No (S)pain, no gain

A number of my recent writings have referenced statements from previous columns. This contribution will be no different and there is an altruistic reason why this is so. It is really for the benefit of those who do not read this space every week. The financial markets are continuous and interrelated, making it necessary to go back to an earlier period to create the context for the current scenario. Also, when forming an investment outlook it is important to reflect on how those views panned out and what was the initial thought process that gave rise to them. The process matters more than the result and my reference to earlier pronouncements is simply to outline the thought process at a time when the result may not be as obvious as it is now. Hopefully, readers can take this on board and be guided in their individual investment decisions in order to avoid buying at the top or selling at the bottom.

 

 

Creating history

To be honest, there are many factors that you need to look at and dots to connect. Two months ago at the end of the United States winter, there was a proliferation of tornadoes in the US Gulf region. Back then I sent out a tweet on Twitter (@iannarine) that said: “Warm weather in the US Gulf causing tornadoes today. Does that mean hurricanes in the Gulf of Mexico in the summer?” 

The hurricane season officially started last Friday. It is the first time since 1908 that there were two storms before the official start of the season, both in the northern part of the hurricane zone. This may impact oil and US gasoline prices if there are disruptions in the Gulf.

It is not just the weather that is creating history. The bond markets of the developed world are in similar mode. The ten-year US Treasury bond closed last Friday at 1.46 per cent. In case you are wondering, that means investors are prepared to lend money to the US government at 1.46 per cent for ten years. 

 

 

During the financial crisis of 2008, the ten-year bond yield went to two per cent. Last year on September 23,  it touched 1.67 per cent. June 1, it went to 1.44 per cent intraday. Referencing information put out by Bianco Research, these are the lowest yields since the end of World War II, but more than that it is the lowest yield since stocks first began trading on Wall Street in 1792. 

Sounds startling? Well there is more since there are ten countries as at June 1, 2012, that have yields on their ten-year bonds lower than the US. The ten-year yield in the United Kingdom is the lowest since the 16000s. Investors are currently prepared to lend to the German government for ten years at 1.16 per cent. In Japan, the rate is 0.81 per cent. Last week Switzerland had the distinction of the lowest ten-year sovereign bond yield ever recorded anywhere at 0.48 per cent.

 

 

Fear factor

Something is causing investors to be fearful and rush into safe haven bonds pushing down rates to the lowest history has ever seen. Bear in mind as well that these record low yields are coming at a time when countries such as the US, Japan, France and the UK have either been downgraded or are on negative watch for downgrade by the ratings agencies—a factor which should cause their rates to rise. Of course, if you limit your reading to the local economy, you would never know that there is fear and panic around the world. In T&T we have simply downgraded our growth forecast despite the fact that our economy has not grown for three years. Our business sector is “not surprised” with this downgrade. The Government is promising to spend more while trade unions are adamant in their demand for higher wages. Historic times for call historic solutions, yet it seems we are oblivious to where we stand in history. Of course, as with everything else, this to shall pass. The problem is that no one seems to be thinking about how we should be operating while this phase of the world’s economic and financial history is unfolding. I have said it many times before we are in a different era to the oil, gas and Point Lisas model of foreign direct investment but, clearly, no one is listening. We will, however, leave that discussion for another day. Low bond yields in traditional safe haven countries form one half of the story. The other is that ten-year bond yields in Greece is 30 per cent, Portugal 11.9, Ireland 7.5, Spain 6.5 and Italy 5.7. What is also notable is that the ten-year yield for France is 2.25 per cent, which represents a massive 1.084 per cent difference between France and German ten-year paper. 

 

 

Let’s review my writing on March 22nd 2012. This was when the US stock index, the S&P 500 was up 31 per cent over the prior 12 months. The importance of that period was that up to that time the S&P 500 had bounced up against the 1375 level and retreated many times. On this occasion, it breezed through this resistance point crossing into 1400 territory and eventually getting to 1419 on April 2. 

My headline of March 22, was: The Market’s Are Up. Now What. Here was the warning to temper the market optimism at the time. “Recognise that job growth is a lagging indicator….as it takes consumption to increase before job growth takes place and if the rate of consumption growth is decreasing, then it means be on the lookout for challenges up ahead.” Within two weeks of that warning the markets topped out and last week the US employment reports showed that the unemployment rate rose from 8.1 to 8.2 per cent, that payrolls increased by 69,000 versus expectations of 150,000 and payrolls for the previous two months were revised lower by 49,000.

From the heightened expectations, many on Wall Street did not appreciate the point I was making back in March. As at last Friday, the S&P 500 is back to 1278, right where it was at the start of the year. The point of the March 22 article is in the conclusion: It is my view that globally the business cycle has moved from a period where there were ten-year periods of growth and months of recession to shorter periods of growth and longer periods of recession. 

 

 

Spain curves

During the following week (March 29), just days before the market top the focus was shifted to Spain under the headline, Watch those Spanish Curves. Not withstanding the alluring headline, the warning was the problems in Spain are intractable and probably beyond the capability of the European Central Bank to solve. Appreciate that Spain is contributing a big part to the current market turmoil. 

I have warned about bank runs in Europe many times in the past as being the action that will create the tipping point for Europe. For reference, the information I have is that 100 billion euros was removed from the Spanish banking system in Q1 2012, which represents ten per cent of Spanish gross domestic product. In April and May, the situation accelerated with 31 billion euros and 66 billion leaving the country, respectively, in each month, the latter being the most since records began in 1990. The bottom line is Spain is a European economy too big to bail out and they have all but rejected austerity as an option. 

 

 

This flies in the face of the conditionality’s set by the European Union and the International Monetary Fund and the credibility of these agencies and the G7 central banks are now at stake. The pain in the financial markets will not go away until there is a solution to the Spanish story. Yet the problem is now bigger than Spain. Europe is in recession at a time when the structure of the Euro Zone is in balance. China, the market’s savior, has been contracting for almost a year. Growth in the US remains anemic at best. We are in the midst of a global economic slowdown, which requires coordinated action. Political pressures and the desire for self-preservation makes such coordination unlikely. We are at a stage where there is no region left to cushion the other. May be another temporary “solution” will provide respite, but increasingly it is the fear valuation rather than the fair valuation that is the focus of investors. 

 

 

 

Ian Narine is a broker registered with the Securities and Exchange Commission