to get this deal approved and there is zero chance the German public will allow her to drag down their economy to preserve an EU project of which they were skeptical from the beginning.
As for our own debt troubles, a deal to raise the debt ceiling remains elusive. It appeared that the grand bargain the President wants was within reach last week, but talks broke down late Friday. The problem here is that both sides want to gain an advantage for the next election and there is no way to cut that Gordian knot. The latest idea to emerge is a deal to cut spending by $1 trillion (over ten years, a mere $100 billion a year) and raise the debt ceiling by that amount while yet another bipartisan commission continues to negotiate. That would keep this hanging over the economy until that commission fails and we’d be right back where we are now. That might be good for grandstanding politicians but it sure isn’t good for the economy.
I have no idea how all this will turn out, but I don’t expect the US to default. One way or the other, the Social Security checks will go out on time (by the way, what’s up with that Social Security Trust fund?) and we’ll pay our bills. My best guess is that we’ll get some kind of last minute deal as neither party wants to take a chance on getting blamed for shutting down large parts of the government. If the ceiling isn’t raised the budget will have to be cut immediately by about $100 billion per month. That would be hard to do - not impossible - but would definitely have an effect. I don’t think anyone would miss some parts - what the heck does the Commerce Department do anyway? - but cutting back that abruptly would be jarring to the economy in the short term and have ripple effects at the local and state government levels. I honestly don’t know how markets would react and I don’t want to find out. Anyway the drama continues next week so hang onto your hat - markets will probably be volatile until it is resolved.
The economy continues to struggle along even without the added drama of not getting a debt deal done. There were some encouraging signs in the housing market data last week but the rest was fair to middling at best. We’ll get 2nd quarter GDP next Friday and I don’t expect it to show anything we don’t already know. Growth in the quarter was certainly no better than the first quarter and I wouldn’t be surprised in the least if it comes in even weaker.
Despite the weak US growth, corporate earnings seem to be coming in pretty good. I was worried that higher commodity prices would be a drag on margins but so far that isn’t showing up in the numbers. The majority of companies are beating estimates and the guidance hasn’t been awful. Part of that is due to the fact that many US companies now get a substantial or even a majority of their earnings outside the US. Emerging market economies are doing much better than the US or Europe and that is helping the bottom line. I’m worried about how long that can last though. China is slowing and if that continues, the other emerging markets such as Brazil will surely slow as well. We need better US growth to keep the earnings growth going.
The good news in the housing sector came via the housing starts report which showed a rise of 14.6% from last month and 16.7% from last year. All of the growth came in the form of multi-family starts which is something we’ve been talking about for months. Rents are rising and vacancies are falling which has to mean more building at some point. Construction has been the missing piece of the recovery puzzle so this is very good news if it is sustained. Not as good was the existing home sales report. Sales were down 0.8% on the month and 8.8% year over year. Interesting though was that both median and average sales price rose month to month and year over year. Is this the long awaited bottom? Maybe….
The rest of the data was just a confirmation that this slow growth phase is continuing. The retail reports from Goldman and Redbook both showed a slight slowing month to month and decent if not spectacular year over year growth. The Philly Fed survey managed to post a positive number after last month’s disaster but the underlying data was still weak. New orders were flat and backlog fell again. Manufacturers are staying busy filling their existing orders but new orders need to pick up soon. The Leading Economic Indicators were higher last month by 0.3% but one can’t help but notice that the major contributors were financial measures. Money supply and the steep yield curve were the biggest positive contributors. With the banks not lending neither of those are all that important for growth.
Jobless claims were a disappointment again rising 10k to 418k. With mass layoffs seemingly in style again - Cisco just announced major layoffs - claims don’t seem likely to improve soon. This is still a very tough job market. Things could get better if construction continues to improve but it seems highly unlikely that will be enough to reduce unemployment significantly. And until that happens, the slow growth continues.
As for markets, the movement last week didn’t change any trends. Stocks are back near their highs but still in the range they’ve occupied since February. Commodities rallied a bit with a weak dollar but remain well below recent highs. Gold made a new high in dollars which says nothing good about the current state of the US economy or the public’s feelings about the future. REITs continue to surprise on the upside but are overvalued from a fundamental perspective. Emerging market stocks are still struggling - as they have all year - with inflation problems and a potentially slowing China. European markets are cheap but deservedly so; until we know if the banking system is sound, all bets are off. We made no changes to our conservative investment stance continuing to hold a large cash position and a core position in gold. There might be a pop in the market if/when a debt deal is reached but we don’t expect it to last unless there is a long term fiscal plan that addresses both growth and the deficit. And that seems unlikely at the moment. Stay conservative.
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