Spain & Weak US Economy Dominate Markets
Halbert Wealth Management
By Gary Halbert
June 7, 2012
IN THIS ISSUE:
1. Â Spain in a State of Emergency
2.Â The Failure of Spainâ€™s Bankia SA
3.Â Latest Red Herring: A Eurozone â€śBank Unionâ€ť Fix
4. Â The Future of the Euro and the Eurozone
5.Â Consumer Confidence Heads Further South
6.Â The Fed: Time for QE3?
7.Â June 25: The End of Obamacare Rally!
Stock markets around the world have been pummeled in recent weeks amidst the growing reality that weâ€™re in a global recession, especially in Europe. Fears that the US will also fall into recession have intensified, particularly in light of last weekâ€™s very disappointing economic reports.
At the same time, the European debt crisis has once again raised its ugly head, this time with the spotlight on Spain. Spainâ€™s own Prime Minister has admitted that the country is in a state of emergency, and money is gushing out of Spanish banks. Interest rates have soared once again to levels that led to the European Central Bankâ€™s â‚¬1 trillion bailout package late last year and early this year.
Last week, the yield on Spainâ€™s 10-year bonds spiked to 6.7%, a whopping premium of more than 5.5% above the yield on the 10-year German bund at the time. Meanwhile, short-term rates in Germany fell to zero as new money seeks a safe haven there and in the US where 10-year Treasury-note yields fell to a post-war record low of 1.45% last Friday.
For now, however, the ECB is resisting printing more money for sovereign bailouts, but it may be only a matter of time. As discussed below, yields on Spainâ€™s bonds are nearing record levels seen last November when the ECB launched its â‚¬1 trillion bank bailout. In that rescue effort, the ECB loaned money to troubled European banks at 1%, which they immediately invested in sovereign debt at much higher yields. The trouble is, now those same banks are back at the trough, especially in Spain. What happens next is anybodyâ€™s guess.
Next, weâ€™ll discuss Rasmussenâ€™s report yesterday that its Consumer Index fell five points just over the course of the weekend.Â The obvious cause was the weak jobs report on Friday.Â Iâ€™ll shed more light on that issue as well as throw in a discussion about whether QE3 is more likely now than previously believed.
We end up today with a suggestion on my part that the current swoon in stocks is a BUYING OPPORTUNITY. No one knows where the bottom is, of course, but consider this. If the Supreme Court renders Obamacare unconstitutional later this month, and I think it will, we could see a MONSTER RALLY in stocks. This is why I think you need to be getting back in the market now, while it's down. And I offer two excellent suggestions on just how to do that at the end.
Spain in State of Emergency
Before we get into the specifics of what is happening in Spain, letâ€™s put this in perspective, especially as compared to Greece. Spain is the 12th or 13th largest economy in the world (depending on whose stats you read), with a population of over 47 million people and a GDP of $1.54 trillion. By comparison, Greece has a population of only just over 11 million people and a GDP of only $312 billion.
Spain has been in a recession for a year with GDP contracting by 0.4% over the last 12 months. Unemployment is at 25% nationally, and is above 40% for younger workers. Spainâ€™s budget deficit ran 8.9% of GDP in 2011, and its national debt is $960 billion according to the IMF. The yield on Spainâ€™s 10-year bonds soared as high as 6.7% last week, up from less than 5% in March and approaching the euro-era record of 6.78% hit last November. Debt service costs have risen by 18%.
Meanwhile, the collection of Spanish tax revenues has collapsed, much like the pattern in Greece. Fiscal revenues have fallen 4.8% over the last year, and VAT returns have slumped 14.6%. The country is caught in a classic deflationary vice: a rising debt burden on a shrinking economic base.
As a result of all this, Spain is in a near total state of emergency. As noted above, money is rushing out of Spanish banks for safer destinations like Germany, the US and Switzerland. â€śWeâ€™re in a situation of total emergency, the worst crisis we have ever lived throughâ€ť said ex-premier Felipe Gonzalez, the countryâ€™s elder statesman.
