Sunday, October 30, 2011

Eurozone cleanup process continues, but it's still a mess

On Thursday, global markets responded with an ”emotional” and positive reaction to the “rescue” news that Eurozone leaders had a “comprehensive package” to address the two-year-old crisis - consisting of a mix of 1) more funding for troubled borrowers, 2) a draft plan to stabilize European banks and 3) reducing Greece’s debt.

To understand some to the Eurozone’s economic challenges, consider the following. When the Eurozone was set up in 1992, a condition for membership was that a country’s gross government debt to GDP ratio should not exceed 60%. The current figures for Eurozone members include: Greece 166%, Italy 121%, Ireland 109%, Portugal 106%, France 87%, Germany 83%, and Spain 56%. (Note: figures for Japan 233%, U.S. 100%, U.K. 81% and China – unknown).

MY TAKE: The Eurozone financial recovery plans released last week are fragile and short on details. On Friday, Germany’s Constitutional Court ruled that the process used to allocate funds to the Eurozone mess was unconstitutional. Additionally, Italy is entering center stage of the crisis as Prime Minister Silvio Berlusconi provides limited direction on addressing its significant financial issues. Global investors will continue to walk on a delicate tightrope.

Q3 earnings - good, U.S. GDP - reasonable, Supercommittee progress - unknown

After 293 companies in the S&P 500 have reported third quarter earnings, the average growth in revenue is 11% and growth in earnings is 19%. Additionally, third quarter U.S gross domestic product (GDP) was 2.5% - suggesting that recession is averted for now, but some of its sub-components are less clear on its strength. However, there are concerns that the U.S. Congress’ "Super Committee", appointed to determine $1.4 trillion in U.S. budget cuts by late November, is not making progress.

MY TAKE: In an environment of heighted uncertainty, the corporate earnings and GDP results are reassuring. Hopefully, the Super Committee can avoid partisan bickering and provide constructive budgetary guidance. Anything less, from the U.S. Congress, may result in another set of U.S. credit downgrades and more market turbulence.

Sunday, October 23, 2011

In Europe, as another deadline moves back - "curb your enthusiasm"

Last week’s post suggested avoiding optimism about the G20’s statement that on Oct. 23 the European Union (EU) will "decisively address the current challenges through a comprehensive plan”. Recent comments suggest that the situation is worsening and the Oct. 23 deadline has evolved into a multiday planning session. An unnamed European official, cited by the Financial Times, said; “We’ve lost the main parachute and we’re on the reserve chute and we’re not sure that will even work.” German Chancellor Angela Merkel said they are working with “a technically complex process” but expects a breakthrough on Oct. 26.

MY TAKE: Europe and the global economy confront a broad set of complex and multidimensional problems. While some investors believe that Europe will “muddle along”, the probability of unexpected consequences from near term policy actions, or perhaps inaction, seem to have increased the market risks. With Eurozone leaders poorly managing the Eurozone crisis for about two years, a “wait and see” approach to this week’s events seems prudent.

Sunday, October 16, 2011

After another G-20 meeting, the Eurozone is still looking for a plan

This weekend, finance ministers from the “Group of 20” (Argentina, Australia, Brazil, Canada, China, European Union, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, U.K. and the U.S., along with the International Monetary Fund and the World Bank) met in Paris to discuss the Eurozone financial crisis. A statement released from the meeting suggested that on October 23 the European Union will "decisively address the current challenges through a comprehensive plan”.

MY TAKE: While optimism has recently increased about a positive outcome, fundamental issues presenting significant headwinds include 1) high unemployment, 2) tightening financial conditions, 3) high debt levels and 4) a broad Eurozone economic slowdown. After a two year process of underestimating Eurozone problems, European leaders seem stuck in a “we have a plan for a plan” mode. Separately, the U.S Congress seems to be in its own “working on a plan for a plan” mode with its “Supercommittee” addressing significant federal government budget issues. Let’s not become too optimistic.

