Tuesday, November 15, 2011

November, Monday 14, 2011

Dow – 74 = 12,078
SPX –12 = 1251
Nas – 21 = 2657
10 YR YLD = 2.04%
OIL – 1.34 = 97.65
GOLD – 8.20 = 1781.30
SILV - .42 = 34.34
PLAT – 1.00 = 1647.00

Last week the stock market got excited about the prospect of new leadership in Greece and Italy. Papandreou was out of Greece and there would not be a referendum vote on whether or not Greece would be saddled with the bailout plan. Lucas Papdemos was put in to head a caretaker government. Papademos is a former vice president of the European Central Bank. The Greeks did not vote for Papademos.

Then came Italy. As Athens threatened to go under, the contagion spread to Rome, which also has unsustainable high levels of debt. Silvio Berlusconi was booted out on Saturday and his replacement is Mario Monti, a former EU Commissioner and former advisor to Goldman Sachs. Berlusconi had become quite unpopular with the Italians and global investors. The Italians did not vote for Monti. The president of the European Council said the countries need reforms, not elections.

A dirty little secret was uncovered; the markets don’t really like democracy; it is messy and ugly and slow and it doesn’t always go the way you might want. The idea is that the new technocratic leaders of Greece and Italy will be able to push through economic reforms that can only be done by a government that is not responsive to a single electoral base. The question is whether they can craft reforms that will be accepted by a majority, or whether the reforms will just be crammed down the throats of the people.

Make no mistake. We have just witnessed a bankers’ coup in Europe; the ECB takes over Greece; Goldman Sachs takes over Italy; no guns, no blood, just economic shock and awe and the threat of a financial meltdown. It is possible the technocrat/banksters will impose financial discipline but it is also possible there will be populist dissent. Populist dissent without democracy is another name for mob rule. Good luck with that.

There are already problems; Greece’s new opposition party isn’t going along with the plan -  saying they will not sign a pledge of support for conditions on the new bailout agreement demanded by the EU Economic and Monetary Affairs Commission. Those terms have not yet been specified but may require new measures. Papademos faces a confidence vote on Wednesday.  Tens of thousands of people angry at the austerity measures are expected to rally on Thursday, the anniversary of a 1973 student uprising that helped bring down a 1967-1974 military junta.

New Italian PM Monti is expected to deliver his proposals tomorrow; he is expected to call for 300,000 public sector job cuts, raising the retirement age, and raising taxes. I doubt he’ll find unanimous in Italy.

BlackRock, one of the world's largest asset managers, said debt restructuring in Greece, Portugal and Ireland should include losses of 75 percent to 80 percent for private bondholders -- above the 50 percent envisioned in Greece's rescue package -- to help stop a global meltdown.
A research note from Blackrock said: "Governments are falling, bond yields are zig-zagging by whole percentage points and markets around the world are locking up: the euro zone turmoil risks turning into a global crisis."

German Chancellor Angela Merkel said: "Europe is in one of its toughest, perhaps the toughest hour since World War Two." Merkel did not offer any new solutions.

Once investors begin to fear that a country may default on its debt, however, a vicious cycle takes hold. Interest rates soar, which in turn makes the debt compound faster. And that, in a sort of self-fulfilling prophecy, further increases the chances of default. This is exactly what has been going on in Italy.

In one way, national debt is like credit card debt: If the interest on existing debt becomes greater than the monthly payment people can afford, the debt never gets paid off. It just grows and grows until it reaches the maximum amount that lenders are willing to provide. For countries, the equation is a lot more complex, of course. For starters, the interest rates countries pay are far lower than what credit cards charge. If interest rates are only 3% or 4% and the current budget (before interest) is more or less in balance, then economic growth may be enough to keep debt constant as a percentage of a country’s economic output (GDP). Such a situation can be stable indefinitely even if the debt level is fairly high.

Typically, an over-indebted country would see its currency decline in value relative to other currencies, which would help its economy by lowering labor costs compared with those of other countries. Such a policy would typically be accompanied by higher inflation that would also reduce the real value of the country’s debt (in terms of the amount of goods that the money could purchase).
The euro, however, prevents such a devaluation from taking the pressure off a troubled economy. That only increases the risk of an eventual default and makes bond investors demand higher interest rates. Once interest rates climb above 7%, as they have recently for Italy, a debt spiral is hard to avoid.

Since the euro also directly links the economic fate of 17 out of the 27 countries that make up the European Union, Europe will probably be unable to escape some sort of broad default crisis. When this occurs, no matter how well it is managed, major banks will take losses on their bond portfolios.

