Greece, Spain…Who’s Next? Wenzhou or Wisconsin?
We certainly do live in interesting times, especially if you are like me—a stock market junkie who also follows world events with equal measures of interest and cynicism. Before I continue, I should point out that I started writing this blog a month ago, but I could have just as easily written it three or four months ago. That’s how long these major market headwinds have been around–and most much longer (e.g. Greece). Given how fast things move in the financial markets, and more importantly in the world at large, the enduring nature of our most pressing problems is worth noting.
This is a piece about the stock market, and how long the U.S.—and most other global markets—have behaved in such an insular, illogical fashion for so long. It is as if the outside world did not exist, which is what has traders so frustrated for so long—and why I have agonized over this market for months. In fact, I have hated this market since June.
Like so many other investors and money managers, I have been awaiting some financial disaster—a “Black Swan” event or a “Lehman moment”—that would simply crush U.S. markets. That’s why I have been largely short the market since June, with Facebook at the top of my short list (and Apple a close second since before the troubled iPhone 5 release. But I closed that winning position quite recently). In other words I made a major bet that the markets would fall since early summer, and that just didn’t happen. However, with terrible earnings thus far in Q3, all of that looks like it might finally change—and change fast. Either way, until quite recently, the last months have been nothing short of stock market torture.
I am not alone in calling this “the most hated market rally of all time.” Many money managers have not participated in this market “melt-up.” Research reveals that in 2012 well over 90 percent of portfolio managers have failed to keep pace with the returns of the S&P 500 (which is up 15% through three quarters, its best performance in years). That means that there are literally tens of thousands of traders and money managers who were judging the market on macro events, and as a result, like me, were under-invested. But when the central bankers—first Mario Draghi in Europe and then Ben Bernanke in the U.S.—promised to do “whatever it takes” to prop up respective economies, that artificially propped up most global markets by more than ten percent since late July. I say artificially because that sort of open-ended monetary policy seldom leads to the kind of authentic growth that can lift economies for the long-run, and not just financial markets for the short-term.
The reasons for my continued market pessimism should surprise no one. There is the horror-zone that is Europe with negative-growth countries needing to be bailed out by at least one other country in which its citizens don’t want any part of any additional bailouts (hint: they invented the blitzkrieg). Then there is the much talked-about “fiscal cliff,” which reveals the absolute inanity of the U.S. government. It is a travesty that they cannot get a thing done. Give congress a lamp and a light bulb, and you will still be sitting in the dark a month later. Congress won’t budge an inch on the “fiscal cliff” with its automatic spending cuts and expiration of the Bush tax cuts. The GOP won’t risk making Obama look competent a few short weeks before the election. As a result, businesses are frozen in place. Since they don’t know what the tax situation will be next year, they are loathe to hire new workers, which only adds to uncertainty—and markets detest uncertainty.
Then there is the China slow-down, which is a huge factor sparking another huge problem: the slowing of growth in the U.S., as evidenced by a multi-year high of corporations missing their top line numbers (in the current quarter only four of ten companies have made their top line revenue targets thus far—despite the fact that these numbers have already taken a haircut or two. That’s down by more than 30 percent from an average earnings report). Also, China gives us reports year-over-year without any quarterly adjustments, which obscures the meaning of their numbers even more.
You can stop reading here, or get more detail on the key headwinds described above. If you are still with me, let’s get back to Europe.
Most of Europe is in either recession or depression or heading in that direction—with things getting worse with each passing week (although many talking heads on financial networks will talk of declining Spanish bond yields as evidence of an improving economy. Spoiler alert: they’re wrong). The most beleaguered country—Greece—is experiencing a full-blown depression. With overall unemployment rates of 25%, and a jaw-dropping 55% for young people of working age, Greece is sadly an unmitigated disaster in which things will get worse before they get better. European leaders are finally learning that austerity measures are the enemy of growth, a lesson they should have learned long ago (but are still not changing their stance much on austerity measures). Instead of an accurate representation of the state of these broken economies, what we usually get are platitudes on “progress being made” and “more time should be given” [to Greece]. It appears that Europe’s politicians will say most anything to kick the can down the road to preserve the euro—and the 17-country euro zone—for as long as possible. However, that can only work for a a finite amount of time as the truth of Greece’s inability to pay off their debilitating debts become apparent to everyone [Citigroup puts the chances of a Greek exit from the euro zone at 60%, down from 90% a month earlier].
