Lexington, Massachusetts Investment Management
Lexington, Massachusetts Investment Management
Timeo Danaos
"Timeo Danaos, et dona ferentes.” (“I fear the Greeks, even if bearing gifts.”) – Publius Vergil, The Aeneid
The markets did manage to avoid the ignominy of another consecutive losing week, but only barely. There is plenty of work that remains to be done. To begin with are the problems of the weaker Eurozone countries, with Greece still standing in the spotlight. Rumors of an EU fix were good for some rally points during the week, but by Friday the lack of any concrete program was creating doubt and skepticism.
There are good reasons for taking a skeptical view, because the EU is in a bind. Member countries from the PIIGS group might be best served by currency devaluation, but that isn’t possible within the framework of the Euro.
While the Eurozone and the EU aren’t the same thing, they are closely interlinked. In the at times euphoric expansion of the European Union in the post-Soviet world, countries clamored for inclusion. France and Germany, the Union’s two largest economies and dominant members, looked upon the appellants with very different eyes.
For the French, expanding the Union’s size was vital. They will tell anyone willing to listen that a larger and unified EU is vital to every European country, or they will lose influence in a one-superpower world. An enlarged EU is a necessary counterweight to create a level playing field with the Americans, or so the argument goes. A fundamental underpinning of the French position is that the EU is the best platform for the French to wield their beneficial influence on the world, for the elite corps that runs much of the country expects to dominate the EU apparatus. The bigger the EU, the better for France.
The Germans, though, don’t see the EU as a path towards political supremacy, nor take the French ambitions very seriously. They do see the Euro as a way to spread the rectitude of German fiscal policy among their neighbors. They were willing to accept the French dream of an enlarged EU on the conditions that the European Central Bank (ECB) adhere to Bundesbank-style policies, and the new Eurozone members had to agree to behave responsibly with their finances.
In the event, some fudging went on. Some of the countries that joined the Eurozone had poor track records with public finances, but promised to do better. Skeptics predicted that the Euro would fracture with the first recession.
That recession is not only here, it’s the worst in over seventy years. Bad luck to get such a difficult taskmaster for one’s first exam, but there it is. Whether one takes the Germanic perspective that the countries at risk have been slackers, or the opposing view that the Germans are too rigid and obsessed over inflation, there is no easy answer.
Acceptance of the German view means heavy budget cuts and severe austerity at a time of economic hardship. Right or wrong, it isn’t going to promote growth prospects within the Union, and that idea is sinking into the equity markets. At the opposite end of the spectrum is a partial disintegration of the Eurozone. It’s an unlikely event, with the alternative being, as the Wall Street Journal observed in a pessimistic weekend essay entitled “The Greek Tragedy that Changed Europe,” that “Greece will promise a pound of flesh, hoping not to pay.”
We expect that the Union will come up with some sort of aid-and-guarantee package that will kick the can down the road. The Germans are very unlikely to agree to unconditional handouts of money all around – more likely, they would prefer a staggered release of any funds and will want to impose conditions. The other countries will probably agree to accept the conditions, but then pray for a miracle to arrive instead. In the end, the choice will come down to looking the other way, or breaking up the Eurozone.
In the Asian currency crisis of 1997-1998, Western markets succeeded in ignoring the situation for a long time. Eventually, though, the bill came due and markets fell hard. Given that this crisis involves Western countries, one might not expect the same measure of indifference, but we’re not sure.
The markets are fatigued, and probably looking for some excuse to take a timeout from the whole mess. Traders may also be ready to opt for the approach of looking the other way and hoping for the best, much as they did during the early ripples of the tech-wreck and subprime meltdown. It didn’t stop the bill from coming due, true, but the Street has a knack for hoping that this time will be different.
We should also add that for the moment, the Street is still more worried about China. Mutual fund managers have been pounding the table about cheap valuations based on forward earnings – but if China retrenches, those earnings estimates will begin to look a lot more doubtful The Chinese New Year begins Sunday the 14th, and many are hoping that the country will return with a more positive message than it has had of late.
Monday is a holiday in America, and all markets will be closed. Friday is an options expirations day and the February one is often quite volatile. The week has a heavy slate of economic releases and earnings on tap. Given the foregoing, the only thing we can feel confident about at this point is more volatility. In the interim, we wish a relaxing holiday to our American readers.
