Monday morning a client and I were discussing what had changed that would explain the shift in investors’ sentiment from safety to risk. According to the several sources I read on a daily basis, my answer was that absolutely nothing had changed. All of the structural problems both domestically and globally were still on the table. The stock markets’ rally as well as the support in copper, oil and interest rates can only be tied to investors’ shortsighted expectations of economic policy going forward. Unfortunately, we all know that expectations can be quite different from reality.
Ben Bernanke’s comments from the Jackson Hole meeting on August 26 suggest lower interest rates throughout 2012. However, he was quick to point out that any long-term recovery would have to be headed by Washington because it is not the Federal Reserve’s job to do the heavy lifting of job creation and budget management. This was Bernanke’s way of putting the focus of the economy back on the Congressional cause rather than expecting him to deal with the effects of their actions.
The economic data here in the U.S. continues to weaken and expectations of another recession are rising. Last week, jobless claims came in over 400,000. Remember, we need to create more than 115,000 jobs per month just to hold the unemployment rate steady. This week, the mortgage application index dropped to its lowest level since February of 1997 and the Michigan Consumer Sentiment Index has fallen more than 20 points in the last three months. The correlation between this index and domestic GDP is high enough that the decline in the index points to a year over year drop in GDP by more than 2%. This type of decline in GDP has always led to recession.
The supporting arguments for the stock market’s continued success are usually tied to low interest rates, global trade and positive earnings. Unfortunately, when these factors are put into the context of our current economic cycle, the long-term negatives will outweigh the short-term positives. The historically low interest rates are due more to fear than they are a stable economy or falling inflation. When investors are willing to pay the U.S. Treasury to hold their money, fear is clearly the driving cause. The global trade argument has two flaws. First, our companies doing business over seas are being paid with a U.S. Dollar that is declining in value. The Dollar is only 4% off of the ’08 lows and is down more than 17% from last year’s high. Secondly, Europe, which makes up 57% of the U.S. Dollar Index is facing a meltdown similar to ours from 2008 and the trigger could very well be pulled next week.
The political dissent in Germany is running at a feverish pace. Next Wednesday, the Bundestag, Germany’s constitutional ruling court will vote on the legality of the European Union’s bail out. Specifically, Germany will determine whether the $600 billion bailout fund conflicts with Germany’s own fiscal solvency. Recent polls show that Chancellor Merkel will be unable to even count on her own party’s support.
Investors have reached a perverse sentiment where the worse the news becomes; the more likely they think a government coalition is to be there to bail them out. Remember the banking and auto sectors of ’08? Here we are years later and the economy is worse off than it was before yet the Dow Jones was within 10.5% of its all time high and more than 80% higher than its ’09 lows just one month ago.
The U.S. debt ceiling debacle triggered the most recent wave of selling. The markets have been relatively quiet since with strong buying coming in near the lows from commercial traders. My concern is that the commercial traders will be net sellers of stock index futures this week as they bank some profits and take risk off of the table in advance of next week’s Bundestag ruling on the constitutionality of Germany’s direct participation in the European Financial Stability Facility. Any withdrawal of support from Germany would literally be, catastrophic. Given Germany’s history of political dissent as well as their recent history of economic self-sufficiency this decision could very well be an historic landmark.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
