In Europe the euro debt crisis is nothing but bad news.
Riots in Athens. Strikes in Spain. Shrinking pay checks. 20% unemployment. Rising taxes. Cuts to government services. Hard times for as far as the eye can see.
In the U.S? Sure, the crisis has sent a shiver (well, make that a great big shudder) through the stock market but it’s also responsible for falling interest rates, cheaper mortgages, and lower gas prices.
In the medium term it might even lead to sooner-than-expected turnarounds for emerging stock markets from Brazil to China.
Go figure.
Globally the euro debt crisis has sent stocks tumbling from New York to Sao Paulo on worries, well-founded worries, that the crisis will spread from Greece and Spain and Portugal to, first, France, and then to banks as far away as California. The People’s Bank of China isn’t talking but Beijing’s foreign exchange reserves, held increasingly in euros in recent years as China diversified away from the U.S. dollar, have certainly taken a beating from the 15% decline in the euro. Prices for everything from oil to copper have plunged.
But no bad deed goes completely unrewarded.
And the euro crisis is actually good news if you’re thinking of buying a home in the United States, or own a portfolio full of U.S. Treasury bonds.
The crisis could even make U.S. stocks the best performing in the world for a while. (Yes, I think the current market drop is a correction and corrections end.)
Further afield although the crisis has fed into relentless declines in emerging market stocks—iShares MSCI Brazil Index ETF (EWZ) is down about 13% for 2010 and the Shanghai stock market is in a bonafide bear market with a better than 20% decline from its November 2009 high. But for these markets the euro debt crisis promises an accelerated end to the decline and a quicker rebound. (For more on China’s bear market see my post https://jubakpicks.com/2010/05/18/chinas-bear-how-long-are-its-claws/ )
What are the magic ingredients that have turned what is unrelievedly bad news for Europe into good news for U.S. home buyers, U.S. investors, and developing economy stock markets?
Lower interest rates and lower inflation.
In the United States the euro debt crisis has worked like this:
The euro’s pain has been the U.S. dollar’s gain. Investors, traders, and speculators fleeing a sinking euro have bought dollars and dollar-denominated instruments such as Treasury bonds. That’s moved the yield on the 10-year Treasury bond, the one that many mortgage lenders use as their benchmark, down to 3.34% on May 18.
That’s a huge turn around. The yield on the 10-year Treasury had been on an inexorable march upward as financial markets prepared for the Federal Reserve to start increasing interest rates and as bond buyers demanded to be paid more to take on the risk of a falling dollar. From 3.14% on May 15, 2009 the yield climbed to 3.94% on April 9, 2010. Some days it flirted with the psychologically important 4% threshold. And then as the euro crisis hit, the yield on the Treasury plunged. In the bond market where daily changes in yield are normally measured by a few hundredths of a percentage point, the yield on a 10-year Treasury fell by 60 hundreds of a percentage point in a little more than a month. That’s a 15% decline in yield in a month. If we were talking about the Dow Jones Industrial Average, we’d be shaking our heads over a 1600 point drop in the index.
The U.S. Treasury market has seen bond buyers go from worried about interest rate increases as early as the fall of 2010 to a belief that the Federal Reserve won’t move until 2011. Bloomberg’s regular poll of economists showed that as of May 10 the median forecast called for a very modest 0.25 percentage point increase in interest rates to 0.5% by the end of 2010. That’s down from the April 29 median forecast of a 0.75% target rate by yearend.
Why the change? The thinking is that with the euro debt crisis causing growth in the Euro Zone economies to slow to 1% or less in 2010, the Federal Reserve will be extremely reluctant to slow U.S. growth with interest rate increases and risk stalling the U.S. economic recovery.
The reversal in interest rates has rippled out across the U.S. economy.
For example, mortgage rates have fallen almost as fast as Treasury yields. On May 18 the interest rate for 30-year fixed mortgages was 4.70%, down from 4.79% on May 11, according to Zillow Mortgage Marketplace. The last time the interest rate on a 30-year mortgage was this low was in December 2009.
