Stocks fell Friday after a surprisingly weak June employment report. But an afternoon rally mitigated the losses.
This morning, however, the gloom has returned and with some justification. All last week, amid a mixture of decent U.S. economic news, spreads on European bonds and banks widened sharply. In particular, Italian banks seemed to be in the crosshairs in anticipation of bad news coming out of European stress tests due out at the end of this week. Unfortunately, it seems that all the economic imbalances within the European Union (EU) prevent any solution that will permanently restore equilibrium, at least not any time soon. Although in many ways Italy is in far better shape than Greece, the poster child for EU fiscal mismanagement, Italy has the second highest percentage of debt to GDP. Thus, if Italian interest rates rise rapidly, debt service becomes more of a burden. If Italian banks “flunk” their stress tests, they will be under increasing pressure to either raise capital or constrain lending at a time when faster growth would be a solution to economic woes. With that said, odds of imminent default aren’t very high. But it is clear that an EU bailout of Italy would be prohibitively expensive. As always, the media and speculators will accentuate the negatives and blow the short term issues out of proportion. Because there is no easy short term solution, the problems are likely to fester for a long time to come. Every time the news front elsewhere calms down, European debt woes will once again rise to the surface.
But Italy isn’t the only issue facing investors this morning. Certainly last Friday’s U.S. employment report is still on everyone’s minds. The small 19,000 increase was far below expectations. Not only was the increase small but virtually all the details within the report had negative connotations. If you looked at temporary employment data, the average work week, or average wages, you came away with a sour feeling. Employment is a lagging indicator and one should remember that, but recent trends have been unfavorable and leading employment numbers, such as weekly jobless claims, haven’t been good lately.
The employment report didn’t evoke as negative a reaction as it could have because so much recent data seemed to contradict the weak report. It allowed investors to consider it as a bit of an outlier. However, it is probably more appropriate to recognize that we are almost two years into economic recovery and the data still suggests an economy struggling to get its sea legs. Certainly a moribund housing market is a liability. A world recovering from too much debt is another factor. Banks, burned badly in the recession, remain reluctant to lend. At best, this is an economy that is going to recover very slowly and it is destined to hit speed bumps along the way.
The third thought buffeting investors is another breakdown in talks to extend the debt ceiling. This is classic theater of the absurd. Both sides of the aisle are speaking to their own constituencies and not listening at all to the other side. Most of us aren’t constituents of either extreme; we are somewhere in the middle, tired of this circus, hoping that a few hundred grownups in Washington will do something simple and logical without causing worldwide consternation. So far, financial markets are assuming that, somehow, this theatrical mess will come to some sort of conclusion before disaster strikes. But the further this carnival extends, the greater the risk becomes that it all ends ugly with a host of unintended consequences. Neither side wants to be the loser but if this ends ugly all sides will be big time losers.
Tonight begins earnings season as Alcoa reports. Don’t look for good news there. In fact, don’t look for much good news this week. Most of the major reporting companies are financials and there is little hope for good news from them. Second quarter earnings will probably be just fine but we aren’t likely to see that picture displayed until next week.
Thus, we face what could be a tough week, quite a contrast to what we have been experiencing for the past two weeks. Indeed, the mood swings simply reflect the reality of worldwide economies gradually getting back on their feet after the worst recession in over 50 years. Until housing stabilizes, until leverage levels return to normal, and until monetary velocity picks up, the road is going to be bumpy. That isn’t bad; it’s just the way it is.
But there are few signs that the road is reaching a dead end. The problems in Europe are being addressed. Granted they aren’t solved and they won’t be solved any time soon. But virtually every government is taking constructive first steps to get their houses back in order. Will there be some necessary defaults along the way? Quite possibly. Will some banks or private investors get hurt in the process? Almost certainly. Will world financial markets collapse once again unable to withstand the weight of leverage? I don’t think so. The reality is that there is plenty of money sloshing around that can solve a good many problems. Default contagion need not be fatal. In fact, it rarely is. Lost in all the negative news this weekend was news from China of very strong persistent economic growth. Earnings reports beginning next week will be good. Hopefully, the Washington circus can avoid calamity at the proverbial eleventh hour.
I suggested last week that we had moved from the bottom end to the top end of an extended trading range. After two steps forward, we are probably destined to take a step back. That’s normal and it should be viewed that way. Ultimately, the patients will heal and the recovery will gather steam. It may take a few years for that to happen. A better package of fiscal and regulatory policies might help but we are going to have to play with the hand dealt. The bottom line is that slow growth is with us for some time to come.
Futures suggest a very ugly morning.
Former heavyweight champ Leon Spinks is 58 today. Giorgio Armani turns 77. Today is also the 84th anniversary of the birth of the 7-Eleven store. Did it get its name from the fact that it originally opened at 7 and closed at 11 or for the fact that it was born on 7-11? Legend supports both answers.
James M. Meyer, CFA
610-260-2220
jmeyer@towerbridgeadvisors.com
Additional information is available upon request.
# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.
Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.
