Tower Private Advisors
- Rally caps on
- Europe gets closer to a solution
- Consumers, scared to death about the economy, assuage their fears by spending money
Capital Markets Recap
This week’s market action saw an embracing of risk assets and a flight from safety. At least three factors, mentioned here in some form over the last few weeks, had primed the pump–compressed the spring–choose your metaphor–for the rally.
- Excessive pessimism sent investors from the risk of stocks to the safety of cash.
- October 12 marked the date that, historically, has marked the beginning of the fourth quarter rally for stocks
- Last week saw capitulation by investors as marked by Selling Climaxes. A selling climax occurs when a stock makes a new 52-week low and goes on to finish the week with a gain. As Investors Intelligence puts it, “they are a sign of accumulation and indicate that stocks are passing from weak hands to strong ones.”
Like an aircraft carrier turning in a sea, Europe continues to inch closer to a final solution. Stories on the European financial crisis were in Bloomberg’s top stories every day this week. Included in those were one saying that German banks were bracing for a 60% haircut on Greek debt they hold. As recently as July, the European banks had agreed to a 21% reduction in the value of their Greek debt holdings in the event of a default. Today’s top top story said that the European Union was looking at a “one-time 50% Greek debt writedown, bank backstop.”
Here’s an excerpt from the story.
Oct. 14 (Bloomberg) — European officials are considering writedowns of as much as 50 percent on Greek bonds, a backstop for banks and continued central bank bond purchases as key planks in a revamped strategy to combat the debt crisis, people familiar with the discussions said.
The Greek bond losses may be accompanied by a pledge to rule out debt restructurings in other countries that received bailouts, such as Portugal, to persuade investors that Europe has mastered the crisis, said the people, who declined to be identified because the negotiations will run for another week.
In the works is a five-point plan foreseeing a solution for Greece, bolstering of the European Financial Stability Facility rescue fund, fresh capital for banks, a new push to boost competitiveness and consideration of European treaty amendments to tighten economic management.
This approximates the solution that one of our key research partners, BCA Research, has prescribed for Europe, although they say that an open-ended pledge by the European Central Bank to purchase debt of the troubled PIIGS would pretty much end the crisis. That’s what the Federal Reserve engaged in here. They called it “quantitative easing;” others called it “monetizing the debt;” you called it “printing money,” and it’s as objectionable to the Europeans as it is to you. They hint at that with the phrase, “continued central bank bond purchases.”
Now, here’s the deal with the so-called haircut.
European banks hold Greek sovereign debt; it’s the latter that is affected by the so-called haircut. However, even though the market is pricing the bonds at a small fraction of their face value (the Greek one-year note below is selling at 45% of par), the banks are pretending they’re worth somethink like the par value they paid for them. In fact, they’re only pretending to pretend; some sick version of accounting only requires them to carry the bonds at their cost. When Greece defaults on its sovereign debt it’s not like they won’t pay anything. Instead, it’ll be determined–agreed to, rather–that, say, just 50% of the debt won’t be paid back, and the banks will have to write down the value of their Greek debt by 50%. That hit comes goes right to the equity section of the bank’s financial statements–that’s capital to you and me, and it’ll leave those banks undercapitalized, at best; bankrupt at worst.
In the midst of a gradually recovering stock market, the third quarter earnings season started this week, with Alcoa kicking off–and, as usual, missing the ball–the big cap company earnings parade. Alcoa missed its earnings estimates, while Google exceeded its estimates. Analysts have been grudgingly reducing earnings on the companies they cover, so it could make for a rough earnings reporting season.
The other big story didn’t make the list of top stories, per se, but the release of the September 21 Federal Open Markets Committee meeting minutes were highly anticipated. As usual, instead of wading through them for you to find some gem the Wall Street Journal found on Wednesday, I give you a word cloud of the release. The larger the word the more frequently it appeared in the minutes.
There were four important economic releases in the U.S. this week. Two were as expected; two, not. The National Federation for Independent Business’s Small Business Optimism index came out on Tuesday, almost just as expected. The actual figure was 88.9 versus expectations of 88.8 and a previous release of 88.1 Also about as expected was the weekly Initial Jobless Claims figure. Economists were looking for 405,000, and the actual figure was 404,000. The previous week’s 401,000 was revised up to 405,000. Historically, 400,000 was the demarcation line between an improving (less than 400,000) and a deteriorating (more than 400,000) jobs picture, and that level is proving difficult to penetrate, suggesting that the pace of layoffs is staying constant.
You and I would not be surprised to know that consumer confidence slipped recently, but apparently the economists eyeballing the University of Michigan Consumer Sentiment release were oblivious to the hit suffered in 401(k) plans and other investment accounts. Instead of the modest improvement (what?!) they expected (from 59.4 to 60.2) the index fell to 57.5, which is essentially the lowest level since 1980, as shown below. As consumers, however, we are notorious for saying one thing and doing another. For example, if consumers’ expectations for the future had darkened, one would have expected them to cut back on spending as they retrenched. Instead, Retail Sales grew sharply in September. Excluding Auto Sales they jumped by 0.6% (versus expectations of 0.3% and a previous figure of 0.1%); Excluding Autos and Gas, they jumped by 0.5% (versus expectations of 0.4% and a previous increase of 0.1%).
Key indicators to watch
- Empire State Manufacturing Index (Monday) – October
- Industrial Production (Monday) – September
- Capacity Utilization (Monday) – September
- Producer Price Index (Tuesday) – September
- Consumer Price Index (Wednesday) – September
- Federal Reserve Beige Book (Wednesday)
- Initial Jobless Claims (Thursday) – weekly
- Leading Economic Indicators (Thursday) – September
- Philadelphia Federal Reserve index (Thursday) – October
- NAHB Housing Market Index (Monday) – October
- Housing Starts (Wednesday) – September
- Building Permits (Wednesday) – September
- Existing Home Sales (Thursday) – September
Graig Stettner, CFA, CMT
Chief Investment Officer
Tower Private Advisors