Greece Now Faces a Funding Crisis
Good Evening: After being thoroughly drubbed on Tuesday, U.S. stocks managed a bit of a comeback on Wednesday. Today’s rally was accomplished in spite of an S&P downgrade of Spain’s sovereign credit rating, a move that came only 24 hours after Portugal was similarly nicked and Greece was downgraded to junk status. Not wanting to lose their short term focus on positive corporate earnings on this side of the Atlantic, U.S. investors decided to shrug off worries about further contagion in Europe. Apparently, market participants must still think highly of central banks — that the ECB will ride to the rescue in Europe and that the Fed will somehow protect U.S. portfolios from harm. Today’s FOMC meeting may have reinforced this trusting notion, but Greece has now entered what can only be described as a funding crisis. Credit Suisse wants to help by offering an ECB-centric solution for Greece and the other PIGS. Investors, however, would be well advised not to simply trust in the power of central banks to painlessly paper over recurring financial problems.
Equity markets around the world were under pressure overnight in response to the emerging funding crisis in Europe, but U.S. stock index futures enjoyed a green hue this morning nonetheless. Corporate earnings continued to come in on the high side of expectations, leading many analysts and strategists to defend the rationale for staying long in this tricky environment. One of the chief proponents of this “buy stocks” because “Greece doesn’t matter” was none other than Kenneth Fisher (see below). If you find yourself nodding in agreement with Mr. Fisher, please keep in mind that he was just as bullish during the entire 2007-2009 bear market. Perhaps because his firm has sent me some annoying spam over the years, I decided to go to Mr. Fisher’s website and view his past prognostications for Forbes (see below).
You will simply be amazed by what he wrote in 2007 and 2008, though in the interest of fairness I will also say he did call tech stocks a bubble in March of 2000 and correctly stayed defensive for the next two years. The real lesson here is for readers to seek out multiple sources of information before making their own decisions about the markets. The best sources (my favorites are Fleckenstein, Grant, Grantham, Ritholtz, and Rosenberg) for helping folks decipher what is happening now will be those who understood the consequences of the late credit bubble — while it was inflating.
U.S. stocks opened higher this morning before drifting back toward unchanged. Investors may have noted what was unfolding in Europe, but they were soon comforted when the FOMC meeting broke up this afternoon. Issuing a press release that looked like a carbon copy of each one put out this year, the Fed left market participants looking forward to cheap funding for at least the balance of 2010. The major averages edged higher into the bell, with the gains ranging from the modest (S&P +0.65%) to the miniscule (NASDAQ +0.01%). Treasurys were heavy, with the belly of the curve (5 to 7 years) sagging the most. Yields rose between 3 and 9 basis points. The U.S. dollar was mixed, and commodities rose in concert with stocks. Led by a $1/bbl. gain in crude oil, the CRB index rose 0.5% today.
When the yield on a nation’s 2 year note reaches double digits, that nation has a problem. When the yield on that same piece of paper breaches 20%, as it has for Greece since the S&P downgrade, that nation is staring down the barrel of a funding crisis. It’s not just Greece, either, since just about every sunny destination in Europe is under a debt cloud these days. And because OTC derivatives have yet to moved to exchanges, banks everywhere in Europe will face serious stress if Greece decides to default. The potential losses could easily exceed e200 billion, and there might even be a hedge fund or two that will be found floating in the Thames.
Given that what’s happening in Greece DOES matter in Europe and in quite a few other time zones, Credit Suisse has kindly offered up its version of a solution for the EU (see below). According to CS, the way out involves hefty amounts of debt monetizing by a central bank — in this case, the ECB. The CS piece is thoughtful and well reasoned, but only if the ultimate goal is to hold the EU and euro currency together in their current legal structure at all costs. Other solutions range from kicking Greece and other weak sisters out of the EU to seeing Germany withdraw and go it alone with a new deutsche mark. All avenues, whether they involve a shift in EU membership, money-printing, or some combination thereof, are problematic and will lead to further volatility in the markets. We should also think of the daunting challenges facing Athens, Madrid, and Lisbon as a sort of dress rehearsal for what could be visiting other capitols in the years ahead.
Unfortunately, what ails Greece, Spain, and Portugal is also what will soon ail the U.S., the U.K., and Japan. The issues in Europe and elsewhere are not just simple bouts of illiquidity suitable for near term stabilizing by central banks. These are structural financial problems created by too much borrowing and spending relative to incomes. The situation has been exacerbated by the financial promises made to citizens who are living longer in retirement than the actuaries ever imagined. Real solutions require political will and sacrifice, not yet another papering over. There is no easy answer, and the implications of this mess for investors thus depends upon which solutions the EU powers come up with for Greece and the other Club Med countries. Stocks will suffer more than bonds in some scenarios, while in others the reverse will be true. Cash will be safe from market gyrations but not from inflation and currency debasement. To understate the case, traditional asset allocation will be difficult until the EU ministers reach a consensus — perhaps even more so if they choose unwisely.
Longer term, it makes sense to avoid investments denominated in currencies that are home to overly generous politicians and over-active central banks. Gold is the world’s oldest currency, and the barbarous relic is the one asset that stands to benefit from all this monetary turmoil. Gold is the only store of monetary value where the supply is physically constrained by its fractional presence in the earth’s crust. It cannot be belched forth in a crisis by a central bank. Until voters in the developed world force their elected officials to be more fiscally responsible, gold will be an anchor for portfolios otherwise awash in a rising sea of paper money.
– Jack McHugh
Stocks Rise in U.S. on Fed, Earnings; Fall in Europe on Spain
Stocks $1 Trillion Loss No Reason to Sell for Funds
Ken Fisher’s Forbes Columns
Spain Has Rating Cut to AA by S&P as Greek Contagion Spreads
Greece Bondholders May Lose $265 Billion in Default
Credit Suisse: Investment Themes Beyond Greece
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