Financial Review

Unsustainable

Financial Review by Sinclair Noe

DOW + 93 = 17,776
SPX + 12 = 2081
NAS + 5 = 4997
10 YR YLD – .05 = 2.23%
OIL + .14 = 52.67
GOLD – 15.50 = 1155.30
SILV – .70 = 15.15

 

These are interesting times. There is the situation in Greece; the Chinese equity markets are suffering a bit of a meltdown; Puerto Rico has fallen into a black hole of debt; negotiations are underway with Iran; and the cherry on top – earnings season starts tomorrow. Traders might be forgiven if they were a feeling a little jittery. This morning the stock market headed into triple digit negative territory, (the Dow was down 200 points earlier) only to get an afternoon jolt of good news; namely, there may be a deal to be had with Greece. So, let’s dig in there.

 

Greek Prime Minister Alexis Tsipras is in Brussels for an emergency Eurozone summit. Over the weekend, Greeks overwhelmingly voted to reject more austerity. Actually, they voted on a debt proposal that is no longer under consideration, but figuratively they voted against austerity. Greek banks remain closed and ATMs are reportedly running out of cash. The European Central Bank has maintained its emergency loan cap for Greek banks. German Chancellor Angela Merkel said there was no basis for reopening negotiations with Athens. European leaders have all made clear the onus is on Greece to explain how it plans to pull itself out of the crisis.

 

Before the meeting, President Obama got involved; making phone calls to Merkel and Tsipras. At the meeting, Greece proposed a settlement until the end of the month; an intermediate stop-gap measure, with promises of a more substantive proposal to follow tomorrow. And the longer this drags out, the optics of soup kitchens upon soup kitchens paints an ugly picture of modern day Europe. And Sunday’s “no” vote is already resonating with several other Euro countries, especially the southern tier of nations. And the “no” vote was also a figurative vote to default on Greece’s debt to the IMF, and a defeat for Germany’s Angela Merkel and the Troika of creditors she led that insisted and continue to insists that there is no way out for Greece but to pay back its debt. The “no” vote was also a victory for democracy. We should have greater trust in the democratic process.

 

Most of the news stories about Greece harp on the idea that the Greeks are lazy and irresponsible; they borrowed money unwisely, they spent too much on pensions and other government giveaways, they didn’t pay taxes, and now they don’t want to pay their debts. The reality is that the effective tax rate to GDP in Greece (even after the tax evasions) was higher than ours. Their work week is higher than ours and Germany. And much of the country’s tax-collection problems stem from the fact that there are two and a half times more self-employed and small-business people in Greece than there are in the average country. And small businesses are expert at avoiding tax. If Greece were more like Germany, with big corporations and unionized workforce, in other words if they were more socialists, then tax collection would be much higher in Greece. And about irresponsibility, remember the banks decided to lend three hundred billion to Greece despite knowing all these facts (corruption, tax evasion). So who was more irresponsible, the banks or the Greeks?

 

Debt carries risk; risk for the borrower and risk for the lender. That is why borrowers pay interest on debt to the lender. The lender does not get a guarantee; they could lose their money; that’s how free markets work. And if the borrower does not or cannot repay, the lender does not enslave the borrower. We now have bankruptcy laws that allow a borrower to get out from under unsustainable debt and get a chance at a fresh start.

 

When it comes to loans, it takes two to tango. One party lends and the other one borrows. Both sides take risks and both sides receive benefits. It is incumbent on the lender to assess the risks and set interest rates at appropriate levels to compensate for taking the risk. If the lenders are not well-prepared they can lose. That is how a free market is supposed to work.

 

Greece’s lenders were not well prepared, and that was their failure. The loans were originally made by private investment banks, such as Goldman Sachs. And when they were staring in the face of losses, the banks managed to unload their bad debts onto the Eurozone governments, who were not well prepared. Germany and its allies should have left the debt in private hands where it belonged, but the politicians have a tendency to kowtow to the bankers, and that was their failure. The IMF’s own assessment of Greek debt, published just a few days ago, states: “Coming on top of the very high existing debt, these new financing needs render the debt dynamics unsustainable.” Germany’s own bankers knew Greece couldn’t pay this back. And yet Merkel persisted, demanding a pound of flesh in lieu of cash.

