In spite of continued strength in the leading economic indicators we watch, the market can’t seem to muster a sustained rally. Market volatility is extremely high, with the market seemingly locked in crisis mode in spite of strong corporate profits. We believe that the crisis in Europe is to blame.
The Germans have a big enough bank account to fund a bailout, but oddly enough the Germans aren’t anxious to subsidize its Eurocurrency partner losses. France is also working overtime to save the euro. Our view is that the German plan – whatever it is – will prevail.
Germans advocate that the rule of law should determine what happens next while France and other troubled, free-spending nations in Southern Europe want to print money a la the U.S. “quantitative easing” policies in order to inflate their way out of debt. As several experienced analysts have observed, it rarely makes sense to bet against the Bundesbank.
My best guess is that eventually Germany will relent and approve a Quantitative Easing program for Europe. Germany will not agree to this plan until it has extracted a price from the spendthrift countries that led them into the crisis. At summit after summit, Germany is enforcing the adoption of new austerity measures and tighter banking controls on other EU members. These are not easy measures for Greece, Italy, France and the other EU member countries to adopt. I believe that they are adopting these new policies with the understanding that once these policies are in place, Germany will step up to the table to approve much needed help. In the end, however, Germany must be holding out a carrot. Otherwise, why would the other countries agree to such politically costly treaties?
Until the final solution is in place, the risk is that a large bank could fail. It could happen any day, and one large failure could trigger others. Time is not the friend of a crisis. The euro, itself, has been an interesting indicator. While the U.S. market goes up with each meeting in Europe (and there have been a lot of them), the euro is re-testing lows and is a much better indicator of eurosummit achievement (or lack thereof). Once the solution is unveiled, the market could easily “melt up.” But will it melt up FROM current levels? Or back TO current levels?
In any event, we remain in a high risk market. Last summer, we reduced (but not eliminated) risk in equity oriented accounts. In the near term, all asset classes seem to be correlated; it’s hard to imagine a crisis in Europe not coming back to haunt U.S. equity investors. U.S. businesses are doing remarkably well, so much so that it feels to me like the Great Recession is slowly morphing into a new, different, and better stage of recovery.
The great news is that the problems in the U.S. seem to be evolving from one of excess supply to one of not enough demand. Since 2007, the economy has been dealing with an excess of housing inventory. By 2009, excess housing inventory had shut down the U.S. building sector. A million construction workers lost their jobs and a huge segment of the U.S. economy closed down.
In 2012, the high housing inventory-to-sales ratios conceal the “problem,” which has shifted from the numerator (inventory levels) to the denominator (the general level of economic activity). Home inventories are still a bit high, but nothing like the levels seen in 2009. If economic activity was anything near normal, and household formation wasn’t in collapse, the industry might be fairly close to stabilizing.
At a Grand Junction Chamber luncheon this week, Richard Wobbekind, the Senior Associate Dean for Academic Programs at the University of Colorado, agreed that household formation as been far below norm, and that an employment recovery would dramatically improve the construction industry’s supply/demand balance. The recession we’ve experienced for the past three years, as a result of supply excesses, will look a lot different than the slow growth period ahead of us, which results from a lack of economic vigor, which won’t be helped by a recession in Europe.
Arguably, it’s a great time to be investing in stocks, for many reasons. Unfortunately, because of the crisis in Europe, an even better opportunity might be just around the corner.