However, Greece is not lonely at the bottom, nor is it Europe’s most severe problem.
That honor goes to Spain, Europe’s 4th largest economy. This proud nation is in crisis. They accepted $100 billion euros to bail out their banks, but that was just to prop up failing financial institutions. The rest of the country is mired in a double-dip recession, and the country needs to be capitalized or risk running out of money. Unlike Greece, Spain cannot be swept under the euro zone rug for months to come. The country is too big, and its problems much bigger; yet their leader, Prime Minister Mariano Rajoy, stubbornly refuses to request a bailout for the country. And in the “new” Europe, a country must officially request a bailout, and all the growth-killing austerity measures that goes with it—to get any funds from the European Central Bank. But who can blame Rajoy? Every other leader who received bailouts have been voted out of office. It does not help that Rajoy is a serial procrastinator, and is not likely to request a bailout anytime soon, despite weekly press reports to the contrary. He may simply follow Europe’s lead and kick that same can down a different road—a road that leads to additional pain, more debilitating austerity, and ultimate insolvency.
Next up—China. According to numbers coming out of that country, growth is slowing quickly, with growth expected to come in at about 7%-8% for all of 2012. That would be amazing for the U.S. or Europe, but not for China (the U.S.is growing at a rate between one and two percent). In many ways, China poses a far more vexing problem than Europe. Another important aspect of the China problem is that their numbers are likely a canard. China is of course not a democracy, which makes any numbers emanating from that country suspect. That’s why, for example, anchors on CNBC use things like Chinese electricity consumption numbers as a more accurate guide to measure Chinese economic growth. I believe that when the real numbers are finally revealed in 2013, it is far more likely that China had grown by perhaps by four to six percentage points in 2012. We know that dozens of countries in the U.S. have missed their top line revenue targets in the second and third quarters because of slowing growth in China and the euro zone, but more CEO’s have pointed to China as the biggest problem, especially technology companies. This is true with the best U.S. tech names like IBM and Intel. Some large company CEO’s have said that China “feels” like it is growing at two to three percent rather than the seven or eight percent sworn to by China. There is also a monumental change in leadership coming soon in China, which only adds to anxiety in a way that the fiscal cliff has added to fear and anxiety in the U.S.
One city in China—Wenzhou—gives a more accurate picture about what is really going on inside world’s second largest economy. Quite recently the Washington Post ran an article entitled: “Some see China’s in Debt-Ridden City of Wenzhou.” The article made the point that the debt issues of this city bears some resemblance to the Bear Stearns of 2008, which was the first shoe to drop in the debilitating liquidity debt crisis of 2008-2009. The piece also mentioned that a prominent professor from Beijing saw Wenzhou as a “signal that high-interest private lending might trigger a debt crisis.” China’s total debt is estimated to be somewhere from 10 trillion to 14 trillion renminbi (about $1.6 trillion to $2.2 trillion). That pales in comparison to the U.S. with more than $16.1 trillion debt, which comes out $51,472 per American citizen. Hence the title of this posting.
If we are not far more prudent with our fiscal and monetary policy going forward, is it possible that the U.S. becomes the next Spain? It is surely possible, especially since congress is such a dysfunctional organ of our government. Since the stock market is forward looking, I would expect the market to be weak (meaning down) over the next few weeks as uncertainty rules the day. We will know more after the U.S. elections and the ringing in of the new year. Until then, consider buying some protection for your portfolio (e.g. buy some SPXU which is the inverse of the S&P 500), stay tuned and fasten your seat belts.