MV Financial Blog

Posts published in November 2010

Technical Comment: Return of the Eurojitters

November 17, 2010

By Katrina Lamb, CFA

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One way to visualize what is happening in this latest round of Euromarket jitters is to look at the present disparity in returns among European stock markets.  Sweden and Denmark, both non-Eurozone countries (i.e. they continue to use the Swedish krona and Danish krone respectively), are at the top of the tables with year to date returns in the neighborhood of 25% as of November 12.  Germany, the Eurozone’s putative anchor of stability, is up 8.2% YTD (also as of November 12) while other relatively stable markets like Belgium, Austria and the Netherlands are in low-single digit territory.

Then the bottom drops out with the Not-So-Fabulous-Five: Portugal, Italy, Spain, Ireland and Greece cover a spectrum of returns from -6.5% (Portugal) to -37.0% (Greece) as of 11/12 year to date.  The EU, the world’s second-largest economy when aggregated, is bookended by countries whose national currencies are not directly affected by the fate of the Euro on one side, and the countries that actually could determine the currency’s fate on the other side.

This is the background context for the latest slings and arrows to rail at the ramparts of Fortress Europe: these being of a decidedly Emerald Isle flavor.  As we write this the consensus appears to be forming around the conclusion that Ireland will require a financial bailout to the tune of $100 billion give or take.  A “technical team” is in Dublin now to review the details, even as the Irish government continues to dissemble about not actually-really-totally needing the bailout just yet.  As yields on Irish government debt rise to record levels this appears to be Act III of the Greek Tragicomedy of 2010, with Acts IV and V (Spain? Portugal? La bella Italia, cosi fan tutti?) plausibly waiting in the wings.  You will recall that Greece’s woes catalyzed EU policymakers and central bank authorities to mobilize €750 billion earlier this year, and the Irish bailout, should it proceed, would be drawn from those funds.

This time around there is less genuine fretting among observers that the Eurozone is teetering on the edge of the abyss – the stability of the currency does not appear to be in doubt.  Actually, the fiscal house of Europe is in better order than those of either the US or Japan, and from our standpoint there appears to be a greater level of seriousness among EU policymakers in addressing the crisis than could be said of their colleagues in Tokyo or Washington.  Having said that, there are sharply defined tensions among Eurozone countries, with most of the ill will being directed at Germany.  The Germans have been constant critics of the bailout from its early days, and recent days this criticism has sharpened around the notion that public funds from the bailout should ensure the return of 100 cents on every euro held  by private bondholders.  The sharp rise in Irish bond yields reflects in part a concern by would-be investors that a bailout might fully compensate them in the event of a default.  From their side the Germans argue that private investors need to wean themselves from those warm and fuzzy guarantees of full compensation they have become so used to hearing.  Sound familiar?  Debates over the Greenspan/Bernanke put are an ongoing feature of discourse on this side of the jet stream.

All of this matters greatly from an asset allocation perspective.  We have been used to a world defined by two flavors of non-domestic investments: “developed international” and “emerging markets”.  The topography of the real world is considerably more complex than that.  You can’t really look at the EU as one “asset”, for example, when you have such fundamental disparity between the economic strengths and weaknesses of its member countries.  EAFE – Europe, Australasia and Far East – is hardly an adequate benchmark for international equities when it includes nearly-insolvent European states alongside the high-growth markets of Pacific ex-Japan.  The job of making intelligent portfolio allocation decisions becomes ever more challenging – and we believe there are opportunities amidst the chaos.

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This Week in Global Markets: Technical Comment

November 9, 2010

By Katrina Lamb, CFA

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Two events of considerable and related importance took place last week. The 2010 US midterm elections produced a seismic shift in the balance of power of the legislative branch, from Democrats to Republicans. And the Federal Reserve announced its long-anticipated plan to embark on a new program of quantitative easing. These two events give us considerable insight into how US economic policy is to be approached for at least the next twelve months and possibly longer.

The markets took a day to digest all the news as it unfolded over Tuesday and Wednesday, and then erupted for major across-the-board gains on Thursday. In fact, as it stands now 2010 is shaping up with potential to be another strong year in US equities following the performance in 2009. Years like 2009 and 2003 are rebound years – they come off the trough of a major bear market and often register calendar year gains over 30%. But sustaining that kind of strength into a follow-on year of double-digit growth is somewhat rarer (2004, for example, produced rather anemic returns for US equities in the mid-single digits). As of the Friday 11/5 close the Russell 3000 was up 12.9% year-to-date, and the market’s firm undertone suggests that a year-end “window dressing” momentum rally could conceivably take the indexes higher still.

Is it all justified? Let’s take a closer look at last week’s news events. We start with the Fed’s action because, quite simply, the Fed is where it’s at for just about any economic policy is likely to be enacted for the next year or more.

QE2, the new round of quantitative easing announced last Wednesday, will pump $600 billion of new money into the markets to purchase long-dated Treasury bonds. The Fed will do this to the tune of about $75 billion per month up through the end of the 2nd quarter in 2011. In addition the Fed will reinvest proceeds from existing securities (from the 2009 QE program) as they come due, meaning that in total its national balance sheet goes up by that $600 billion. Now, bear in mind that the Fed’s charter has a double mandate: promote policies that maintain healthy levels of employment in the economy and stable prices. The desired outcome, in this regard, would be for QE2 to stimulate new credit creation, spurring businesses to expand and hire new workers, while at the same time not triggering inflation beyond where it currently sits – about 1-2% per year.

That second goal – 1-2% inflation, is probably more likely than the first.  Inflation may be a problem again one day, but for now the conditions needed for it to happen – either organic growth in household incomes leading to increased spending; or some kind of indexation between wages and prices like the catalyst that sparked the inflation of the early 1970s – is unlikely. On the other hand, for QE2 to make a meaningful dent in that sticky unemployment number will require a bit more heavy lifting. Not only will the eased credit conditions have to really induce companies to expand – but they will actually have to make proactive decisions to hire more US workers rather than, say, some combination of outsourcing and investing in more business automation to achieve productivity gains. It’s possible – but the case is awfully shaky.

As for that other event of last week – it is hard to say much else other than that we are likely to be in for a long period of legislative gridlock. Depending on your political point of view you may find that dismaying or comforting – but to the extent that any bold policymaking actions are going to have an impact on the economy next year those actions are much more likely to be originating from Ben Bernanke and his team than from Capitol Hill or the White House.

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