Lower mortgage rates are, of course good for a U.S. housing industry that is still crawling off the bottom. Housing starts boomed in April, government numbers released on May 18 showed, with builders starting construction of 672,000 new homes, well above the consensus projection of 655,000 and the highest level since October 2008. Housing starts remain at an extremely low level and it’s premature to talk about a recovery but I think it is fair to say that the housing industry is showing signs of stabilization. And that’s good news, especially because economists feared that higher mortgage rates would send home sales and starts back down.
The reversal in the upward direction of interest rates and lowered expectations that the Federal Reserve will move on rates any time in 2010 have also turned income investors’ strategies inside out. While earlier in the year income investors were moving away from Treasuries because they thought bond prices were due for a decline as interest rates climbed, now Treasury bonds promise positive total returns for the year. Yields are still absolutely low but a 2% plus real yield (that is the yield of 3.34% minus the 1.1% annual rate of inflation as measured by the core Consumer Price Index) stands up pretty well against the volatility of the stock market right now.
And, of course, the euro debt crisis, with its guarantee of lower economic growth in the Euro Zone and lower demand for global commodities such as oil and copper, promises to put a damper on global inflation. In the United States that will be one more reason for the Federal Reserve to put off raising interest rates anytime in 2010. In the world’s emerging markets lower inflation is likely to mean a more rapid end to moves by governments and central banks that have sent stocks in those countries reeling. (For more on how this is playing out in China see my post https://jubakpicks.com/2010/05/11/chinas-stocks-enter-bear-market-territory-on-inflation-fears/ )
Higher commodity prices aren’t the only reason that inflation has picked up in China, Brazil, India and much of the rest of the developing world, of course. (In many of these countries, and in China in particular, there’s the little matter of a run away money supply.) And it will take months of lower than expected inflation numbers to convince central banks in emerging countries that they can relax sooner rather than later. But there’s a good chance that lower commodity prices will result in central banks that were planning on four interest rate increases stopping instead with three. I think this is especially likely in emerging economies with a strong commodity export sector. In those cases stagnant or falling commodity prices will cut into inflation at home as well as slow the economy as export growth moderates as a result of the euro debt crisis. Brazil is to my way of thinking the prime example of just such an economy. Indonesia would be another in that group. (For more on plans by the Banco Central do Brasil to raise interest rates see my post https://jubakpicks.com/2010/05/14/economic-growth-policies-to-fight-inflation-and-now-budget-cuts-in-an-election-year-from-brazil/ )
Right now the fear that the euro debt crisis will spread beyond the Euro Zone and that slower growth in Europe will derail the global recovery overshadows any more nuanced way of looking at the results of the crisis. When you’re worried that the world is coming to an end, you don’t stop to notice that spring has come early this year.
The euro debt crisis is indeed a major economic and financial crisis that will play out across the world. But the complexity of the connections in the world economy, the way that on pieces pushes on another so that a third goes up while the first rocks down, pretty much guarantees that bad news is almost never uniformly bad news in every market and for every consumer and investor.
Toward the end of what is shaping up as a very rough 2010 I think investors will have gained enough perspective—which is just a fancy way to say that the fear will have receded a bit—to start to bid up stocks in emerging markets as interest rate increases and inflation fighting policies end shorter than expected runs.
The stock market rallies that will result will be based largely on the strength of these emerging economies. But today’s euro crisis will play a part—if only to the degree of speeding up a return to accelerating growth in the developing world.
bsdvg…
When you said “look at the volume” before buying, does that mean look at the number of shares outstanding for a particular stock??
“Look at the volume. You want high volume in uptrend.”
victorjet – i’m still researching the best ways to invest in emerging markets in this environment, but I do have an eye out for agriculture related companies in particular. I noticed that DBA, an agricultural commodity ETF I hold a little of went up ~1% this past week in which the Dow dropped 4+% or so and other commodities and commodity stocks were trashed. I think it’s possible ag commods may be forming a bottom, and some of the related companies may do well, even in a tougher market environment. Also, I don’t believe in just investing for a melt down scenario. Truly, no one knows how things will evolve from here. Being diversified, long/short (near market neutral) and using similar strategies leave open the possibility of staying safe and doing well, even if the world doesn’t melt any time soon.
kelvinator – a few more specifics would be appreciated about which emerging markets or companies you see surviving the coming global melt down???
