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Mark's Market Blog

6-3-12: The Fear Factor Increases

By Mark Lawrence

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Markets turned back down on news that Greece continues to deteriorate, Spain and Italy bond rates are skyrocketing again raising fears of contagion, and Germany very vocally vetoes any idea that has a hope of actually working. I'm on record, the European Central Bank will pull some kind of rabbit out of their hat in a few weeks, this can will get kicked yet again, but first the fear level has to increase a bit more. Greek elections are June 17th, nothing useful will happen before that. Greek politicians are raising the heat on their rhetoric and if you were to take them at their word them you would think the Drachma might well reappear this month. How bad is it out there? As of Friday, the US and Thailand are the only two stock markets in the world trading above their 200 day average. And I expect we'll drop to and likely below our 200 day average in the next week (red line in the chart below). I still pay attention to the 200 day, but unlike previous centuries where violating the 200 day average was an infrequent indicator of major change, now it seems to be a twice yearly indicator of banking crisis and reserve bank intervention. Gold went up this week: if you're going to get zero interest on your German bonds, you may as well own Swiss gold. Bank stocks are leading the way down as this fear is, after all, all about banks.

S&P 500 December 8 2011 to June 1 2012

Robert Zoellick, the outgoing president of the World Bank, said "If Greece leaves the Eurozone, the contagion is impossible to predict, just as Lehman had unexpected consequences." Fears are mounting that Spain will be crippled by its banking sector and will be the next domino to fall. Mr Zoellick said: "Eurozone leaders need to be prepared to recapitalise banks. In the Eurozone, the guarantees of some national sovereigns are unlikely to be sufficient and only that of the 'euro-sovereign' will suffice. It is far from clear that Eurozone leaders have steeled themselves for this step. Eurozone leaders need to be ready. There will not be time for meetings of finance ministers to discuss the outlook and debate the politics."

Facebook - I'm really enjoying this in a schadenfreude sort of way. It ended the week at $27.72, off 27% from the opening price of $38. I have a Facebook page, so does pretty much everyone I know, but try to charge me $5 per year for a subscription and I'm outta there. I'm very old fashioned about business, I believe to make money you have to make or do something useful. In my mind the billionaire and millionaire founders of Facebook haven't met that criteria. About $16 billion of Facebook stock was sold the first day; half of that went into Facebook's bank account (now I think they're worth $8 billion, heck, maybe even $12 billion), the other half went to what I think of as the smart founders, who cashed out at what I expect will prove to be the best price for a long time. Lawsuits are flying fast and furious. Several other companies that were planning IPOs about now have suddenly decided to delay their stock offerings. I guess it's hard to get excited about ordering dinner when the kitchen is on fire.

US job creation has stalled out, unemployment is increasing a bit, and fears that we may be entering our next recession are increasing. You might say, "When did we leave the last recession?" That's a valid point, but things can get worse from here. This would be the first time since the 1930s that we will enter a recession before employment and GDP have made it back to their previous levels. Obama has to be sitting in the oval office watching the wheels come off Europe, China having difficulties, the US entering questionable economic territory, markets dropping, and just hating it all. His reelection chances are closely tied to the unemployment rate and the stock market.

US interest rates continue to drop as there's a rush to get money into a safe haven. Isn't it interesting that government laws and bureaucrats effectively decide if there will be a banking crisis and what the response will be, and the result of this banking crisis is that it gets really cheap for the government to borrow money for more growth? Anyway, we often chart interest rates as a function of debt duration - the rate on 90 day notes, then 180, then 2 year, 5 year, 10 year, 30 year. This is called the yield curve. The yield curve has been dropping for five years now to historically unprecedented low levels. What happens to government and entitlements and inflation when the curve starts to rise back up and the cost of the government debt increases? Maybe that will never happen. . .

The Euro was as high as $1.60 four years ago. It's been at or above $1.30 pretty much non-stop since 2007. Today it's at $1.23 and dropping. There's massive pressure on the ECB to print money, and as I see it the question is when and how much, not if. I expect the Euro will continue to drop, likely reaching $1 within a year. If you had hopes of selling things to Europe, sorry, that's going to be very difficult. On the other hand, that Greek vacation might be very cheap a year from now, when Euros are off by a third and Drachmas are half a Euro - less than 20¢ on the dollar compared to a few years ago. Not to be outdone, many other countries are dropping the value of their currencies to keep up. Only the Chinese, also apparently headed for recession, are smart enough to know not to provoke us like this. As we've seen, when the US runs huge trade deficits our government debt goes up and our unemployment increases. If this sort of thing continues, you're going to hear more and more out of Washington about predatory trade practices and the possibility of import duties and trade wars.

Berlusconi, the outspoken and "interesting" PM of Italy, said Friday on his Facebook page "I can't remember a time in my life more difficult than this. People are really hopeless. What move can change the recessive spiral? The economic crisis is not resolvable internally. The Government must pick up where we left off and change its political line. We have to go to Europe to say emphatically that the ECB should start printing money. So change the economy. The ECB must change its mission, must become the guarantor of last resort debt and begin to print currency. Otherwise, we should be strong enough to say 'bye, bye' to the euro and therefore leave the euro, while staying in the EU, or tell Germany to leave the EU if they don't agree." Of course everyone knows the PIIGS are thinking this, but it's still stunning that someone would actually say it in public. Spain's economic minister said Friday the future of the euro will be determined in the next few weeks and will depend on the stability of Spain and Italy. I disagree with this, the end game will be next year, not next week. But I admit if I lived in Spain I would be withdrawing my money from all banks and buying rice, beans, gold. In any case he also called for more ECB intervention and money printing, and a new organization to guarantee deposits like the US FDIC. Germany predictably disagreed.

