The price-to-peak earnings multiple rose to 12.1x as of last week’s close. U.S. equities reversed four weeks of declines in last week’s trading as earnings continue to come in better than Wall Street’s expectations. European sovereign debt issues, which have weighed heavily on the minds of investors, abated somewhat last week as the European Union announced a willingness to rescue Greece from default. Although this should avert immediate disaster in Greece, more debt problems loom in Portugal, Ireland, and Spain. Without significant fundamental economic improvement and a willingness to dramatically curtail debt-financed spending, the other PIGS (Portugal, Ireland, Greece and Spain) countries will come “hat in hand” for loan guarantees and bailouts soon; how can the stronger EU nations not rescue them after doing so for Greece?
Like all too many modern societies, the PIGS economies are excessively leveraged. However, unlike most sovereign nations, since they are all part of a common European currency, they lack the ability to devalue their currency verses others, which is a common mechanism to deleverage in such a dire circumstance. Individual countries within the EU have no access to fiscal policy tools that nations in such a dire situation typically use to combat such problems. For example, historically, nations that reach this desperate situation normally lower interest rates and devalue their currency in an effort to export their way to growth. However, using a common currency, these nations can only lobby for looser monetary policies. The relatively-healthier and more influential economies of the EU (Germany for example) oppose such actions and actually are pushing for tighter fiscal policies. This intractable conflict calls into question the sustainability of the Euro concept, whereby economies with very different fiscal needs are bound by a single currency. It worked relatively well during robust economic times, but the challenges that lie ahead may prove its undoing.
The percentage of NYSE stocks selling above their 30-week moving average has rebounded to about 59%. This level of sentiment is neither a bullish nor bearish indicator. Based on recent market action, it is clear that investors are concerned about the rate of recovery. We continue to believe that U.S. equities have priced-in a robust recovery despite the ongoing deleveraging cycle and continued weakness in labor and real estate markets. No one…
knows how strong this recovery will prove to be, but we remain concerned about the risk to stock valuations of a slower-than-expected rebound.
Currently, the greatest economic uncertainties come from abroad rather than the U.S., which is a reversal from the initial stages of the Great Recession. The Euro has a tough road ahead, and new reports out of China suggest that its recent exuberant growth is unsustainable. The Chinese central bank is raising reserve requirements in an attempt to restrain growth following 10% GDP growth in the last quarter. The Chinese recovery began before the rest of the world, and any weakness in China could presage a slow down in other parts of the world. Over the last three months, Chinese stocks have fallen more than 10%.
Following the market’s recent correction and in combination with improving corporate earnings, we no longer see the U.S. equity market as overvalued. Furthermore, sentiment has recently cooled to a much more moderate level, which was needed since it remained quite bullish for the better part of a year. Now, the more pressing concerns for investors are overseas. While Greece has been offered a lifeline, it is unclear what demands will be made of the Greeks regarding fiscal austerity and how that issue will play out in the months ahead. In this week’s Thoughts from the Frontline Weekly Newsletter John Mauldin talks about the unenviable position in which the Greek’s now find themselves.
Between Dire and Disastrous
While German Chancellor Merkel has indicated a willingness to help, the German finance minister and other politicians are suggesting German cooperation will either not be forthcoming or only be there at a very high price; and the price is a severe round of “austerity measures,” otherwise known as budget cuts. Greece is being told that it must cut its budget to an 8.7% deficit this year and down to 3% within three years.
For my American readers, let’s put that into perspective. That is the equivalent of a $560-billion-dollar US budget cut this year and another such cut next year. That would mean huge cuts in entitlements, Social Security, defense, education, wages, subsidies, and on and on. And repealing the Bush tax cuts? That would just be for starters. No “let’s freeze the budget” and try and grow our way out of it, as we effectively did in the ’90s, or gradually cutting the budget a few hundred billion a year while raising taxes. That combination of tax increases and budget cuts would guarantee a US recession. Unemployment, already high, would climb higher.
And yet, that is what the Greek government is being asked to do as the price for a bailout. — John Mauldin 2/12/2010