 

The IMF analysis also suggested the Europeans would have to accept a principal writedown. As a member of the so-called troika of creditors that included the European Commission and European Central Bank, the fund’s hands were tied from the start, and the analysis was little more than an admission of the inevitable; the bloodletting failed to cure the patient. An internal review in 2013 concluded that the IMF should have pushed earlier for a restructuring of Greece’s debt, which would have eased austerity and limited the economy’s contraction. As it turned out, Greece plunged into a much deeper recession than anticipated, with unemployment surging to about 25 percent. So, it wasn’t surprising that the Greeks voted against more of the same.

 

The Greek situation still is a long way from being resolved, but if Greece gets kicked out of the Euro, it wouldn’t be the worst thing that could happen.

 

 

Wiping out much of yesterday’s rebound, Chinese shares fell yet again today, casting doubt on the slew of recent support measures unleashed by Beijing. Traders are also getting increasingly nervous about the unusually large number of Chinese companies asking for their shares to be suspended. About a quarter of the roughly 2,800 companies listed in Shanghai and Shenzhen filed for a trading halt by the close on Monday, and another 200 announced a suspension today. In the face of a big sell-off, the Chinese answer is to stop the trading, and the logical next step is to forbid talking about selling. Shanghai -1.3%; Shenzhen -5.8%; ChiNext-5.7%.

 

Iran and six major powers will keep negotiating past today’s deadline for a long-term nuclear agreement as they try to tackle the most contentious issues, including the continuation of a UN arms embargo on Iran. The spokeswoman for the US delegation said the terms of an interim deal between Iran and the six would be extended through Friday to give negotiators a few more days to finish their work. The negotiations have been impacting the price of oil. Yesterday, US crude oil futures dropped by 7.7%, or $4.40, to close at $52.53, almost rivaling the price decline in the aftermath of OPEC’s decision to not intervene in oil markets last year.

 

Lawyers for Puerto Rico have asked the U.S. Court of Appeals in Boston to reinstate a law to help it deal with $72 billion in debt. The court resisted, agreeing instead with a San Juan judge who threw out the statute in February. The dispute centers on whether the island, which is excluded from federal bankruptcy code regarding municipal entities, can make its own rules for allowing public agencies to seek protection from creditors. In a majority decision, the appeals court wrote: “In denying Puerto Rico the power to choose federal Chapter 9 relief, Congress has retained for itself the authority to decide which solution best navigates the gauntlet in Puerto Rico’s case.” Barring help from federal lawmakers, the decision means Puerto Rico will have no other choice except to continue piecemeal negotiations with creditors.

 

We have a couple of economic reports today:

Corelogic reports home prices increased 1.7% in May, while year-over-year growth rose to 6.3%, the fastest annual pace since last July. CoreLogic expects home prices to slow to annual growth of 5.1% by May 2016.

 

The US trade deficit widened in May as exports declined by the most in three months, showing businesses were having trouble drumming up sales to overseas customers. The gap grew 2.9 percent to $41.9 billion from the prior month’s revised $40.7 billion. Domestic crude production reduced America’s imported fuel bill, which dropped in May to the lowest level since February 2002. While persistent US household spending led to record automobile imports.

 

Job openings at U.S. workplaces rose to a record high of 5.36 million in May. Compared with same period in the prior year, May’s job openings rose 16%.  With 8.67 million unemployed people in May, there were about 1.6 potential job seekers per opening, matching April’s ratio. In May 2014, there were about 2.1 potential seekers per opening.

 

Alcoa kicks off the second quarter earnings reporting season tomorrow after the closing bell. A recent report from FactSet examines expectations for second quarter earnings as reporting season approaches. According to the report, year-over-year earnings and revenue for the S&P 500 are expected to decline by 4.5% for the second quarter of 2015. If that happens, it will mark the largest year-over-year decline in earnings since the second quarter of 2009. The last time the index reported a year-over-year decrease in earnings was a 1.0% dip in the third quarter of 2012. Companies that generate more than 50% of sales inside the United States are anticipated to have an earnings growth rate of 0.3%. Companies that generate the majority of their sales abroad, however, have an estimated earnings decline of 11.4%.

 

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