Also, I am looking at adding to emerging markets positions now, too. Being overly bearish and “safe” has its own substantial risks when cash, bonds and most traditionally safe investments are being manufactured at a breakneck pace. I’ve heard of a local guy who keeps $1 million in gold in a safe in his basement, but that seems kind of risky, too 😉
Jim, I agree entirely that often the difference between being bullish and bearish is a matter of time frame. Bears have a habit of being surprised that the world holds together and prospers way longer than they’d thought possible, while bulls are surprised when the dire future arrives next week instead of next decade.
Along with you, I’m hoping that the surprises are on the upside, I just think it’s going to be a very tricky investment environment to get right going forward, just like the last three years. Who’d a thunk that major investment houses almost would go bankrupt – Morgan Stanley, where I used to work, Goldman, and the rest? I think as confidence in governments capabilities and guarantees continue to wane and quality of life gradually declines for a so many people, the added stress in a complex system makes the economic and political events affecting markets very hard to predict, just as we’re seeing now.
This about America’s very own “lost decade.”
http://www.nytimes.com/2010/05/21/opinion/21krugman.html?partner=rssnyt&emc=rss
This is not a correction due to overextended rally or euro crisis or China bubble. This is about the economy slowing down, leading most probably to contraction.
http://pragcap.com/ecri-economy-continues-to-slow-2
Kelvinator, sometimes the difference betweeb bullish and bearish is actually a difference in time frames. I think you will be able to make money in emerging markets over the next 12 to 18 months. I think the long term picture for the global economy is pretty dire–if we’re talking 10 years or more. Wait for my post on Tuesday morning on why we’re likely to see the Greek crisis replay over and over again over the next two decades. I gave a talk in Orlando in February entitled Honey we bankrupted the kids. Had ’em rolling in the aisles. But I am by nature an optimist. I did say that compared to the poor Roman citizen living in Spain in 400 AD who didn’t have the foggiest idea that he was about to be conquered by Vandals and then enter a period so grim they are called the Dark Ages–in comparison to that guy, hey, we don’t have it so bad.
On MXWL and TC the updates are in the works. I always get jammed up during earnings season and like the butcher who backed into the fan, I get a little behind in my work.
yx, thank you. some people on here need to realize that just b/c a stock has broken down, does not necessarily mean the company/business has done the same. If the reasons Jim reccomended the stock have not changed, you’re not going to hear any updates no matter how many times you ask!
For those who repeatedly bugging on Jim to updates on TC and MXWL:
If Jim is not saying anything, he probably does not have anything to say! As I said before ,take Jim’s recommendations as advice and make your own minds. I sold TC and MXWL long time ago. I made decent profit on MXWL and even on TC.
bsdgv
Agree. I “work” on my buy list, but does not mean I “buy” those on the list. In fact I said today and Wed. that I wanted to see “stability” before buying. However I do have couple of very low buy orders pending.
Those tc and maxwell updates have to be the most anticipated posts
Folks, look for the Euro to bounce, as it has started, to the $1.27 level before returning to its inexorable decline (to $1.11 or, IMO to $0.89).
Caution on those desiring to buy commodities-related stocks — global demand is weak, governments, like Australia, desire to tax the miners/producers, and global growth is overestimated. These factors argue strongly against buying shares of mining/materials campanies for awhile.
bsdgv – great advice – before “bottom-fishing” buying, let a security rise for a day or two; you’ll leave a percent or two on the table, but you’ll have more likelihood that a reversal (an uptrend) may be in place.
Jim-
As always, I greatly appreciate your insights and enjoy your writing.
