Eye of the Hurricane
2012 June 18 - 8:13 ET
Well, that’s a relief. The worst possible outcome from Greece was avoided. Now, it is on to the next crisis. It could be Spain, Italy, France, or even Greece again. The European developments will occur against a backdrop of slowing global economic growth and sluggish earnings.
Well, that’s a relief. The worst possible outcome from Greece was avoided. Now, it is on to the next crisis. It could be Spain, Italy, France, or even Greece again. The European developments will occur against a backdrop of slowing global economic growth and sluggish earnings.
Reflections on the Greek Election
The market avoided a potentially severe negative event as a result of the Greek elections. It appears as if a coalition government will be formed that seeks to avoid Greece leaving the eurozone – at least for now.
The elimination of a negative, however, is not the same as a positive. Greece still has a long way to go before it is on the path to sustainable fiscal and economic conditions.
Greece must still:
- Establish a coalition government. The two parties expected to form a government have just 162 of the 300 seats in parliament. It will be fragile.
- Develop a credible fiscal plan that accommodates additional bailouts. The deficit is currently projected to run at 5% to 6% of GDP this year.
- Deal with an economy that is imploding. Real GDP has fallen about 15% total over the past four years. It is expected to decline 5% this year.
- Prevent capital outflows that were reportedly very high in recent weeks.
- Deal with the reality that a county can not pay pensions of 80% to retirees at 58 when fertility rates are just 1.52. Birth rates have been below replacement level (2.1) for three decades. The actuarial math is undeniable – it implies fiscal calamity.
None of this will be easy. The unemployment rate is 22%. The risk of civil unrest is high (and understandable). Life will be very hard in Greece for quite some time.
All that the election did was prevent an immediate crisis of the country leaving the euro-zone and precipitating a credit crisis throughout Europe.
All that the election did was prevent an immediate crisis of the country leaving the euro-zone and precipitating a credit crisis throughout Europe.
None of Greece’s underlying problems have been solved by the election. Any relief rally in the market will be short-lived.
Spain and Italy and France, Oh My!
Greece is just 3% of the eurozone economy. There are bigger concerns. Spain is over 13% of the eurozone economy. The problem in Spain is that a massive bubble in the housing market has burst, undermining the stability of the banking system.
The unemployment rate is 24% and the economy is dead in the water. The announced banking bailout in early June has yet to be finalized, and there are doubts it will do much more than prevent a crisis.
Spain has a massive government fiscal deficit and faces demographic problems similar to Greece. Spanish 10-year bond yields went over 7% this morning. Whether 6% or 7% is ultimately an unsustainable level is arguable, but the reality is that either compounds very quickly, particularly when the economy and government revenues are flat.
Spanish fiscal issues could quickly turn into a market crisis the next few weeks.
France also has major fiscal problems and appears to be in denial. The election on Sunday of a Socialist parliament in France means that needed reforms won’t even get a look. France will choose “growth” over “austerity” in that false dichotomy which simply allows the government to spend more money while not addressing the long-term structural problems that are causing deficits.
The Socialists have promised to hire more government workers and are not expected to increase the retirement age. Spending more money in the short-term may boost the Keynesian math of GDP, but spending money in ways which do not increase productivity won’t help make France more competitive long term.
Italy deserves respect in that its primary government deficit (excluding interest payments) is in surplus. Interest payments have to be made, however, and Italy’s economy is also stagnant with the same demographic problems plaguing Greece. Italy can not be ruled out as a potential crisis instigator in the months ahead.
Global Economic Growth
The potential for a credit contagion from Europe remains serious. Unfortunately, these concerns will persist in a worsening global economic environment.
The problems are well known. Growth in China is slowing, though the degree is hard to quantify. China's real GDP has grown over 8% per year since 2002, but is expected to grow “only” 7.0% to 7.5% in 2012. Second quarter growth is expected below 7.0% so a second half rebound is optimistically forecast to get total growth back above 7.0%.
European economic growth will be near zero this year, and could well be in recession. US second quarter growth is on track for about a 2% real annual rate. That follows an average of about 2.3% over the past four quarters. That is below long-term trends.
Sluggish economic growth around the world will make the task of fiscal reform extremely difficult for Europe. It will not be possible for countries to rely on revenue growth to pull them out of their downward fiscal spirals.
What It All Means
Last week’s column was about the Spanish bank bailout and how it only partly addresses the issues in that country.
This week’s column is about how the Greek election simply eliminates a downside risk for the market but offers no positive developments.
Next week’s column will be on the sluggish trend in US real GDP and second quarter earnings expectations (barring some major development from Europe). Unfortunately, earnings estimates have been coming down. The earnings outlook is not worrisome, but it isn't exciting either.
The litany of negative trends and risks isn’t about to stop just because it appears that Greece may form a coalition government that will attempt to stay in the eurozone.
US equities represent tremendous relative value. They are extremely cheap by almost any measure. At this time, however, the focus is correctly on the risk associated with equities rather than the potential long-term rewards. It may stay that way through the summer.
Long-term investing will prove worthwhile, but there are plenty of short-term problems to overcome first. The Greek elections this weekend simply present a lull before the next storm from Europe hits.
Founder and Chairman, Briefing.com
No comments:
Post a Comment