Sunday, June 24, 2012

Troubling Economic Data Triggers Market Swings and Concerns about Deflation

Challenges confronting investors last week included: 
  • downward revision by the U.S. Federal Reserve for U.S. economic growth to between 1.9% and 2.4% for 2012 with expectations that unemployment may remain at 8.2% this year and 8% by the end of 2013, 
  • higher than expected U.S. initial unemployment claims  for the week ending June 16, 
  • weak factory activity in both the New York City and Philadelphia regions,
  • a decline in U.S. existing home sales
  • a Chinese Purchasing Managers Index of 48.1 for June, the eighth month below 50 – a  level which signals economic contraction and 
  • news that Eurozone leaders Italian Prime Minister Mario Monti,  French President Francois Hollande and Spanish Prime Minister Mariano Rajoy endorse the use the eurozone’s bailout funds to “stabilize financial markets” but  German Chancellor Angela Merkel is less supportive.  
Much of this news triggered sharp market moves on Thursday:  gold dropped 3.1%, the S&P 500 dropped 2.2%, and the CRB Commodities Index fell 2.1% while the VIX volatility index rose 16.5%.  On Friday, markets recovered a bit on 1) hopes that global central bankers will step in with more stimulus and 2) relief that credit rating downgrades by Moody's Investors Service of 15 global banks had finally taken place for Bank of America, Barclays, BNP Paribas, Citibank, Credit Agricole, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley, Royal Bank of Canada, Royal Bank of Scotland, Societe Generale and UBS.

  • With so many issues for investors to worry about, the recent weakness in commodity prices should not be overlooked.  Pullbacks from highs earlier this year include gold – down 12.2%, copper - down 17.2% and oil - down over 26%.  At some stages of the economic cycle, declines in commodity prices can help increase consumer spending and lower input costs for businesses.  However, declines in economic output and credit can also drive prices lower and trigger deflationary dynamics.  
  • On November 21, 2002, Federal Reserve Chairman Ben Bernanke presented a speech entitled "Deflation: Making Sure It Doesn't Happen Here" that suggested the best way to avoid deflation is to make sure it does not start.  Economists and investors such as Paul Krugman, Joseph Stiglitz and George Soros believe austerity measures proposed by some politicians in the U.S. and Europe will likely trigger deflationary trends if enacted. Deflation is very hard to manage and a great destroyer of wealth.  I hope that policy makers understand the potential consequences of these dynamics

Sunday, June 17, 2012

Is JP Morgan Chase "Too Big to Manage" and Dodd-Frank "too big to work"?

At last week’s U.S. Senate Banking Committee hearing, JPMorgan Chase CEO Jamie Dimon responded to questions about trading loses lead by the London Whale” at it chief investment office (CIO).  His comments included 1) “this portfolio morphed into something that, rather than protect the firm, created new and potentially larger risks”,  and 2) regarding large banks “There are some negatives to size” such as “greed, arrogance, hubris, lack of attention to detail.” Comments and questions by several senators focused on the effectiveness of the Dodd–Frank Wall Street Reform and Consumer Protection Act as well.

When enacted, the Dodd–Frank Act was a 2,300-page document – it is still working its way through regulatory interpretations and continues to expand. When the Glass-Stegall Banking Act of 1933 was passed by Congress “to provide for the safer and more effective use of the assets of banks, to regulate interbank control, to prevent the undue diversion of funds into speculative operations, and for other purposes”, it was 30 pages long.  Perhaps it is time to return to simplicity and introduce Glass-Stegall version 2.0.  NOTE: During testimony, Dimon commented on the U.S. debt problem and suggested that something like the Simpson-Bowles proposal (titled "The National Commission on Fiscal Responsibility and Reform"), a package of spending cuts and tax increases, should be pursued by Congress.

Will Greece's Election for Prime Minister Reduce Market Uncertainty?

Today, as Greek voters attempt to select a new Prime Minister, the winner will have to wrestle with 1) the country's significant financial problems and 2) citizens that seem reluctant to comply with austerity measures required under its financial bailouts. Expectations are that this is a “binary event”, suggesting that its outcome will have either very negative or very positive effects. It is assumed that G-20 leaders (who will meet in Los Cabos, Mexico on Monday to discuss global market instability and how to promote economic growth) will act to mitigate the damage if things get ugly

There has been significant media coverage on the implications of the Greek election, and its potential impact on the Eurozone and global financial markets. It seems that assessing which candidate will win the election and the implications associated with any potential winning candidate on global markets is a very speculative process.  Unless you are good at picking the result of a coin-flip, a short-term "wait-and-see" approach seems like a good short-term strategy.