** REPRINTED WITH PERMISSION FROM TOWER BRIDGE ADVISORS
Fed Watch
Morning Comment July 11, 2011 by James M. Meyer, CFA
This morning, however, the gloom has returned and with some justification. All last week, amid a mixture of decent U.S. economic news, spreads on European bonds and banks widened sharply. In particular, Italian banks seemed to be in the crosshairs in anticipation of bad news coming out of European stress tests due out at the end of this week. Unfortunately, it seems that all the economic imbalances within the European Union (EU) prevent any solution that will permanently restore equilibrium, at least not any time soon. Although in many ways Italy is in far better shape than Greece, the poster child for EU fiscal mismanagement, Italy has the second highest percentage of debt to GDP. Thus, if Italian interest rates rise rapidly, debt service becomes more of a burden. If Italian banks “flunk” their stress tests, they will be under increasing pressure to either raise capital or constrain lending at a time when faster growth would be a solution to economic woes. With that said, odds of imminent default aren’t very high. But it is clear that an EU bailout of Italy would be prohibitively expensive. As always, the media and speculators will accentuate the negatives and blow the short term issues out of proportion. Because there is no easy short term solution, the problems are likely to fester for a long time to come. Every time the news front elsewhere calms down, European debt woes will once again rise to the surface.
But Italy isn’t the only issue facing investors this morning. Certainly last Friday’s U.S. employment report is still on everyone’s minds. The small 19,000 increase was far below expectations. Not only was the increase small but virtually all the details within the report had negative connotations. If you looked at temporary employment data, the average work week, or average wages, you came away with a sour feeling. Employment is a lagging indicator and one should remember that, but recent trends have been unfavorable and leading employment numbers, such as weekly jobless claims, haven’t been good lately.
The employment report didn’t evoke as negative a reaction as it could have because so much recent data seemed to contradict the weak report. It allowed investors to consider it as a bit of an outlier. However, it is probably more appropriate to recognize that we are almost two years into economic recovery and the data still suggests an economy struggling to get its sea legs. Certainly a moribund housing market is a liability. A world recovering from too much debt is another factor. Banks, burned badly in the recession, remain reluctant to lend. At best, this is an economy that is going to recover very slowly and it is destined to hit speed bumps along the way.
The third thought buffeting investors is another breakdown in talks to extend the debt ceiling. This is classic theater of the absurd. Both sides of the aisle are speaking to their own constituencies and not listening at all to the other side. Most of us aren’t constituents of either extreme; we are somewhere in the middle, tired of this circus, hoping that a few hundred grownups in Washington will do something simple and logical without causing worldwide consternation. So far, financial markets are assuming that, somehow, this theatrical mess will come to some sort of conclusion before disaster strikes. But the further this carnival extends, the greater the risk becomes that it all ends ugly with a host of unintended consequences. Neither side wants to be the loser but if this ends ugly all sides will be big time losers.
Tonight begins earnings season as Alcoa reports. Don’t look for good news there. In fact, don’t look for much good news this week. Most of the major reporting companies are financials and there is little hope for good news from them. Second quarter earnings will probably be just fine but we aren’t likely to see that picture displayed until next week.
Thus, we face what could be a tough week, quite a contrast to what we have been experiencing for the past two weeks. Indeed, the mood swings simply reflect the reality of worldwide economies gradually getting back on their feet after the worst recession in over 50 years. Until housing stabilizes, until leverage levels return to normal, and until monetary velocity picks up, the road is going to be bumpy. That isn’t bad; it’s just the way it is.
But there are few signs that the road is reaching a dead end. The problems in Europe are being addressed. Granted they aren’t solved and they won’t be solved any time soon. But virtually every government is taking constructive first steps to get their houses back in order. Will there be some necessary defaults along the way? Quite possibly. Will some banks or private investors get hurt in the process? Almost certainly. Will world financial markets collapse once again unable to withstand the weight of leverage? I don’t think so. The reality is that there is plenty of money sloshing around that can solve a good many problems. Default contagion need not be fatal. In fact, it rarely is. Lost in all the negative news this weekend was news from China of very strong persistent economic growth. Earnings reports beginning next week will be good. Hopefully, the Washington circus can avoid calamity at the proverbial eleventh hour.
I suggested last week that we had moved from the bottom end to the top end of an extended trading range. After two steps forward, we are probably destined to take a step back. That’s normal and it should be viewed that way. Ultimately, the patients will heal and the recovery will gather steam. It may take a few years for that to happen. A better package of fiscal and regulatory policies might help but we are going to have to play with the hand dealt. The bottom line is that slow growth is with us for some time to come.
Futures suggest a very ugly morning.
Former heavyweight champ Leon Spinks is 58 today. Giorgio Armani turns 77. Today is also the 84th anniversary of the birth of the 7-Eleven store. Did it get its name from the fact that it originally opened at 7 and closed at 11 or for the fact that it was born on 7-11? Legend supports both answers.
James M. Meyer, CFA
610-260-2220
jmeyer@towerbridgeadvisors.com
Additional information is available upon request.
# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.
Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.
** REPRINTED WITH PERMISSION FROM TOWER BRIDGE ADVISORS
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