The purpose of my quarterly news letters is to provide my tax, real estate and home mortgage clients with a unique “outside the media” perspective on current market issues and developments. It is not to be considered a substitute for retaining personalized planning from investment and legal professionals.
Following the pattern of the previous two years the stock market appears to have come down with yet another relapse of Spring fever. Pardon my optimism. I should have completed my newsletter a month ago and advised a third “Sell in May!” Yet another reason why you can’t depend on me for financial advice! The Dow industrial average just turned negative for the year, suffering steep losses over the past month and concerns are rising over a perceived Euro/China related world-wide economic slow-down that could leave investors vulnerable to economic shocks of one form or another. One perennial risk is a Greek sponsored collapse of the Euro; another is an Iran instigated mid-east tension build-up that causes a sudden spike in the price of oil. I’d like to share my prospective on each of these legitimate concerns, reiterate again that although recessions are cyclical the much feared U.S. “double dip” is likely more fear than reality, and remind you that stocks are cheap compared to bonds, and probably less risky. Caveat: cheap investment is not necessarily timely one. However, this is the first time in 50 years that the dividend yield on the S&P 500 (2.14%) is higher than the interest rate on 10-year Treasury bonds (1.75%). If you are smart enough to have sold in May, my advice is to buy back slowly over the summer. If, like me, you remain fully invested for what it’s worth, my advice is to hold tight, it’s going to be a rocky ride!
Gr-exit or fix-it? Seems to be the investment question of the day.
Stock marketThe latest out of Europe: Due to recent elections, German Chancellor Angela Merkel has a brand new pack of gigolo suitors trying to coax her into lending them her credit cards. Ask yourself this question? Does she look to you like an easy mark? There’s not a snowballs chance in hell that she will agree to Euro-bonds or any other form of bailout without the structural changes necessary to force each of the little and not so little Euro-pigs (Portugal, Italy, Greece, Spain) to become more internationally competitive economies. This structural change will take a long, long time, but they always seem to find a way to kick the can down the road just enough to avoid catastrophe. Whatever happens, this will be a chronic crisis.
As a recent WSJ editorial points out, the recent Euro dilemma of greater or lesser austerity offers false alternatives. The true alternatives are not greater or lesser but rather between government vs. private austerity. So far, as pointed out is previous newsletters, European governments have chosen to bring budgets into balance more through taxation on the private sector than through government downsizing. If austerity of whatever nature naturally leads to lower GDP, then governments must reduce expenditures faster than the drop in GDP to bring budgets into balance. Raising tax rates while allowing the size of government to grow or remain static only causes GDP and revenue from taxation both to shrink leaving a gap that bond vigilantes will surely attack. Greece’s government actually grew during 2011 to 49.7% of GDP from 49.6% the year prior. Cutting tax rates while shrinking the size of government is the only sure way to grow GDP and resultant revenues, bring budgets into balance, strengthen bond markets and lower government borrowing rates. But this is bitter medicine for European socialists to swallow, and so they lay siege to the streets causing Greece’s tourist industry’s 20% of GDP to further plummet. What are they thinking? These are not rational actions. They are ideological tantrums that are likely as not to lead to disastrous results.
So Grexit or fix-it? One growing school of thought assumes we will take a hit either way. 15% of U.S. money market funds are still tied up in Europe and Euro-zone imports amount to 1.2% of U.S. GDP. European bank loans to U.S. business amounts to nearly 10% of U.S. GDP. Internationally, Europe accounts for 16.3% of China’s exports, 15.5% of India’s and 9.3% of Malaysia’s. So we are talking real pain to international markets, but the sky will not fall over night, and the markets have undoubtedly already priced in some of this. Greece’s unemployment rate is at 21.7% and Spain’s at 24.3%; on the other hand unemployment in Germany is 5.4% and 3.9 in Austria. The German Government can borrow seemingly unlimited amounts of money by way of two year notes at negative interest rates. Ditto for Denmark and Switzerland, yet Greek, Spanish and even Italian rates are at levels deemed unsustainable.
