Friday, July 1, 2011

Growth, not Greece, is fueling the market


On the margin, the news about Greece has been positive, with the government agreeing to austerity measures in order to receive financial assistance. But the market continues to believe that a default (or restructuring) is highly likely, as the above chart shows. Yields on 2-yr Greek government debt have declined marginally, but they are still high enough to equate to a high probability of a significant loss of principal. This can also be appreciated by looking at the price of credit default swaps on Greece, which as of yesterday traded at 2100 bps.


So while the Greek situation looks less dire, it still promises to be painful for many, and the fundamental problem (i.e., grossly inflated public sector spending) is far from being resolved.  Markets understand this. So the impetus to the rally in U.S. equities is likely mostly due to news which suggests the economy is pulling out of its recent slump. A resumption of stronger growth in the $15 trillion U.S. economy easily trumps whether or not Greek bond holders lose a few hundred billion.

12 comments:

septizoniom said...

its amazing how you view the market as understanding what is positive for purposes of your posts, and likewise fearful, irrational or ill informed for others. different markets, or different lenses?

John said...

The stock market rally follows Obama's decision to tap the Strategic Petroleum Reserve, which signaled, along with the IEA, nations are prepared to act to moderate speculative oil price hikes.

Brian said...

Would a looming default cause the equity markets to fade? It seems both sides of the aisle are digging in their heels. The markets seem to be shrugging it off, ie 10 yr sub 3.2%, US cds @ +/- 53 bps, SPDRs up $7 bucks over the last 5 days. W/o an agreement soon all markets seemed to destined to sell-off? Am i missing something?

Benjamin said...

Capital is cheap and abundant now. This is a long-term secular change from 40 years ago.

The problem is deploying the capital sensibly, and boosting demand.

Greece has to trim its public spending, and learn how to stop the tax cheats, which is evidently the national pastime.

Dr William J McKibbin said...

I disagree that "growth, not Greece, is fueling the market" -- I would argue that inflation, not growth, is fueling the market -- everyone should stick with dividend and rent-paying equities and avoid bonds, at least until US Treasuries reach 10-12% (or higher) -- here we go...

John said...

Commodities were down for Q2.

http://www.investors.com/NewsAndAnalysis/Article/576957/201106301807/Big-Drops-In-Q2-CRB-Slides-6-Wheat-Falls-23.htm

Commodities down, stocks up.

Market activity seems largely determined by where the nervous class decides to put their money.

Benjamin said...

Dr. William: I have heard this scare-mongering about inflation now for several years. Occasionally I even get more hopes up that we will have inflation, and not deflation.

When do we get it? Will the inflation carry over to real estate? Why does no one in real estate anticipate inflation?

Dr William J McKibbin said...

Benjamin, patience is the discipline of investing -- the great inflation is coming -- the most significant inflation the world has ever experienced -- that's not fear-mongering -- it's reality all around us -- thanks for your comment...

Benjamin said...

Dr-

Some say the Fed should have been more aggressive. I agree (and I agree with Scott Grannis we need to cut back federal outlays).

Neil Irwin of the Washington Post wrote just last week about how the Swedish economy is doing so much better that the U.S. economy and attributed part of that success to a more aggressive monetary policy there. Here is Irwin:
The Federal Reserve has won both plaudits and criticism for responding aggressively to the financial crisis, pumping money into the financial system in epic fashion. But by one key measure, the Swedish central bank was even more aggressive.
Like the Fed, the Riksbank lowered its target short-term interest rate nearly to zero. But it also expanded the size of its balance sheet more than the Fed did relative to the size of its economy, flooding the financial system with even more cash during the height of the crisis.
In summer 2009, the Riksbank had assets on its balance sheet equivalent to more than 25 percent of the nation’s gross domestic product. For the Fed, that level never got much over 15 percent.


the above quote is from David Beckworth, a conservative economist, but a monetary activist.

John said...

Dr.

When can we expect the great inflation tsunami to arrive?

Frozen in the North said...

Scott:

Sorry to rain on your parade but the Greek problem is much more severe than what you posit, in fact yes the public sector employee have gotten an amazing ride, but "capitalists" don't even pay taxes in that country. Imagine there are less then 5,000 people that declare a revenue of more than Euro 100,000.

Employing "American" analogy only take you so far. I have good friends who live in Athens and pay virtually no tax, they do earn serious money, but have negotiated a payment to the tax collector to "reduce their stated income". Last time we spoke they have a stated income of E70,000. A big ass house in one of Athene's more expensive neighborhoods, a weekend getaway in the islands. A a number of cars. And two Children in Swiss schools -- if memory serves the tuition is slightly more than their income.

Greece's problem is bankruptcy, nothing short of massive write-down of the debt is required here. so far the French an German banks are playing a game of "kick the can down the road" and get the ECB to bail their asses out!

They take the view that eventually they will have to pay some taxes. In the mean time, they have closed all Greek bank accounts, converted their assets in cash / marketable securities and have stashed these "outside of the EU".

TradingStrategyLetter - Weekly Summary said...

Swap spreads on Italy rising. If it wobbles then look out!