Sunday, October 9, 2011

High Frequency Trading, 3rd Quarter Earnings and Looking for Light at the End of the Tunnel

Since late July, global markets have moved wildly, driven by a broad set of global economic concerns. In addition, an article in today’s New York Times noted that regulators are concerned that high-frequency trading is increasing market volatility. This week, the 3rd quarter earnings season begins with financial results from firms such as Alcoa Inc., Google Inc., Infosys Technologies Ltd., JP Morgan Chase & Co. and PepsiCo, Inc.

While investors are justifiably concerned about economic uncertainty, a lot of the bad news is well understood (a lack of transparency in the banking system mixed with poor political responses). The earnings season commentary from hundreds of companies in the coming weeks will be critical components in assessing short and intermediate term economic and investment trends. Given the almost universally negative tone in the markets, perhaps a short term bottom has been established. Regarding high-frequency trading, it is about time this significant problem is addressed.

Occupy Wall Street Enters the Stage

On Friday, as the U.S. Bureau of Labor Statistics reported that unemployment remained at 9.1%, the Occupy Wall Street movement continued to gain momentum and expand across the country. While critics suggest it lacks a clear message (most early stage grassroots movements confront this challenge), its initial concerns are well understood: 1) “Wall Street”- known for obtaining government bailouts with minimal benefit to average citizens and 2) corporate profits - at a record high as U.S. wage growth stagnates and jobs are outsourced.
In addition to government debt and foreclosures issues, the U.S. socio-economic landscape also includes the following challenges:
  • High unemployment among the young - employment among 16-to-24-year-olds this past summer was 48.8%, the lowest on record (back to 1948),
  • a 15.1% poverty rate - the highest since 1993 and
  • a record-high 45.3 million citizens participating in the Supplemental Nutrition Assistance Program (aka food stamps). While media pundits jockey for attention and politicians position for effective fundraising, grass-roots organizations such as Occupy Wall Street will likely become more relevant.
Note: Well-known investor Jeremy Grantham, chief strategist at GMO (with $100 billion in assets) recently sharing a colorful perspective of Wall Street at a Council of Institutional Investors conference calling the financial sector “a blood sucker” which provides little economic value and accused bankers of “obfuscating and bamboozling” clients. Democracy is messy; it may get messier.

Sunday, October 2, 2011

What are some of the world's largest investors doing?

Pension funds are among the largest investors in the world and generally have a long-term investment focus. Last week, Takahiro Mitani, president of Japan’s Government Pension Investment Fund (GPIF), the world's largest public pension fund with $1.49 trillion of assets under management said it would begin investing in emerging market equities by March 2012. Additionally, Joe Dear, Chief Investment Officer of the $221.3 billion California Public Employees' Retirement System (CalPERS) said that meeting its targeted investment return of 7.75% this year would be difficult. In the short run, CalPERS plans to increase its exposure to hedge funds and other alternative investment strategies to compensate for stock market losses and poor Treasury bond returns. (Note: CalPERS has 70% of the funds needed to meet its pension obligations).

MY TAKE: While pension funds are not immune to investment mistakes, it is important to understand the strategic changes taking place among these significant institutional investors. With global markets increasingly integrated, it remains to be seen if economic decoupling by emerging markets occurs.

ECRI calls for U.S. recession

On Friday, the Economic Cycle Research Institute (ECRI) a research firm widely followed because of its “better than most” ability to pick economic turns, said, “A new recession isn’t simply a statistical event. It’s a vicious cycle that, once started, must run its course. Under certain circumstances, a drop in sales, for instance, lowers production, which results in declining employment and income, which in turn weakens sales further, all the while spreading like wildfire from industry to industry, region to region, and indicator to indicator. That’s what a recession is all about.” and “because the “Great Moderation” of business cycles (from about 1985 to 2007) was now history, the resulting combination of higher cyclical volatility and lower trend growth would virtually dictate an era of more frequent recessions.”

MY TAKE: Globally, the economic healing process will require the passage of time, a lot of hard work and many difficult decisions. During this period, a focus on capital preservation is essential. In the short term, long only equity investors may increase cash levels (potentially driving markets down further), value/deep value investors are seeing more opportunities, and investors with the ability to navigate current global equity volatility and credit market trends are
likely not feeling much pain. The playbook for many investors continues to be rewritten.