The Italian bank, UniCredit today announced third quarter losses of more than 10.6 billion euro. They also announce they will cut more than 6,000 jobs. They also announced they will ask shareholders to pony up more than $10 billion dollars to help recapitalize the bank, and there  was also speculation they might announce a reverse stock split. UniCredit does not look like they’ll be buying more Italian bonds.
Italian bond yields retreated last week after the news that Silvio was out, but today the yields moved higher – back up to 6.76% on the 10-year bonds, and an auction of 5-year bonds found tepid response to yields at 6.29%. Meanwhile Spanish bond yields slipped above 6% for the first time since August.  Who wants to buy Italian bonds?

Well, the ECB has been buying but they claim they will not be the lender of last resort but nobody really believes that. The equity markets may be are just wavering from headline to headline but there doesn’t seem to be great fear. The view is that if the European debt crisis improves then the riskier trades, like stocks, will perform well. And if the Euro debt problem gets worse, the ECB will start printing money, and riskier trades will perform well. The answer to the debt crisis is likely to be more debt. So nobody worries about risk.

Of course the Germans might not like the idea of the ECB printing money, because that would result in more debt for the strong Euro countries like France and Germany; quite simply, there is no appetite in Germany for bailing out Greece and Italy.

And ultimately, even if the ECB doesn’t start printing money, there is another backstop. Remember that approximately
half of all US banks have significant exposure to the debt crisis in Europe.  Much more dangerous for the US taxpayer is the dollar's status as reserve currency for the world, and the US Federal Reserve's status as the lender of last resort. And it’s estimated U.S. banks have over a trillion dollars tied up in at-risk German and French banks.

What, then, would be an intelligent financial strategy for an individual in the U.S.? This seemed to be one of the most frequent question this past weekend at Financial Fest.

Basically, bullish with a slight chance for collapse. So, the appropriate move would be to invest; defense, with an eye out for buying opportunities.
• The economy appears to be past the short-term bottom, at least as far as corporate profits are concerned, but a full recovery — including unemployment and real estate prices — could take several years. In other words, we could see a short-term rally in a long-term down market. There is also a seasonal factor to consider. Bottom line is that you don’t want to miss a good chance at a rally, but stay alert –because this whole mess could implode quickly.
• Minimize your debt, maximize your liquidity (keep some available cash) and try to manage down your monthly expenses as much as you can.
• In your stock portfolio, maintain a cash reserve and wait for opportunities to buy high-quality assets at bargain prices.
Keep some money in reserve to buy opportunistically in the event of a blowup in Europe.
• Consider buying real estate, if you have a long horizon. This is especially true if you are renting and would basically be exchanging your monthly rent for mortgage payments. Home prices may take a long time to recover, but in some places, they’re cheap. 
If you’re closer to retirement age, consider safe, guaranteed income – more on that coming up later with Steve Jurich.
Precious metals have been the top performer over the past decade, and I don’t think the trend has reversed. Remember that metals can rise in an inflationary environment and a deflationary environment. There is also the safe haven aspect of gold. Also realize that whatever happens the Central banks will respond by printing more money.
And don’t forget one of the key lessons of the meltdown of 2008; remember when it looked like we would have several big banks collapse? It didn’t happen. The banks are extremely powerful. While we are likely seeing economic shock and awe, the plan is to scare everyone, not to destroy everything.

Bank of America has dropped its monthly fee for using a debit card, but remember I told you they would hit you with other fees. The New York Times tells us that banks are in the process of imposing a host of new charges. For instance, TD Bank will charge $15 for an inbound wire transfer. A replacement debit card will cost $5 at Bank of America. Citibank is increasing the fees on a basic checking account by $2 a month; Bank of America, by $3 a month.

Occupy Wall Street protesters are planning an attempt to shut down the New York Stock Exchange on Thursday, Nov. 17, as part of a series of actions to mark the movement's two-month birthday

Occupy Wall Street is facing increased oppostiion all across the country.
 In Portland, Ore., more than 50 people were arrested Sunday night after police officers in riot gear moved in to empty the parks.
In Oakland, riot-clad law enforcement officers cleared out the city's encampment just before dawn Monday, arresting 32 Occupy demonstrators and removing tents from a downtown plaza after issuing several warnings over the weekend, Plaza.

In Eureka, Calif., more than 50 Eureka police officers, Humboldt County sheriff's deputies and California Highway Patrol officers moved in on Occupy Eureka early Monday, arresting more than 20 protesters. No warning or order for dispersal was given.

In Philadelphia, Mayor Michael Nutter has increased the uniformed police patrol near the city's camp because of safety concerns including combustible structures, lack of an emergency fire lane and growing problems with litter, public urination, defecation and graffiti.

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