Sunday, June 10, 2012

As Spain Moves Beyond the Denial Stage; What Happens Next?

After years of uncertainty, countless meetings among central bankers, financial ministers and policy makers; Spain, the country with likely the largest set of financial issues in the Eurozone, is beginning to acknowledge that its banking system may need assistance.  On Saturday, Eurozone finance ministers agreed to provide €100 billion in bailout funding.


Similar to other Eurozone countries, Spain’s denial was followed by admissions of significant financial problems.  In this light, the Eurozone makes progress with each admission.  However, topics needing clarity include: 
  • how large are the region’s economic problems, 
  • how effective will  responses by policies makers be, 
  • how vulnerable is the region  to social unrest and 
  • what impact will the Eurozone have on the global economy?  Stabilization was the tone across many global markets last week – but the duration between positive and negative market swings may be contracting.

Will Ben Bernanke and the Federal Reserve provide more monetary stimulus?

On Thursday, U.S. Federal Reserve Chairman Ben Bernanke’s testimony to the Congress included comments on: 
  • The housing market - it has “been an important drag on the recovery. Despite historically low mortgage rates and high levels of affordability, many prospective homebuyers cannot obtain mortgages, as lending standards have tightened and the creditworthiness of many potential borrowers has been impaired” and “a large stock of vacant houses continues to limit incentives for the construction of new homes, and a substantial backlog of foreclosures will likely add further to the supply of vacant homes. However, a few encouraging signs in housing have appeared recently, including some pickup in sales and construction, improvements in homebuilder sentiment, and the apparent stabilization of home prices in some areas”,  
  • Government spending and the U.S. fiscal cliff – lacking Congressional action on spending/ taxes before year-end, the economy could take a hit of “ between 3 and 5 per cent of GDP, which would have a significant impact on the near-term recovery”,
  • the Eurozone: “the situation in Europe poses significant risks to the US financial system and economy and must be monitored closely, and
  • Labor market – “the larger gains seen late last year and early this year were associated with some catch-up in hiring on the part of employers who had pared their workforces aggressively during and just after the recession”.

Many investors assume that additional economic weakness will trigger more stimulus efforts by the Federal Reserve.  Questions to consider include:
  • have such stimulus efforts reached the point of diminishing returns and  
  • can Congress effectively address the challenges confronting the U.S economy?

Sunday, June 3, 2012

Global Weakness and the Dynamics of Inflation and Deflation

Last week’s troubling economic data included 1) a report by the U.S. Bureau of Labor Statistics  that 69,000 jobs were created in May (150,000 jobs were expected) and unemployment increased to 8.2%, 2) in the Eurozone, Eurostat reported that May unemployment was 11% (22.2% for those under 25 years old) with Spain at 24.3% (51.5% for those under 25) and Germany at 5.4% and 3) in China, the purchasing managers’ index (PMI) for manufacturing fell to 50.4 in May – while it represents expansion, the number has been declining in recent months.


  • As the global financial crisis continues, it is important to understand that the dueling forces of deflation (a painful and value destroying process) and inflation (challenging but more manageable) will continue to drive significant market swings.  Some political leaders and central bankers may continue to print money to address the problems caused by too much debt - potentially stabilizing and/or inflating real estate, equity, commodity and bond prices.  Other players believe that “natural forces” should address economic imbalances - potentially resulting in deflation.
  • Bottom Line: Most equity and commodity markets continue to lose value and wage growth for many workers remain stagnant – this could lead to deflation. Investors need to understand the changing economic bias (inflation or deflation) and act accordingly.

The Investor Challenge: "Buy on the Dips" or Manage Volatility and Risk

On Friday, several factors including those mentioned above, drove the VIX volatility index up 26.4%. The VIX, which is a measure of expected volatility of S&P 500 stocks in the next 30 days, is considered a measure of investor fear/uncertainty. As the VIX increases, it is assumed that investors are less sure of market direction.


Some traders and investors thrive on volatility and seek “fast paced” opportunities. However, a market where volatility is increasing and the VIX is above 25 can be challenging for longer term investors. While a “buy on the dips” approach may work for some investors, I continue to encourage a more cautious short-term approach to the markets and wait for more stability.