Euro zone officials announced a debt deal yesterday requiring insurers and private banks to accept a 50% loss on current Greek bonds. They also committed to throw another one trillion Euros at recapitalizing the insolvent banking system in Europe, which is about half of what has been conservatively estimated is required to keep the system afloat. In essence, Greece has defaulted on their debt, but in order to try to prevent a massive unwinding of unsecured Credit Default Swaps or CDS’s they are calling it a “haircut”. Italy is most likely next and these bailouts only serve to reinforce the behavior that created the mess in the first place.
The markets, of course, are soaring today as a result.
These actions are nothing more than mafia tactics that put a gun to the head of bankers in Europe and tell them that they can have either their signature on the agreement or their life. What is important to note is the entire details of this scheme have yet to be agreed upon or even worked out, and at the end of the day, will not prevent an eventual cascade of solvency crises yet to come.
Since the collapse of Bear Sterns in February of 2008, the stock and bond markets worldwide have been taken over by governments and central banks. These actions have made it extremely difficult to navigate as portfolio managers, because like today, the interventionist policies of these entities have continued to reflate already overvalued stocks, and kick an even bigger can down the road.
The US stock markets have risen almost 10% since October 3rd, as of yesterday, and our analysis of the short term trends indicates we will most likely give back a large amount of this rally in the ensuing days or weeks. We have raised some cash by liquidating our clients’ small cap positions, however, our research indicates that after a short term pull back we may see a rally into the year end, so we may increase US stock positions again soon. The S&P 500, as of yesterday, is up .38% year to date.
The 3rd quarter GDP preliminary numbers were basically in line with expectations but still well below the levels required to produce any meaningful growth of jobs. US corporations are lowering their 2012 earnings guidance, and our long term forecast shows that we are still in a secular bear market. We believe it is highly likely the stock market will give back most if not all of the returns we have seen since the March 2009 lows. Our analysis indicates the intervention measures that central banks and governments are engaging in will only exacerbate the eventual day of reckoning.
The past decade has shown unprecedented volatility in the US and foreign stock markets. Hindsight at this point in time would lead one to believe that “hanging in there” might have been the best course. However, the emotions involved and the effects of seeing ones portfolio decline 20, 30, 40, or 50% may have certainly caused many to get out and never recover. We have seen the evidence of the effects of volatility on decision making over the past ten years as the vast majority of new clients we are now seeing have made little or no money over that time period. Our research continues to indicate that it is wise to maintain a low level of volatility, while continuing to pursue upwardly sloping returns.
John L. Brotherton, CFP®