It’s always interesting that people with an overarching bullish orientation like yourself and people like me with an overarching bearish orientation tend to find facts and theories to support our intuitive approach. My over-arching view is that we’re way beyond having enough real productivity globally to service the exploding debt in developed countries, and enough cheap resources vs global income to support mass consumption that keeps the game going – particularly while likely heading into the jaws of an energy squeeze in the next two years. The stock investments we’re talking about are tiny things, floated by a huge Bernie Madoff scheme held together by our fine financial institutions in league with global governments. If you knew you were invested with Mr. Madoff, when would you want to pull your investments? Debt has gone exponential, and unlike the 1980’s latin debt crisis, I personally doubt it can be smoothly “managed”. It’s just a matter of very unpredictable time until some event in a very complex system triggers a rapidly growing realization that return of principal in real value is just not going to happen for many investments. In 2008, we saw that markets aren’t self correcting, but required paternalistic government intervention with ultimately false guarantees to limp along. The phase in which the confidence in the con game of government intervention disappears, which has now started regarding Europe, won’t ultimately end in a pretty way, in my opinion. The timing of what happens between now and then may be extended, but is so risky and so tough to predict, I think, that it affects prudent allocation of life savings now. Personally, I was looking for a bounce today, and will keep “de-risking” if the market moves higher. The nuances and complexities that provide encouragement to you are the same ones that worry me.
suntzu1079,
LOL.Same here. My friends have started to make fun of my investing skills. They’d say if anyone shorts the things I buy, they’d make a ton of money.
Like many other unfortunate folks, I bought TC when it was trading at close to $13. Early this week, I double shorted all mining stocks and kind of offset my losses since then (though I’d lost more than 25%). For some reason, I felt uncomfortable and sold the short yesterday. TC is going up today, if I was still holding the double short, I’d be under the rocks now as it’s 8% down for the day.
At least glad MRVL has jumped up!
For those who think of buying into weakness…
I would wait for signs of stabilization and even strength on the upside. How? Look at the volume. You want high volume in uptrend. You will leave some money on the table but you will definitely increase your chance of success. This advice is kind of directed to CallOfDutyFan. All the great books in your list are from fundamentalists. I would put some weight (not necessarily a lot) in technical analysis. In an atmosphere like the current one, the following book would come handy:
http://www.amazon.com/How-Make-Money-Stocks-Winning/dp/0071373616
Jim:
Thanks for this very timely and calm post. I saw it earlier on MSN. I know some people would accuse me of “cheering” again. When I saw the 5% GDP exposure to Euro zone, I felt the traders are insane. Yes, how could I not call them insane when I saw report of them “just want to get out, no matter what”.
All:
Remember several comments that I made last night and this morning before market opened. Remember the lessens from history. (1) Stock market will FLUCTUATE. (2) We went through much worse time and it all came back. (3) Do not sell at the bottom!
I am so glad that I was working on my buy list instead of selling at the bottom. This morning when I saw futures is down, I decided to go to exercise and let the market drop! Boy, what a start. It’s all GREEN!
I pulled the trigger on WHR today. You’re gonna have to be relatively risk-tolerant to make money in this market. I would still leave a little powder dry as Jim says though…
@EdMcGon (from your comment on the previous article)
“For those of you willing to think outside the box, there will be opportunities. Learn your market options. Learn ETF’s. Learn commodities. Learn shorting. Do NOT just restrict yourself to long positions on company equities.”
Ed – All I do is go long common stock. What books do you recommend for learning about options, ETFs, commodities and shorting? Any online message boards?
I have read the following books:
“The Intelligent Investor” (Graham)
“Learn to Earn” (Lynch)
“One up on Wall Street” (Lynch)
I have the following on my to-do list:
“Common stocks, uncommon profits” (Fisher)
“Winning on Wall Street” (Zweig)
“Securities Analysis” (Graham/Dodd)
Any recommendations would be appreciated.
i am pulling the trigger on BRF, POT, PALL, INTC, and PBR today.
So wait 5 days for the inevitable 20% drop that follows all of my purchases, and you should be good to go 🙂
To all,
I had 38 as a target for BRF. Now we’ve broken below that and I’m getting some cold feet. Anyone else pulling the trigger here?
Thanks for any insight!