The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Good Evening: U.S. stocks continued their recent advance today, and the benchmark S&P 500 has now posted positive closes in eight of the previous nine trading sessions. Though the rally is most likely attributable to price momentum and rising risk appetites, more than a few will credit today’s levitation in share prices to statements made this morning by former European Commission president, Romano Prodi. “‘For Greece, the problem is completely over,’ said Prodi, who was also Italian prime minister, in an interview in Shanghai today. ‘I don’t see any other case now in Europe’.” (source: Bloomberg article below). Over? And not just for Greece, but for all EU nations?

Mr. Prodi may turn out to be right some day, but Greece has yet to roll over huge slugs of debt, and neither the EU nor the IMF has yet wired Athens a single euro. This drama may recede from the headlines for a while, but it is far from over. Mr. Prodi sounds like a police officer trying to clear a crowd away as they gawk at a burning building. “Move along, folks, there’s nothing to see now. The Fire Department is here”. If the less encumbered EU nations (France, Germany, etc.) can be thought of as the Fire Department in this comparison, then to me it looks like they are standing around and arguing about which fire hydrants to hook up first. Maybe the financial fire threatening Greece will burn itself out via self-imposed fiscal responsibility, but maybe not. The EU hoses may be trained on Greece right now, but not a drop of liquidity has reached the flames.

Another story that captured the attention of market participants today was the notable rebound in both Chinese imports and exports (see below). If this report sounds like good news for the global economy, it is. But some investors worry that China’s success will lead to further monetary policy tightening by Beijing. The potential for further measures to rein in growth in China will receive more attention tonight when that nation’s latest CPI report hits the tape. Whether these concerns over stimulus withdrawal played a role in today’s decline in the precious metals, I have no idea. Then again, if Romano Prodi’s optimism about the fiscal condition of various EU members is indeed justified, how could the latest quote for gold be anywhere near $1100/oz?

Stocks opened marginally higher but the major averages were soon up 0.5%. The Dow and S&P then dipped back toward unchanged, but the Russell 2000 and NASDAQ curiously remained aloft. The Dow never did muster much of comeback, but the other indexes rallied to close at nearly their best levels of the session. The gains, ranging from the Dow’s +0.03% to the Russell’s +0.8%, actually masked the considerable strength in certain important sectors. The semiconductor, bank, and biotech indexes galloped ahead by +2%, +2%, and +5% respectively. Treasurys were down as yields rose a modest 2 to 5 bps across the coupon curve. Today’s ten year note auction was particularly well received, with the sale benefiting from what some reports claimed to be a record high bid-to-cover ratio. The dollar seemed not to notice much of anything today and slid 0.2%. And, despite the damage visited upon the precious metals, the CRB index itself was only fractionally lower on Wednesday.

It wasn’t so many years ago that a U.S. budget deficit of $221 billion brought with it howls of concern over the sustainability of so much red ink and the damage it would some day bring to our children and grandchildren. Today our government announced that we reached this negative milestone in a single month (see below). February’s deficit figures are a record high for any month in our nation’s history, a fact which is even more depressing when one considers it came during the shortest month on the calendar. With apologies to Will Rogers, our Congress seems to have never have met a deficit it didn’t like. In fact, there are far too few on either side of the aisle that think budget deficits even matter.

They do matter. The most poignant and articulate explanation about why they do so can be found under the heading entitled “Risk Factors” in the latest issue of Grant’s Interest Rate Observer. Jim turned his entire issue into a would-be prospectus for an upcoming 30 year bond auction. It is a must read for all investors, not just those who like to clip coupons.

As for why deficits don’t seem to matter right now but will at some point in the fairly near future, consider the latest views of PIMCO’s Mohamed El-Erian. The PIMCO CEO presents an excellent case in today’s Financial Times, but rather than put my words in his mouth, the final paragraph of his Opinion piece will do nicely:

“Our sense is that the importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood. Yet, with time, it will prove to be highly consequential. The sooner this is recognised, the greater the probability of being able to stay ahead of the disruptions rather than be hurt by them.” (source: FT article below)

Since I agree with Mr. El-Erian but would like to take his “not yet sufficiently appreciated and understood” notion a step further, I would like to offer a modest proposal for at least a partial solution. First, I propose that whenever the previous year’s budget deficit exceeds 3% of GDP, an immediate and across-the-board salary freeze be put in place for anyone on the federal payroll. Yes, no COLA adjustments for anyone, period. The only justifiable exception would be for military personnel serving in combat areas. Unlike bureaucrats, Congress-people, and even Presidents, soldiers earn their pay by risking far more than their incomes.

Second, I propose that whenever the previous year’s budget deficit exceeds 5% of GDP (as is currently the case), all federal workers receive a 5% pay cut and are frozen at that level until the deficit drops back below the 5% of GDP threshold (again, with an exception for combat personnel). I would double the cut to 10% for all Senators, Representatives, and yes, even the President. The resulting cries of anguish from inside the Beltway would be matched only by the “serves you right” murmurs outside it. What would also happen in short order is that our federal workforce would suddenly find unique and concrete ways to be more efficient and productive. The ideas for saving money in order to restore their compensation would flood corner offices and oval-shaped rooms all over official Washington. We could even propose bonuses for the best money-saving ideas, or even modest, across-the-board bonuses once the budget reaches surplus.

My ideas are unlikely to ever see a House committee room, let alone the Senate floor or the President’s desk. If they did, however, the incentive-driven behaviors they would unleash at the federal level might stun even the Tea Party crowd. What’s more, these concepts are scalable in reverse, since they apply equally well at the state and local levels of government. And if I’m wrong about the behavioral changes I envision, it won’t be a total loss. We’ll have saved the money on those frozen/shrunken salaries and reduced our budget deficit in the process — not to mention giving hundreds of thousands of federal employees a taste of how things work for those of us in the private sector. If we’re all in this together, and if shared sacrifice is the way out, then it is high time federal workers begin learning how to share.

– Jack McHugh

Stocks Climb as Treasuries, Yen Retreat on Economic Optimism
Greek Crisis Is Over, Rest of Region Safe, Prodi Says
China’s Exports, Property Prices Add Pressure to Pare Stimulus
Budget Deficit in U.S. Widens to Record $221 Billion
How to handle the sovereign debt explosion