The ECB is pushing Spain to accept a loan package from the EU bailout fund (EFSF), the official body for fiscal rescues. But Spainâ€™s Prime Minister Mariano Rajoy has refused vehemently. A decision to accept a bailout from the EFSF is reportedly viewed with horror in Madrid, because it would result in an unacceptable loss of sovereignty.
The result is paralysis as both sides refuse to give ground. Mr. Rajoy is clinging to the hope that the European Union will restructure Spainâ€™s banks through an EU-wide recapitalization plan that would not undermine the countryâ€™s sovereignty.
The Failure of Spainâ€™s Bankia SA
In December 2010 Bankia SA, a union of seven struggling regional banks, was formed with an injection of â‚¬4.5 billion in capital from Spainâ€™s rescue fund. In 2011, Bankia became Spainâ€™s third largest lender, but Bankia was also the largest holder of real estate assets among all of Spainâ€™s banks.
It was widely believed that Bankia was making money last year. In fact, the bank released financial statements showing it made a profit of â‚¬309 million in 2011. But behind the scene, the bankâ€™s real estate assets were continuing to hemorrhage in value. Recently, Bankia revised its 2011 financials from a profit of â‚¬309 million to a loss of â‚¬3.4 billion. (Yes, thatâ€™s billion.)
By May of this year, the bank was for all practical purposes insolvent. On May 10, the Spanish government said it would convert its preferred shares in Bankiaâ€™s holding company into voting shares, thus giving it, effectively, a controlling stake of 45% in the bank.
On May 25, Bankia asked the Spanish government for a bailout of â‚¬19 billion. Apparently, the government has agreed to the loan, but questions remain as to where the money will come from. In response to growing concerns, Standard & Poorâ€™s downgraded its rating of Bankia's creditworthiness to â€śdouble-B-plus,â€ť making it a junk bond.
The Latest Red Herring: A Eurozone â€śBank Unionâ€ť Fix
Last week EU officials floated the idea for a Eurozone â€śbank unionâ€ť to be implemented by way of the proposed European Stability Mechanism (ESM), which has not yet been ratified by most EU states. Details of this new idea of a bank union are not yet entirely clear, but it is apparently the latest suggestion to rescue banks and sever the dangerous link between crippled lenders and crippled states.
Not surprisingly, the bank union proposal has already been shot down by Germany. Such plans amount to a â€śdebt-mutualization,â€ť a form of back-door eurobonds. The idea of creating eurobonds â€“ no such bonds exist at present â€“ has been suggested several times over the last year. Germany has been vehemently opposed at every turn.
Sources in Berlin say Germany wants Spain to tap the International Monetary Fund for the next bailout. If that were to happen, it would spread the rescue burden to the US, China, Japan, Britain and other IMF members. It seems unlikely that the so-called bank union idea is going anywhere, but you never know.
Where the European debt crisis goes from here is anyoneâ€™s guess. From our side of the pond, it seems incredible that there is not more agreement among the EU members when it comes to some solution that would preclude Spain (and others) from defaulting outright on their debts. Then again, it is Europe after all.
The Future of the Euro and the Eurozone
It is clear that Eurozone leaders would much prefer to keep the EU intact and for the euro to remain the common currency. For much of the last year, this plan has been the only plan up for consideration. But in recent months, it has become clear that the loss of Greece from the Eurozone might be tolerated, maybe even welcomed. But the loss of Spain, a vastly larger member of the EU, is an entirely different matter (at least for now).
Yet as I have briefly outlined above, there is still no plan to rescue Spain. Sure, they may come up with some way to keep Spain from a default for a limited period of time â€“ such as a change of heart by the ECB and another bailout loan â€“ but a long-term solution is not on the horizon. Thatâ€™s probably because there is no long-term solution other than letting these countries default on their debts and suffering the consequences, which would almost certainly be devastating to the banks, not just in Europe but around the world.
