Monday, July 11, 2011

Ramblings of a Portfolio Manager

Here We Go Again?

We awoke early this morning to find futures for markets around the world, including our own, sharply lower, while many Asian markets had already closed deeply in the red. The cause: a trifecta of yet another Southern European debt-laden country nearing a crisis—in this case Italy, the apparent breakdown in debt reduction talks between Obama and the US Congress over the weekend, and, most likely, some carry over from the poor jobs report in the US on Friday. US bond yields, which were heading higher after the strong PMI numbers we received here last week, are back below 3% for the 10-year Treasuries. In short, just about everything that made the markets rally off their bottom in late June—the resolution of the crisis in Greek debt, optimism over a debt deal in the US and a promising ADP jobs report, seem to have been undone since last Friday morning. This, of course, begs the question, are we going right back to our June lows this time quicker than the sickening 6 week slide that got us there? We don’t think so.

Let’s look rationally at each piece of news, one at a time. First, as for Italy, this is no Greece. Yes, it is a much larger market but it is also much different in its behavior toward austerity. We note that the Italians have already put in place some severe austerity programs voluntarily and have already taken steps to reduce their sovereign debt. The IMF has already agreed to backstop Italy and there will be no anxiety-riddled days of waiting on a vote from the Italian Government on a vote to accept the aid and the conditions that go with it. In addition, the situation in Italy is not new news but that doesn’t seem to matter these days. Any weakness on the “Italian Affair” will most likely be a buying opportunity.

As for the spending and debt reduction talks here at home, it did indeed look like Obama had struck a promising $4trillion deal with Congress last week and the markets liked that. Over the weekend, however, old biases crept back in from each side with the republicans backing away over tax hikes for the “wealthy” and our good friend Nancy Pelosi backtracking on any kind of cuts in entitlements. Both of these items were part of each side’s give and take that would have made a $4trillion deal work. Obama has yet to give up on his ambition plan, as it would have been somewhat of an election-enhancing coupe for him, however it looks more likely that a plan with cuts have the size will be what we get. In any case, both sides have made noise about contingency plans on raising the debt ceiling so that should not be a concern, even if they do bring it down to the wire. Furthermore, sad as it may be, a $2trillion deal would actually be better for the US economy as it would include smaller tax and spending cuts. Yes, it does kick the can further down the road but it would be a good start and one that hopefully keeps rates at home and the value of the dollar low, both of which will only continue to benefit the US economy.

Finally, we can’t discount the lousy jobs report we got Friday morning. There was little in that report that was encouraging for employment prospects in the US. We do note, however, that the Monster Employment Index, released the same day, was +3.5%, its best showing since early 2008, prior to the financial crises. Unlike the Government’s data, which is backward looking, this index is real-time data from employers regarding their intent to take on more employees. The ADP report, which is being ridiculed of late do to its apparent “inaccuracy”, is also real-time from a broad swath of employers. In many ways, it is more up to date and accurate than the government’s data. Remember, if the economists are correct about the idea of a temporary slowdown thanks to Japan and oil, that fact would have been captured in the June data, which it apparently was. In sum, we believe the July employment data will be much better, but we will have to wait for that to see. One thing is for sure, with such weak data, there is now more pressure on the Fed to implement a QE3 style program. Look for a softening tone from some of the Fed governors and certainly no talk of liquidity withdrawal for the conceivable future.

So, should we be concerned or is this a buying opportunity. Ultimately, we believe all three issues will be resolved or seen for what they are—temporary—but despite the recent rally the markets are nervous so we may see some weakness over the next few days. The key will be what companies say during their conference calls. So far, the few that have reported have “beat and raised” meaning they see the current slowdown as temporary. Bellwether Alcoa reports tonight and that may well set the tone for what we hear going forward. With its costs falling and prices for its products rising, we think that report will be good and, perhaps, just what this nervous market needs to hear.

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