Greek Fatigue

Greek Fatigue: Condition affecting investors and news junkies, caused by five years of reporting on the exact same topic. Symptoms include weariness, eyes glazing over and sleepwalking through broadcasts/columns/blogs predicting doom and gloom. (See: “US Debt Ceiling” and “The Boy Who Cried Wolf”.) I know you don’t want to hear about Greece again, but we’re getting down to it. Euro group leaders (the European Central Bank (ECB), the European Commission (EC) and the International Monetary Fund (IMF)) were banking on weekend progress to restructure outstanding loans to Greece, which would unlock €7.2B of the total €15.3 billion in rescue funds. Without that money, Greece will not be able to make a €1.54 billion ($1.73B) payment due to the IMF on Tuesday. In order to get the lifeline from the Euro group, Greece must agree to more taxes and an increase in employee pension contributions.

THEN, in a twist worthy of a Broadway “11 o'clock number” (“Rose's Turn” from Gypsy being hands-down the best, ever!), in the wee hours of Saturday morning, Greece’s Prime Minister Alexis Tsipras went on television and called for a surprise referendum for July 5^th, where Greek citizens will have the opportunity to vote on the euro group’s demands. Tsipras called on Greeks to vote “no to the ultimatum” and at the same time, sent his Finance Minister Yanis Varoufakis into the Euro group meeting to ask for a one-month extension on the talks to allow time for the vote. European officials quickly rejected the request, saying there was “no support for that.”

Over the weekend, Greek Prime Minister Alexis Tsipiris stunned the world with an announcement of a surprise referendum next weekend, where citizens will have the opportunity to vote on the euro group’s demands for an increase in taxes and pension contributions. Concurrently, Greece asked the euro group for a one-month extension to the negotiations, which officials quickly dismissed.

Then the European Central Bank announced that it would not increase short term funding which has allowed Greek banks to meet withdrawal demands. Without the lifeline, Greece had no choice but to announce that banks would be closed for a week and to impose capital controls, which limit how much money citizens can withdraw from the banks (€60/day, though no limit if drawing from a non Greek bank card, so foreign tourists are not affected) and transfer out of the country.

Barring a last minute-effort, Greece is now likely to fall into technical default on the IMF loans, though not necessarily on other debts. That puts the country in a dubious club that includes Cuba, Zimbabwe and Somalia, but it would not immediately lead to cascading problems. That is, unless Greek bank depositors make a more fervent dash out of the banks and investors get antsy, during the week leading up to the vote.

The total outstanding amount extended to Greece is nearly $270B, of which the European Central Bank’s exposure stands at about $170 billion. About 80 percent of the ECB’s money is keeping the Greek banking system afloat and the rest is in the form of longer-term Greek bonds, which require a $3.9B installment on July 20^th and the remainder must be paid by the end of August.

I know that it’s easy to paint Greece as the screw up, prodigal son in this story, but Irish economist Karl Whelan wants to set the record straight. Whelan cited the EC’s report on Greece from last year, which found that total public sector employment declined over 25 percent from 2009 to 2014. During the same time, Greece reduced its fiscal deficit from 15.6 percent of GDP to 2.5 percent, according to the OECD.

Perhaps because Euro group members are not willing to discuss the progress that Greece has made or the pain that ordinary Greeks have endured, Tsipiras and many within Greece’s ruling Syriza party are balking at even more austerity, which the party had promised to bring to an end when it successfully won seats in parliament in January.

The defiant Greek posture only inflames emotions more, leading many in Europe to posit that a default and exit from the euro zone, combined with a new (and much devalued) currency and structural reforms, would be best for Greece in the long run. The Financial Times Martin Wolf is not so sure: “Far more likely is a period of chaos and, at worst, emergence of a failed state…Neither side should underestimate the risks.”

While a deal between Greece and its creditors may finally emerge, “it still looks unlikely to include the substantial debt relief needed to end the crisis and eliminate the risk of Grexit”, according to Capital Economics. That’s a shame, because the answer seems so clear: European financiers pushed the ultimate drug into Greece—cash. Now that the addicted country is coming off the stuff, it would be foolhardy to go cold turkey.

US Jobs Report in a holiday-shortened week: Here in the US, there continues to be evidence of economic improvement. New and existing home sales reached 6 to 7 hear highs; personal income and spending jumped in May; and sentiment came in at a 5-month high. The better than expected results overall is prompting some economists to increase their projections for the June employment report from 215,000 to closer to 250,000. And there may be even more progress on wages: “Adjusting for inflation, disposable income for the first five months of the year is up a strong 3.6 percent compared to the same period last year,” according to Joel Naroff. Just a reminder, the report will be released on THURSDAY at 8:30ET, due to the Friday observance of Independence Day.

MARKETS:

• DJIA: 17,946 down 0.4% on week, up 0.7% YTD
• S&P 500: 2101, down 0.4% on week, up 2.1% YTD
• NASDAQ: 5,080 down 0.7% on week, up 7.3% YTD
• Russell 2000: 1279, down 0.4% on week, up 6.2% YTD
• 10-Year Treasury yield: 2.47% (from 2.27% a week ago, highest yield in 9 mos)
• August Crude: $59.63, down 0.6% on week
• August Gold: $1,173.20, down 2.4% on week
• AAA Nat'l avg. for gallon of reg. gas: $2.78 (from $2.80 wk ago, $3.68 a year ago. AAA predicts that 35.5 million people will drive over Independence Day weekend, the most since 2007 and they will pay the lowest price at the pump since at least 2010)

THE WEEK AHEAD:

Mon 6/29:

10:00 Pending Home Sales

10:30 Dallas Fed

Tues 6/30:

GREECE PAYMENT DUE TO IMF

9:00 S&P Case Shiller Home Price Index

9:45 Chicago PMI

10:00 Consumer Confidence

Weds 7/1:

Motor Vehicle Sales

8:15 ADP Private Sector Jobs Report

9:45 PMI Manufacturing

10:00 ISM Manufacturing

10:00 Construction Spending

Thurs 7/2:

8:30 June Employment Report

Fri 7/3: MARKETS CLOSED IN OBSERVANCE OF INDEPENDENCE DAY

El-Erian: “Income Inequality is Horrific”

There is nothing better than an hour spent talking to Mohamed El-Erian at the annual LinkedIn Finance Connect event. El-Erian has a unique ability to break down hardcore economic concepts into digestible, easy-to-understand analogies. For example, when I asked him about his prediction about worldwide growth this year, he said, “imagine if you were a elementary schoolteacher and I told you that overall, your classroom would be better this year than it was last year. Unfortunately, that slightly better classroom that still has troublemakers." Those rambunctious troublemakers include: Russia/Ukraine, Greece, Brazil, Venezuela, Nigeria – any one of them could disrupt global economy and threaten the progress of the “limping along” economies of Japan and Europe, as well as the improving U.S. economy. One bright spot for El-Erian is China, which is clearly downshifting from 10 percent growth over the past three decades, to a more sustainable 6-7 percent rate. Although many have predicted looming disaster for the world’s second largest economy, El-Erian believes that China will be able to make a soft landing.

He’s less sanguine about Greece, where the probability of three possible outcomes is:

• 45% Greece and Eurozone officials muddle along
• 50% Greece leaves Eurozone (“Grexit”) and a massive dislocation in financial markets ensues
• 5% Greece wades through and comes out better

As Greece teeters on the edge of disaster, other European countries (Germany, Switzerland, Sweden, Denmark) are seen as bastions of safety. In fact, some investors are actually paying countries to hold their money. Mohamed says that there are two types of investors, who buy bonds with negative interest rates: (1) Those who are willing to pay up to ensure that their money is safe and (2) those who are betting that negative returns get more negative. Although negative interest rates have persisted longer than El-Erian though they would, he does not believe that the situation will last.

The US economy should continue to expand this year at a 2.5 percent annualized rate and El-Erian is hopeful that monthly job creation will average over 200,000. The combination will prompt the Fed to increase interest rates at its September policy meeting, but El-Erian noted that this is likely to be “the loosest tightening in history,” so it will take a considerable period of time before conditions look normal again.

As far as the labor market is concerned, while job creation should pick up, stagnant wages are limiting growth. “Income inequality is horrific,” and while this is a decades long trend, in the six years since the official end of the recession, only a small percentage of Americans seem to be back or better off than they were before the recession. El-Erian said, “100 percent of the total income growth during this recovery has gone to the top 5 percent of earners.”

While some companies are actually doing more to help narrow the income gap, El-Erian would like to see an overhaul of the corporate and personal tax systems. On the individual side, lawmakers should consider raising the minimum wage and eliminating some of the benefits, which wealthy taxpayers enjoy, like not paying tax on carried interest and the mortgage interest deduction.

[The April jobs report did not show much progress on the wage front. While the job market recovered in April after getting roughed up in March, the Bureau of Labor Statistics said 223,000 new jobs were added last month and the unemployment rate ticked down to 5.4 percent, the lowest level since May 2008. This time around, the unemployment rate slid for the right reason: 166,000 additional workers entered the labor force and snagged jobs. Average earnings were up 2.2 percent from a year ago, up from 2.1 percent in March - a tiny improvement, but a far cry from 3 percent annualized rate seen during the last expansion.]

Last year, when I interviewed El-Erian, he said that the US economy was approaching a “T-Junction”, where it could veer in one of two directions: (1) growth accelerates, justifying current stock prices; or (2), growth remains sub-par, central bank policy loses effectiveness and stocks tank. This year, he said that the US is moving up the neck of this critical junction and continues to believe that the odds are 50-50 for either outcome. With even chances, the disconnect between markets and economic reality is the biggest risk facing investors and according to El-Erian, you may want to hold a little more cash in your portfolio, just in case the more negative scenario plays out.

MARKETS: In a volatile week, the bulls won out and pushed indexes within striking distance of all-time highs.

• DJIA: 18,191, up 0.9% on week, up 2% YTD
• S&P 500: 2116, up 0.4% on week, up 2.8% YTD
• NASDAQ: 5,003 down 0.04% on week, up 5.6% YTD
• Russell 2000: 1234, up 0.5% on week, up 2.5% YTD
• 10-Year Treasury yield: 2.15% (from 2.1% a week ago)
• June Crude: $59.39, up 0.4% on week
• June Gold: $1188.90, up 1.2% on week
• AAA Nat'l avg for gallon of regular Gas: $2.66 (from $2.61 week ago, $3.66 a year ago)

THE WEEK AHEAD: With earnings season mostly winding down, investors are turn their attention oversees, where once again, problems in Greece and Russia/Ukraine pose risks.

Mon 5/11:

Tues 5/2:

Greece is due to make a 750M euro payment to IMF/Euro Finance Ministers meet

9:00 NFIB Small Business Optimism

10:00 Job Openings and Labor Turnover Survey

11:00 Household Saving and Debt Report

Weds 5/13:

Macy’s

8:30 Retail Sales

Thurs 5/14:

Kohl’s, Nordstrom

8:30 Producer Prices

Fri 5/15:

8:30 Empire State Manufacturing

9:15 Industrial Production

10:00 Consumer Sentiment