Slowly but surely, we are hearing more and more talk about the survival of the European Union. Whereas months ago, no European leaders would even discuss the possibility of Greece exiting the Eurozone, it is now commonly discussed in public â€“ the so-called â€śGrexit.â€ť Who knows, it may not be long before we start to hear the same kind talk that even Spain could end up leaving the Eurozone. I guess theyâ€™ll call that the â€śSpexit.â€ť Â Â
More importantly, there is even talk that the best solution for everyone might be that Germany exits the Eurozone and reverts back to the deutschemark. I would not agree that this option is the best solution, nor is it what Germany has in mind long-term, in my opinion. Germany is in the catbirdâ€™s seat as of now, so why would it leave?
The point is, you have to know that all options are now on the table when there is even talk of abolishing the euro as the joint currency of the EU. Unfortunately, there is no way to know how this will all play out in the weeks and months ahead. Still, I see a real buying opportunity coming (more on this at the end).
Consumer Confidence Heads Further South
Yesterday, the Rasmussen opinion polling organization reported that its daily Consumer Index fell five points over the weekend following the dismal jobs report on Friday. This is on top of the Conference Boardâ€™s report last week saying that its measure of consumer confidence had hit a four-year low. Itâ€™s clear that consumer confidence has been falling as the strength of the economic recovery has recently been called into question.
Since consumer spending makes up apprx. 70% of US GDP, any drop in consumer confidence is a big deal, in that it may be an omen of reduced economic activity in the near future. After all, consumers are not likely to resume spending as long as they are uncertain about whether or not theyâ€™ll have a job.
Here we are, years into an economic â€śrecoveryâ€ť and weâ€™re still worrying about increasing unemployment, decreasing consumer confidence and the possibility of slipping back into a recession in the near future. Joe Quinlan, chief market strategist at U.S. Trust, commented that â€śWeâ€™re seeing the markets pricing in a synchronized global slowdown.â€ť That doesnâ€™t sound like a recovery to me.
That brings us to the elephant in the room: will the economyâ€™s recent swoon be enough to convince the Fed to move forward with a third round of quantitative easing (QE3)?
The Fed: Time for QE3?
Though the Fedâ€™s easy money policy hasnâ€™t led to renewed economic growth so far, thereâ€™s still talk of another round of quantitative easing (QE3), or possibly just extending â€śOperation Twist.â€ť Either way, it would mean another increase in the money supply. To understand why additional easing is being proposed, a review might be in order.Â There are those economists, Chairman Bernanke chief among them, who believe that keeping interest rates extremely low will facilitate more lending to businesses that will, in turn, increase production and employment.
Unfortunately, this line of thought seems to assume that if money is cheap enough, businesses will automatically take advantage of it and expand production. While borrowing costs are a major factor in any business decision, itâ€™s not the only one, nor is it the most important. Businesses donâ€™t expand, hire or build inventory until they are comfortable that there will be an increased demand for their products or services in the future.
Fiscal policy in the form of deficit spending for â€śstimulusâ€ť projects can help create some increase in demand if done correctly.Â However, most businesses are not going to borrow money in the long-term based solely on a short-term influx of cash from Uncle Sam. Nor does easy money mean that bankers are easier to deal with when getting a loan during hard economic times, especially now that regulations have been tightened.
With the most recent jobs and consumer confidence reports pointing to a softening economy, industry â€śexpertsâ€ť are lining up on both sides of the argument of whether QE3 should happen. Many stock market traders want QE3, and the faster the better since quantitative easing tends to drive equity prices higher. As a result of the disappointing economic news last week, Wall Streetâ€™s expectations for QE3 are growing. The median forecasts from 15 large financial institutions that do business directly with the Fed gave a 50% chance that it would launch QE3.
While the first two rounds of QE propelled stock prices higher, the question is, has QE done anything to spur the economy? I think the answer is, little or nothing. Some would argue to the contrary, suggesting that the economy would have been worse were it not for QE1 and QE2.Â Many analysts believe that QE3 would amount to nothing more than a â€śsugar high,â€ť where stock prices rise without an improvement in the underlying fundamentals. Thatâ€™s good for Wall Street traders, but no help for the economy.
