Right Now the Debt Crisis is European, But the Problem is Global

In addition to the European economic recession exerting a drag on the rest of the world, the real threat of bankruptcy of a major financial institution can rapidly spread throughout the globe as a result of a run on the banks or the opaque interrelationships between European banks and financial institutions in other nations

Market Facing Strong Headwinds

All in all, the negative fallout from the EU sovereign debt crisis and the outlook for the U.S. economy are likely to have a strong downward pull on the stock market. Rather than reflecting fear, the market seems unusually complacent as investors are overconfident that the world financial authorities can pull a rabbit out of the hat at the last minute.

Additional Liquidity Is Not A Solution

In sum, it seems clear that the next few days will not produce a long-term solution to the European debt crisis. However, the various nations and financial institutions realize the gravity of the situation, and it seems likely that they will make every effort to reassure the bond markets and stop interest rates from continuing to climb, at least temporarily. It therefore would not surprise us to see a combination of financial institutions inject massive doses of liquidity into the markets in an effort to buy some time. While markets profess not to like government interference, they do love liquidity, and another brief rally is quite possible. However, this treats the symptoms rather than the disease. A dose of liquidity does not cure insolvency, recessionary economies, massive budget deficits and huge debts. At best, this will be another case of kicking the can down the road. At worst—-we don’t even want to think about it

Central Bank Action Not A Solution

European leaders will meet again on December 9th in an attempt to come up with the solution. The important point, though, is that the probable solution would call for European nations to surrender some sovereignty over fiscal policy to a higher authority dominated by the stronger EU nations, particularly Germany. In addition, the new fiscal policy would amount to more austerity. Given that the people in the weaker nations have already been rioting against the austerity programs proposed by their own governments, how will they feel when that austerity is imposed from the outside? And even if these obstacles were overcome, the result would be highly restrictive. As we have repeated ad nauseam, the overall problem is too much global debt. The policy solutions are inherently deflationary and will result in slow growth and disappointing market returns for years to come

Euro Crisis At A Tipping Point?

The European sovereign debt crisis is rapidly approaching what could be a significant tipping point as it threatens to spread to the heart of Europe. In recent days Italian 10-year bond yields have soared to 7.22% and today Spain was forced to pay 6.975% at its auction. Even French 10-year yields have climbed to 3.71%, its widest spread over German bond yields since the Euro Zone was started. All of this has happened despite large ECB purchases of periphery country bonds over the last few months and the installation of technocratic governments in Greece and Italy.

The fear has now spread to the heart of Europe

Euro Crisis Enters Dangerous Stage

We see no easy way out of the current turmoil. The result of enough fiscal austerity to relieve the debt pressures is a severe recession or depression. Historically, independent nations undergoing austerity have accompanied the policy with monetary ease and a devaluation of their currency. This is something EU members cannot do as they share a common currency and therefore do not run their own monetary policy. Default would cause havoc in the EU banking system that holds a significant share of the sovereign debt. A bailout would require at least two trillion euros, a sum that no one wants to pay. And breaking up the EU would cause major turmoil in global financial markets and economies.

So far the market has rallied strongly on every announced plan for the last year and a half only to decline again when it became clear that the crisis was not over

Fed’s Outlook Nothing To Cheer About

The bulls assert that the market is already discounting major risk and is reflecting widespread fear that may prove unfounded. That might be true if the market had collapsed as in 2000-2002 or 2008-2009. However, the current market is more of an extremely volatile trading range with wide swings in both directions. In fact the huge daily swings to the upside on any hints of favorable news indicate that investors are every bit as fearful of missing the next bull market as they are of getting caught in a free-fall. That is not the kind of action seen at major bottoms. In our view the 2011 lows are likely to be tested and breached with a test of the 2009 lows to follow

Another Bear Market Trap

The sharp rally off the October 4th intraday low of the S&P 500 is a result of the assumed prospect of a real plan to save the Euro and slightly improved U.S. economic numbers indicating that we may not be in a recession right now. In addition the market was probably oversold after its rapid plunge below the 1260-1370 trading zone. We think the market will soon be disappointed on both counts

Jobs! Jobs! Jobs! Business Roundtable and Challenger

Since the fourth quarter of 1972 (when founded) the most important thing that the BRT does is a survey once a quarter which provides a forward looking view of the economic outlook of BRT’s 140 member CEOs. One of the other major changes from one month ago was the answer to the question, “How do you expect your company’s U.S. employment to change over the next 6 months?” The response from 24% of the CEOs surveyed, answered that question with “LOWER!!” All in all, the latest report by BRT was much worse this past quarter than almost any time except during the “financial crisis” in 2008-2009.

Challenger, Gray & Christmas, Inc. (Challenger) is in the business of keeping track of job cut announcements. This past September they just reported that layoffs surged to the highest total since April 2009 at 115,730 or 212% higher than one year ago where employers announced just 37,151 layoffs. In fact, this is the first announced monthly layoffs of over 71,500 over the past 21 months

Total Private Market Debt’s Decline Should be a Glaring Warning Sign

The earnings estimates on the S&P must go down significantly. With the problems in Europe, and then the potential slow-down in China (after building more residential and commercial construction than presently needed) we would have to think that declining investment (debt) would be even more cause of concern. In our opinion, the stock market is headed to much lower levels, and as we stated before, any upswing will not exceed the 1250 resistance level of the S&P, and any rally should be sold

Questionable Rally

We continue to be amazed at the eagerness of the market to rally in the face of negative fundamental data. The U.S. stock market rallied today on the news that the European Central Bank is getting together with other Central Banks (Bank of Japan, Federal Reserve, Bank of England, and Swiss National Bank) to provide more liquidity to help Europe as they are trying to keep their heads above water. The coordinated action between governments has generated a “trust” that we expect to be short lived

Market volatility and double dip mean re-test of March 2009 low

This extra $4.5 trillion of household mortgage debt is a terrible burden on the economy since consumers make up over 70% of our economy. This is why consumer spending has been so tepid over the past few years. U.S. consumers spent well beyond their means for decades and now that they are so overleveraged their PCE will stay constrained for years. The consumer spending didn’t seem too onerous over the past few years until the Commerce Department lowered their earlier estimates significantly. Also, consumer confidence by any measure you chose is signaling another recession, and any cuts in federal or state government spending could only exacerbate that. U.S. consumers spent well beyond their means for decades and now that they are so overleveraged their PCE will stay constrained for years. The consumer spending didn’t seem too onerous over the past few years until the Commerce Department lowered their earlier estimates significantly. Also, consumer confidence by any measure you chose is signaling another recession, and any cuts in federal or state government spending could only exacerbate that