It was pretty much a desert last week for data of the regularly scheduled variety. Most of the attention was given over to the latest rumors about the EU, Greece and the rest of the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain. You may also soon see the re-emergence of the “PIIGSTY” acronym that includes Turkey and Yugoslavia).
The highlights were weekly jobless claims and January retail sales, the latter delayed by a day due to the blizzards that shut down the capital for three days. Claims did improve more than expected (440k actual vs. 467k consensus), but another dose of heavy weather in the colder regions has left analysts unsure of the import. Some are speculating that the widespread snowstorms that came during the week that the Labor Department measures monthly job data may result in an artificially low result for February.
There was some disappointing news on inventories: wholesale inventories fell (-0.8)% in December instead of rising, and business inventories fell (-0.2)% instead of rising by the same amount. Pessimists fretted about the pace of the inventory rebuild, optimists insisted it was all noise that also promised faster future growth as inventories have to be rebuilt.
The trade deficit for December was worse than expected, with imports rising faster than predicted. Although the increase was largely due to the oil sector, a higher import total points to another tick or two off of the fourth-quarter GDP result (that we didn’t believe anyway).
Consumer sentiment, in its first February reading, was reported by the University of Michigan to have fallen slightly rather than rising slightly. Like the inventory reports, pessimists worried and optimists shrugged. We’ve been ignoring the little squiggles of the last few months and suggest you do the same. The changes are too small to mean much, and are probably mostly due to which way the stock market had leaned the week before.
Retail sales put on a decent showing for January, increasing 0.5% overall and 0.6% excluding autos. Yet to our cold eyes, it didn’t look impressive through the lens of year-to-year comparisons in the unadjusted data. Gasoline was up considerably, but that was due to price increases rather than demand. Many sectors had negative comparisons against a month when frozen credit was still sending sales off a cliff.
One area of strength was online sales, which showed good improvement. We attribute much of that to the lack of clearance sales this year in brick-and-mortar stores and the widespread growth of free shipping offers from the online retailers. It’s too early to call it a trend, though we’ve no doubt that it will be called that anyway. We’ll have to wait until the spring to find out, because February is typically the weakest and least significant month of the year for sales.
Next week atones for the emptiness of the previous one with a heavy, holiday-shortened schedule. Two regional business surveys for February are due, beginning with the New York Fed survey on Tuesday and followed by the Philadelphia Fed survey on Thursday. Actual production data, as opposed to surveys, will arrive from the central bank on Wednesday with the January industrial production report. The expectation is for a gain of about 0.8%. Lately the data has been running ahead of consensus, so a beat seems like a reasonable outcome.
An update on homebuilders will come with the sentiment survey on Tuesday (“Housing Market Index”) and new housing starts on Wednesday. It’ll be a new look, but probably not a fresh one, as there is hardly any reason for either data series to have broken out of their funks during a cold, off-season month like the last one.
Although there have been some good earnings reports from the homebuilding sector during the last couple of weeks, the results were heavily boosted by the November expiration rush and tax refund help from the feds. Activity has fallen off since then, with no sign yet of a rebound. Housing-related retail categories showed sizable sales declines in January.
It probably won’t all add up to much, but we will get a fairly complete picture of recent price inflation (or the lack thereof) next week, with import-export prices due on Wednesday, the Producer Price Index (PPI) on Thursday and the Consumer Price Index (CPI) on Friday. The general outlook is for a big energy-driven increase in the PPI total, a smaller one in the CPI total, but very little action in the so-called cores, which exclude food and energy.
The minutes from the last Federal Open Market Committee (FOMC) meeting are released on Wednesday afternoon. The usual market reaction of late has been to lurch one way upon the release, and then quickly lurch back the other before settling back to where it had started. This being the Wednesday before an options expiration day, though, there’s a better chance of increased volatility.
The Leading Indicators come out on Thursday. This series has come in for some disrespect lately, as the steep yield-curve that’s been driving the positive results is an artifact of the Fed, one that so far has produced few results outside of helping banks rebuild their balance sheets. Normally it would indicate that money was flowing. That said, the doubts aren’t over whether the economy is really growing at the moment, but about the pace and durability of the rebound.
Despite the volume of data, we suspect that the focus of the week will remain on the EU debt situation, weekly jobless claims, and impending earnings results from Hewlett-Packard (HPQ) and Dell.
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