The best argument against QE3 comes from the one of the Fedâ€™s own officials. Dallas Federal Reserve Bank president, Richard Fisher, has been an outspoken critic of the Fedâ€™s easy money program. Fisher says, â€śâ€¦there is already surplus liquidity sitting on the sidelines.Â Nearly $1.7 trillion in excess private bank reserves are on deposit at the 12 Federal Reserve Banks, lying fallow.â€ť
Fisher also notes that the Eurozone crisis is helping to keep interest rates low as investment flows from the euro to the dollar. According to Fisher, it helps to be the â€śbest looking horse in the glue factory.â€ť In other words, as bad as we have it, weâ€™re still better off than most of the rest of the world. Fisher believes that monetary policy has done all it can â€“ itâ€™s now up to the politicians.
Needless to say, all eyes and ears will be on whatever the Fed officials have to say over the next few weeks. Chairman Bernanke will testify before Congress on Thursday, but he rarely tips his hand as to the Fedâ€™s next move or if QE3 is on the table. The next FOMC meeting will be held June 19-20, and everyone will no-doubt be hanging on every word Bernanke utters after the session. However, weâ€™ll have to wait for the actual minutes that will not come out until early next month to see what really took place in the meetings.Â Iâ€™ll keep you posted.
After two rounds of quantitative easing, we appear to be no closer to a full economic recovery than before. They say that the classic definition of insanity is to keep doing the same thing and expect different results. By that measure, the Fedâ€™s sanity indeed needs to be questioned if it implements yet another round of quantitative easing just ahead.
Conclusions â€“ What You Should be Doing Now
If there is a central theme to todayâ€™s E-Letter, itâ€™s that global uncertainty is elevated and not likely to go down anytime soon. Itâ€™s at times like this that people often get a â€śbunker mentalityâ€ť and move to cash or other low-risk alternatives and wait for the smoke to clear. Sophisticated investors, however, know that these are the times that money can be made.
Warren Buffett has famously said, â€śBuy when everyone else is selling.â€ť And more recently Buffett noted, â€śWeâ€™ve put a lot of money to work during the chaos of the last two years. Itâ€™s been an ideal period for investors: A climate of fear is their best friend.â€ť
Buffett isnâ€™t talking about passive index-based strategies that can subject you to a wild up and down ride.Â What you need is an investment manager that selects companies like Mr. Buffett does, with strong financials and solid management. In the past, I have introduced you to two money managers who do just that, Yacktman Capital Group and Wellesley Investment Advisors.
The recent downturn in the market has created a number of investment opportunities by making the stocks and bonds of some good companies available at a bargain. My staff and I frequently talk to Yacktman and Wellesley, and both have said that the recent market action has created lots of opportunities for those investors positioned to take advantage of them. Here are links to Internet web pages featuring these two money managers:
Hereâ€™s the bottom line: Now may be a great time for you to get into the market. Most everyone is running scared and uncertainty rules the day. This is when you may want to go against the grain and put your money to work. No one knows if the market has hit bottom, but Â if you wait until itâ€™s clear that the bottom is in, youâ€™re probably too late. The current fear in the market might just be your best friend, as Buffett suggests. So I suggest you consider taking advantage of this pullback.
June 25: The End of Obamacare Rally!
Read this very carefully. The US Supreme Court is scheduled to announce its decision on Obamacare on June 25. If the High Court renders Obamacare unconstitutional later this month, and I think it will, we could see a MONSTER RALLY in stocks. In fact, I expect the market to bottom and turn higher even before June 25.
Obviously, I donâ€™t know if the Supreme Court will overturn Obamacare, but from everything I read, it looks that way. But even if it doesnâ€™t, I still think weâ€™re near a bottom. So, if you are on the sidelines or are underinvested, I suggest you seriously consider getting back in (or fully invested) over the next week or two at the latest. Think about it.
Wishing you a summer of fun,
Gary D. Halbert