I said in a recent post that I thought that austerity fatigue had set in in Old Europe. Here’s confirmation, from Bloomberg.com:
European leaders declared a turning point in the Greece-fueled debt crisis, shifting their focus away from the budget-cutting spree that has dominated two years of rescue operations.
With a second Greek aid package wrapped up and the euro region slipping into recession, the leaders committed to a pro- growth agenda that sits uneasily with a deficit-control treaty that was signed today at the 17th summit since the outbreak of the crisis.
“Targets on deficits and debt are intermediate targets, no aim in itself,” European Union President Herman Van Rompuy said. “The restoration of confidence in the future of the euro zone will lead to economic growth. This is our ultimate objective.”
Amongst other actions, it appears they will overtly inflate. Budgetary heaven can wait.
With Goldman Sachs pushing out its scenario for recovery in house prices in the U.S. as reported by ZH yesterday, we have a sort of Goldilocks scenario for financial assets. It’s been my guess ever since the banks collapsed in 2008 and then the various policies were put in place by early 2009, that the government was going to inflate as much as it could so that the housing values on bank (and individual) balance sheets could be made whole in nominal dollar terms. Thus the alphabet soup of housing/bank support programs such as HAMP and HARP came as no surprise.
As Barry McGuire* might have sung back in the day, the Western world, it is inflating, dollars flowing, bankers HAMPing…
This is a classic cycle. It occurred from time to time in the 1920s, 1930s, 1940s, 1950s, 1960s, 1970s etc. The context now though is that of a Reinhart-Rogoff post-credit collapse, and thus private credit demands are low in the aggregate following boom after boom without many intervening busts.
The Dow is hovering around 13,000. This is a personally fraught number, as I exited stocks in summer 2007 around Dow 13,000 around the time the Fed initiated its first emergency discount window rate cut. If someone had suggested that the market would be lower 4.5 years later, I’d have been quite surprised. We’ve been down so long it looks like up to us now. But if we adjust for the price of gold and silver, and the aggregate Federal debt, and to be fair add in the cumulative dividends on stocks, maybe the averages are still down. (Of course, in relation to house prices, stocks are higher than ever, so again, it’s all relative.)
13,000 on the Dow has another meaning. Value Line publishes a regression formula each year that it fine-tunes as each year’s data comes in, attempting to predict where the Dow will trade as the year goes on. Making mainstream assumptions using just three variables- earnings, dividends, and AAA corporate interest rates- its formula predicts an average value for the Dow of yesterday’s closing price, give or take several points. Now, this is just a regression formula based on predictions, and there is a band of uncertainty of a few thousand points from low to high, but my point is that these sorts of fair value computations are done all over the Street. With the Dow “DIAmonds” and the SPY yielding 2.4% and 2% respectively, a lot of people and computers may simply want to put in some sell programs here if momentum in stock prices starts to wane.
OTOH, the same standard formulae give a 3-5 year Dow price projection of around 17,000 (if memory serves), and that is not including the stream of dividends. So stocks are attractive under a muddle-through scenario relative to bonds or cash. Meanwhile, there’s so much underlying economic weakness in incomes and in “underwater” mortgages (the effects of which are leveraged), that I can see interest rates following the post-Depression script and staying very low for longer than the Street expects and even if Treasury yields even at the long end are somewhat below the rate of consumer price inflation.
The above is a sort of Goldilocks scenario for stocks. Not too hot, not too cold. We of course shall see.
The Reinhart-Rogoff study of prior credit collapses shows an average duration of severe economic weakness of 5-6 years. I date (arbitrarily) the onset of the current one to have begun in August 2007 with the first discount rate cut. The Great Recession of 2007-9 had a follow-on mini-recession or severe growth slowdown in 2011. Certainly a drop of about 25% in the Russell 2000, a 1/3 off sale in Dr. Copper, and a more than 1/3 fall from peak to trough in WTI oil, are consistent with a significant economic event. Once again, the Fed engaged in monetary “accommodation” beginning at the end of September (when the market was bottoming) with Operation Twist, followed by creation of new Fed credit with “swaps” to the ECB and also by reinvesting the stream of income from the Fed’s portfolio of MBS into Treasury issuance. Putting it all together, and recalling that the Fed estimated that the Operation Twist was going to be equivalent to half of a “QE” event from the standpoint of “supporting” the economy, and I think we can say that something approaching another QE is again underway. And of course, what’s going on in Europe is more extreme.
Great powers such as the United States can and do set their course. The authorities from the President and the leaders of both houses of Congress have agreed upon a growth agenda, at least as they define it. The Fed, which has never been independent, has supported the political-economic goals set by the leadership. It is this perspective that has led me to reject, from the onset of the crisis, the predictions that float around the Web that the end is nigh. I think the U.S. is in the later stage of the Reinhart-Rogoff cycle and that better times lie ahead, though the path may still be rocky given what happens to economic activity every time the Fed cuts back its support of the deficit spending. In fact, for the only company whose stock seems to matter these days, those better times are manifestly here. It’s not only AAPL; many companies are well-run and are innovating their way to succeeding the old-fashioned way, by making products that improve people’s lives and thus generating growing cash flows for the owners of the companies.
Which brings me back to the lede, about Europe. There is austerity fatigue, indeed. But the debts remain and must be dealt with. Europe is now more leveraged than ever and perhaps not oriented to innovation. Turning that economic battleship around is not going to be an easy task. Talk is cheap. For now, I think the more interesting investment parts of the world are almost everywhere except Old Europe.
Managing money is never easy, and ZIRP is an especially befuddling thing. But the world keeps spinning, and people continue to act purposefully to fulfill their wants and needs. Some needs are eternal, such as for food; others vary, such as for smartphones, as technologies change. Whatever currencies are used to transact any type of business, those wants and desires lead to the formation of markets, which have continued to function for centuries uninterruptedly in the U.S. and many other members of the former British Empire. Business cycles come and go, wax and wane, but well-run enterprises tend to thrive over longer time frames, and well-run municipalities tend to always repay their debts.
Thus for investments, in this very complex macro environment, I’m sticking with high quality assets at the most reasonable prices I can find.
[See comment. -- Ed.]
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