GDP and EFSF, Trick or Treat?
Last week was simply stunning. Barely one quarter of the investing public is now cautious over the market outlook! Well, why not? GDP rose 2.5% and we’re told that there is a plan to save the Eurozone. Phew.
Since I’m a numbers kind of gal, let’s look a little deeper, just for fun. Consumer spending drives GDP in the U.S., making up more than 70% of it. Between the end of the second quarter and the end of the third quarter, consumer spending rose at a whopping 3.9% annual rate. But real income dropped 1.7% at an annual rate! Making less but spending more? What gives? Savings. The savings rate fell from 5.3% in June to 3.6% in September, the lowest level since December 2007. Savings dropped and spending rose, because households had to use their savings to buy the necessities: housing and utilities real expenditures up 2.9% annual rate; health care up 5.4% annual rate; gasoline prices up 32.7%; financial services and insurance expenditures up 3.3%. Even more telling, real expenditures on motor vehicles declined 3.3% annual rate and clothing and footwear declined at an 8.4% annual rate. Employment is not recovering. Housing prices are not improving Interest rates on savings are negative and consumer credit is nearly flat. Clearly GDP growth was not driven by an expanding economy so I’m calling trick here.
What about the Eurozone and the EFSF bailout? EU leaders have now come up with the third rescue plan this year and the equity markets rallied impressively on Thursday, but the bond markets aren’t convinced. On Friday the Euro fell as Italian government bond sales met lower demand than at previous auctions and the country paid the highest premium since joining the Euro. On 10/31 Italian yields started the week off at 6.12%. Keep in mind that at 6%, Italy’s debt starts to become unsustainable.
I have just a few concerns and yes, you did hear a sarcastic tone exacerbated by excessive candy indulgences over the weekend, (I’m a weak woman when faced with individually wrapped Reese Peanut Butter cups):
- European banks need to improve their finances to reach the minimum core Tier 1 ratio of 9%. Many of the larger banks have stated that they intend to accomplish this by reducing lending, retaining earnings and selling assets. For those giddy bulls that pushed equities up last Thursday, how is this credit contraction going to help grow an economy already on the brink of a recession?
- The plan hinges on “voluntary” haircuts. How the heck this is going to work is beyond me. For those who bought CDS to protect against just such an event, this is ridiculously painful. The idea is that no one is going to go to the ISDA and petition for a default ruling which would then trigger payment on the default insurance. How is a 50% haircut not a default? Talk about form over substance. What if a bondholder balks? This deal could very well destroy the CDS markets. How can these contracts be viable when a wink-wink “forgiveness” is used to avoid the reality of a default? Dangerous territory.
- Now we’ve got moral hazard. Greece gets to walk away from 50% of its debt. If you’re Ireland, you’re thinking that sounds like a pretty good deal. What about Portugal, Spain and Italy all raising their hands saying, “What about me?” Why should Greece get preferential treatment?
- Not to be picky, but even Angela Merkel has said, “We don’t know how this works yet.” Umm, if she doesn’t know, who does? So we have a market rally on the promise that these guys are going to figure it out later on? This isn’t exactly a group with a track record of sustained success. Anyone recall the Dexia bank bailout in 2008 that unsurprisingly blew up a few weeks ago?
- If we put Greece into perspective, it only accounts for 1.74% of the Eurozone GDP and look at what havoc it has caused. Italy is on the precipice and it accounts for 12.6% of Europe’s GDP, is the 8th largest economy in the world, with the world’s third largest bond market. Italy’s debt ratio is second only to, (drum roll please) Greece. With the rise is Italian bond yields after Thursday’s announcement, it seems clear to me that we have a long way to go before the “all clear” can be announced. I’m calling a trick on this one too.