It has been said many times that Europe does not have an economic problem, but a political one. Are markets just over-reacting to the down-side every time Merkel says “No!”? The attitude of the northern European countries, which successfully underwent the very same economic reforms necessary to face world-wide productivity standards, seems to be, “bring it on!” Rather than lending Greece more money to keep it afloat, one growing school of thought hopes that a Greek exit from the Euro will prove so devastating to its economy as to scare the remaining pigs into quickly implementing the necessary reforms and resulting government austerities. Might Greece end up being the lamb sacrificed to rid the continent of the last vestiges of socialism? If so, might the negative market affects of a Greek exit be quickly, if not immediately offset by a countervailing positive market response? The other school of thought, to which I am inclined, assumes that the Euro-zone (including Greece) will continue to muddle through by doing just enough to avoid acute crisis to buy the time necessary to very gradually evolve into a more perfect union. This will take years and will probably entail the death of democratic socialism. Whatever outcome, the lessons learned in the interim will be worth the price and the markets will learn to climb this wall of fear.
Are we headed for confrontation with Iran? As this likely scenario continues to develop and threatens to lead to devastating world-wide oil prices it will be important to keep an intermediate-term investment perspective. There is little doubt that the stock market and the price of oil can be inversely related in the short-term. In the past we have seen this relationship complicated by the fact that energy companies make up a significant portion of the Dow and other indices. Thus, there is a counter tendency for stocks to rise with the price of oil over the intermediate-term if the initial “spike” is somehow mitigated by a release from the strategic petroleum reserves, coupled with demand destruction, energy conservation efforts, equipment replacement etc.
Indeed, green energy proponents have long cheered any gradual rise in the price of oil as a positive stimulus to their long-term goal of a post petroleum economy. However, very recent developments have lead to a chorus of traditionally anti-green factions spouting the same “bring it on” attitude that a sustained gradual increase in the price of oil may serve to hasten the transition from an oil based to a more natural gas based, more energy independent economy.
You may be surprised to learn that U.S. imports of petroleum have dropped by 50% to eight million barrels per day over the past five years. This has been partly due to conservation, partly due to U.S. production which has increased by 12%. Imported oil has fallen to 45% of total consumption from 61% over this period and oil drilling rigs have more than doubled from 800 to more than 2,000. Although we are on track to spend $350 billion on imported oil this year that number is down from nearly $1 trillion in 2008. That year it was estimated the U.S. had just 12 years of natural gas reserves and we began construction of facilities to import liquefied natural gas. Reserves are now estimated at 100 years and the price has dropped from $12 – $14 per thousand cubic feet to about $2.5 and we are now planning to use these facilities to export LNG at about $9.50 to Europe and about $16 to Asia. According to the Congressional Budget Office U.S. total energy reserves now exceed those of all other countries, including those in the Middle East and development of these resources is more an intermediate-term political problem than a long-term technological one.
Iran may yet prove to be a paper tiger or a grizzly foe, either way It would seem that U.S. energy independence despite legitimate environmental issues, is but a matter of time and yet again a ‘bring it on” attitude reflects the economics that the sooner we find out, the better.
Finally, as summer passes into fall, regardless of your political views, consider the idea that a change in administration may (whether warranted or not) serve to instill greater optimism about the economy and the markets. Current consumer confidence as measured by Conference Board declined in May from 68.7 to 64.9. These numbers are so low that the Center for Geoeconomic Studies, part of the Council on Foreign Relations predicts a loss for President Obama in this November’s elections. According to Baron’s, the index has been a “perfect indicator of whether an incumbent president wins or loses since it’s inception in 1967. with a measurement below 95 leading to a loss.”
Home builders are reporting their most improved spring selling season in seven years and prices of existing homes fell at the slowest pace over the past year ended in March. Is the slump nearly over?
No, because there is still a backlog of foreclosures and potential short-sales, but keep in mind that it doesn’t have to be over for U.S. gross domestic product to rise due to less negative affects from the housing sector. More important, investors should firmly keep in mind that recovery over the long-term is an economic certainty due to the “new household formation” statistics discussed in previous newsletters as well as the inevitable consequence of our growing population. Unlike every other major modern nation and every developing country, American fertility rates are relatively high, at nearly 2.1. So we are not only successfully replacing ourselves, when immigration is taken into account, we are growing. Nearly every other country is experiencing low or falling birth rates: Japan and Poland (1.3 children per woman); Brazil and China (1.9). According to both the United Nations and the U.S. Bureau of Statistics, the U.S. takes in more immigrants than the rest of the world combined. The U.S. is projected to grow from 310 million today to perhaps 500 million by 2050. One only has to look around at all the children to imagine the economic and demographic affect upon our current suburbs and exurbs. My advice regarding housing remains to hold tight if you own, buy if you can!
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