You may hope that Greece's default of a month ago marked the depths of this crisis, but historically defaults come in dozens in crises, and the way to bet is that there are several more yet to come.

The big issue right now is Spanish banks. They funded a massive buildup of houses in Spain, many of which are now unfinished and unsold. More than half the real estate loans on their books are bad. They need a bailout, but that bailout will put Spain into a decade long depression - remember, this is a country with 25% unemployment and 52% youth unemployment already. Germany adamantly opposes an EU bailout. So, there we are: people are pulling money out of Spanish banks at a record rate, their government bond rates are climbing every week making it more and more expensive to fund the government, and the EU cannot agree on any form of help. By the way, here in the US credit card rates are often 15% to 21%, but that has no affect on me: I don't fund my daily life at credit card interest rates. There are no "mark bonds" whose interest rate I follow with morbid fascination. How is it that the government is less able to handle money than I am? Why do we tolerate a level of government debt that is choking off business investment and economic growth, and ruining our children's futures?

Spanish and Italian bond rates are skyrocketing. European stock markets are dropping. German, US, UK and Japanese bond rates are collapsing as people move their money to the only safe havens they can find. The world isn't ending imho - I believe the EU will announce some sort of massive bailout in a few weeks - but people are preparing for the end of banking as we know it. That's a hint, some day in the next few years banking as we know it will likely end. Good riddance, in my opinion - the top five American banks don't do a thing for me, and I don't believe I'd miss them for even a minute. How do the PIIGS interest rates look? See chart below, pretty glum overall. Spain is well over the 6% white-knuckles level, Italy is headed there quickly, Portugal is a train wreck and Greece has another default already priced in. Germany, France and the UK are seeing their rates drop during this flight to safety. When France's rates start to increase, say past 4.5%, that's when you should start storing water, beans, rice and salt in your basement.

Why do we care about Europe? Americans have a long and storied history of thinking the world ends at our beaches, but in the modern world it's just not true. I can fly to Thailand, almost exactly half way around the world from New York, in under a day. I can get money to or from Thai banks in a couple minutes. People better wired up than me can do it in seconds. When Europe's banking system collapses, trade with Europe will end for a time. This will be an immediate blow to American and Chinese exporters. Also, all foreign trade required banking, and Europe has specialized in that. When their banking system collapses Boeing will find it very difficult to get financing to sell a plane to Singapore; GE and Bechtel will find it difficult to get financing for their power generation systems. There will be massive losses on some European bonds, and some of those losses will be born by US banks, already creaky. The US banking system will also be called into question, and but for massive capital injections by the FED could collapse too (don't worry, Bernanke will write any check rather than see that happen on his watch). My own business, motorcycle windshields, will shrink by 15% or so just due to the loss of exports to Europe; businesses make their money at the margin, meaning the first several windshields I sell every week go to cover my costs, I make my money on the last few sales. A 15% drop in sales might mean a 25% or even 33% drop in profits for me. A collapse in corporate profits like this likely means a US recession as workers get laid off and consumer's purchasing plans get pushed out into the future. Like it or not, the world is much smaller and more tightly coupled than it was even ten years ago. You'd never know it to watch the evening news, but the European banking system is much more important to us than a local stolen car, or a father kidnapping his estranged child from his vindictive ex-wife, or the latest drug bust at a nearby high school. It's just a little harder to identify with. I've already said several times, I don't think Europe collapses this year. This is a practice run. But one of two things is true: either a coalition of genius politicians and bankers will come up with an unprecedented and unexpected solution, or bad times are ahead. Which one sounds more likely to you?

Budget cuts in California continue to dramatically impact the University of California. Californians are told that if Governor Moonbeam's proposed tax increase doesn't happen, things will get quit dire - said Lt. Gov. Gavin Newsom, who is on the board of trustees for the U.C. and Cal State systems, "We're not cutting into muscle or tissue, we're cutting into artery." Meanwhile, I'd love to know what the cuts will be for benefits to illegals. We spent $107 billion in California last year on Medi-Cal, another $20 billion on Human Services (food stamps, housing), $8 billion on jails, and $38 billion on primary education. Somewhere between a third and a half of that $173 billion goes to illegals and their children. Meanwhile the entire UC + Cal State + community college systems together cost the state about $9.5 billion. In the midst of this ongoing budget crisis, California's budget increased 5% from 2011 to 2012. Governments, like any living creature, will fight to live and grow. This equation seems really simple to me: education of our youth is our future, and illegals are, well, illegal. It's nice to have pets - I have a kitty cat - but when you don't have enough money to take care of your children, the pets go.

An interesting rumor is that Saudi Arabia is projecting a world wide recession in the next couple of years, and is intending to ramp up oil production instead of cutting it back. Their goal is said to be $60 / barrel oil, which they think will bankrupt Iraq and Iran - two Shi'ite countries that they think are trying to destabilize the Arab / Sunni world. I dunno if it's true, the Saudi King doesn't call me anymore. But if oil starts drifting down over the next couple of years, you heard it here first. If it doesn't, remember I just called this an interesting rumor, not a forecast. That's called hedging.

Science: A new Danish study suggests that aspirin, taken daily, also helps protect against skin cancer.

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