Market Focus: Aug 16

On August 16, 2011, in Market Perspective, by admin

Thursday’s rally proved to be the beginning of a major short term bounce as I suspected in last Thursday’s e-mail. But more important is whether this bounce preceding tomorrow’s Merkel-Sarkosy Paris summit will produce agreement with sufficient power to stop the destructive feedback loop that has gained power from Greece & Ireland to Portugal, Spain, and now Italy. These so-called PIIGS countries (perhaps better known as the “GIPSI” or “GIIPS” countries) display heavy sovereign debt (except for Spain which is vulnerable to insolvent banks in the event of widespread defaults on variable rate loans issued against inflated real estate prices)

Facing immense domestic pressure, I wouldn’t want to bet on Merkel’s ability to convince German people to bail out the GIPSIs. Word is now coming out that they will not even broach the critical subject of Euro Bonds! (See 

If Germany and France end their summit with only platitudes and half measures, the world economy is in deep, deep trouble. We may need a crisis to get them to actBut if a crisis hits, we could find that we are almost out of bullets to head off a new downturn which would carry serious if not disastrous social consequences. After this rally, it may in short be time to think in terms of “Risk Off.”  It’s normally problematic to look at short term swings; riding this out may require the nerves of a Warren Buffet!

Money center banks are especially vulnerable. Bank America may have been saved from an Irish default but they have another bullet to dodge in the event of a European Bank default. In the end, it’s hard to imagine that a major European bank would be allowed to default despite their apparent insolvency. The ECB has been weakened by purchasing bonds from certain GIPSI countries.

The “Barbell” strategy of balancing risk assets with Treasury bonds has worked well to date, the fall in treasury yields (until their rise over the last few days) makes it difficult for many to stay comfortable with. For those people cash may be king. I would only caution that money market funds exposed to European banks are not the same as cash!  (But perhaps no need to worry so long as European politicians can be counted on to bail out insolvent banks…. which they’ll continue to do as long as possible). Gold is still cash & may again strengthen until the next increase in margin requirements! Central Banks are buying gold; but caution that the IMF could conceivably sell gold holdings to fund short term financial fix.

One more body blow and we will almost certainly find ourselves back into a serious recession. The one hope or saving grace is that the politicians have to understand that a collapse of Lehman Brothers would be child’s play compared to the collapse of a European Bank. In the end, Germany will probably do the right thing for short term Euro survival….but, like Churchill said of the U.S., not until they exhaust every other alternativeHang on to your seat belts!

While market valuations appear to be cheap if we remain in recovery, they are not cheap if we fall into a new recession which could easily lead to a 25% to 35% drop in profits. In fact, it strikes me that prices now reflect a high probability of another recession within the next year. Even if it’s not a full recession (which usually does not occur when an economy is already bumping along the bottom), it may feel like one to most people. As you know, I still look at this as a Contained DepressionPray that it stays containedHistoric Ibbotson Rates of Return are totally irrelevant in this climate!

 Indicators & Risks of Recession                                                                      Mitigating Factors, If Any

Contagion From European Banking Crisis Politicians Have Presumably Learned their Lesson From the Lehman Fiasco & Should Do Everything in Their Power to Head Off
ECB is Drying Up Liquidity a la US 1936-37 ECB may be forced to reverse course
Germany Opposes Fiscal Union & Euro Bonds In the end, Germany “must” underwrite the GIPSIs. Otherwise, the crisis ends in economic catastrophe that does not end until it reaches Paris. Germany “can’t” pull out of the Euro; else France & the GIPSIs would devalue the Euro, creating Deflation in Germany
European Illiquidity Offset by Loans From US & Other Foreign Banks & Money Market Funds Regulators are pressing banks to restrict their exposure to Europe
Austerity in UK Japan may be stabilizing after Tsunami
Austerity Among GIPSI Nations Russia may be adding liquidity
France Slowed to a Crawl in Q2 Germany not yet in recession
Austerity in China China may be soon reversing course
Deteriorating Leading Indicators: Bloomberg, ISM, ECRI hanging above the zero line. Hope & Change!
Fiscal Austerity in the US Possibility of a Stealth QE-3 per the Ben Bernank’s famous 2002 Helicopter speech.
1936-37-style Fiscal Austerity in Europe May “kick the can down the road,” creating a bigger problem for a future administrations
Poor Earnings Guidance for Q3 & 2H 2011 Equity Valuations Reflect Some Weakness


Other Factors that may Weaken Immunity To Any Attack From a Euro Virus


   Fragilizing Factors                                                 Mitigating Factors, If Any

Dodd-Frank & Other Stifling Financial Regs Financial Sector May Shrink in Favor of Mfg
NLRB’s Chilling Effect on New Plants Problems Limited to
ObamaCare Business Saves Costs By Paying Small Fines
Deep Water Drilling Restrictions Windmill Subsidies
Horizontal Drilling Restrictions Subsidized Solar Panels
Fiscal Stimulus Ending Without Finding Badly Needed “Shovel-Ready Projects” despite aging Infrastructure Option to Expense CAPEX thru End of YearQE-3
Growth too small to Reduce Unemployment Lower Growth Constrains Oil Prices
No Relief From twice-taxed Oversees Profits MSFT, AAPL can invest money oversees, trickling down to US
Flattening Yield Curve Hurts Net Interest Margins Bank Refinancing Income from Lower Mortgage Rates
Rising Income Disparity, weakening social cohesion “Let them eat cake” For now
Shrinking Net Interest Margins QE-3 To Further Rebuild Bank Balance Sheet
House Prices Hurt by possible (1) tax reform that eliminates mortgage interest deduction & (2) Fannie & Freddie reform Ben Bernanke could still succeed in inflating away the debt as he suggested in his 2002 “helicopter speech.”



19 Responses to Market Focus: Aug 16

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