European Troubles Starting to Hit U.S. Shores

It seems like forever since I started talking about Europe and their debt crisis.  It's taken awhile, but their problems are now starting to affect the U.S.

In Good News From Europe, Though I Have Trouble Seeing It, I stated that Eurozone spending accounts for 41% of S&P 500 revenue.  During the earnings pre-announcement season, I noted one company that I follow blamed failure to close a few large deals in Europe for their earnings warning.  Now with Q1 results being reported, we learn that IBM and Intel are having trouble in Europe as well.  From Bloomberg, Intel, IBM See Sales Stall as Europe Crisis Crimps Orders

Intel Corp. (INTC) and International Business Machines Corp. (IBM), computer-industry bellwethers, posted the slowest sales growth in more than two years last quarter as the European slump weighed on orders. 

IBM’s revenue climbed 0.3 percent to $24.7 billion in the period, while Intel sales rose 0.5 percent to $12.9 billion. That was the smallest increase for either company since the third quarter of 2009, when the U.S. economy was just emerging from recession. Even so, Intel predicted a pickup in sales for the current quarter. 

The two technology giants are seeking growth in emerging markets while coping with a slowdown triggered by the European debt crisis. The personal-computer market, which contracted in the U.S. last year for the first time since 2001, also is hurting demand for Intel’s processors. IBM, meanwhile, is more focused on expanding earnings per share, rather than pursuing less-profitable orders.

The question now is this a one time event like Intel believes or the beginning of a new trend.  Looking at Europe, I'm not optimistic.  From the Telegraph, Debt Crisis: as it happened, April 18, 2012

14.03 Italy has cut its 2012 economic growth forecast and moved the goalposts on its balanced budget rule.

The Italian economy is now expected to contract by 1.2pc this year from 0.4pc previously, The revision was largely expected, following a series of leaked reports in the media. 

The Italian government, which had vowed to balance the budget in 2013, now expects a shortfall of 0.5pc of GDP next year, and a balanced budget in 2014. In a statement, the Italian government said:

Despite the progress made, there is still a long way to go in a context that is more favourable but still characterised by elements of uncertainty.

Analysts that I've read have been optimistic on Italy because it does not have a budget deficit.  However with the third largest national debt load after Japan and the US, a shrinking economy threatens to overwhelm it's ability to pay back its debts.   Additionally, analysts were also hoping that Prime Minister Mario Monti would be successful in reforming Italian labor laws in the hope of making them more flexible.  After months of negotiating, it appears that optimism may have been misplaced as labor unions do not want to change the status quo.

Moving on to Spain, it has been some time ago when Spain announced that they would not reduce their budget deficit to 3.5% of GDP this year.  After what were surely some intense conversations, Spain agreed to target a 5.3% deficit.

Eurozone is Trending Down

In the U.S., car sales are one quick means to measure how consumers feel.  I'm was not sure this applies in Europe too, but Bloomberg recently dispelled any qualms I had with this headline, European Car Sales Fall to 14-Year Low as Economy Stalls (emphasis mine)

European car sales fell to a 14- year low last month, with Fiat SpA (F), Renault SA (RNO) and PSA Peugeot Citroen (UG) posting the biggest drops, as the region’s sovereign- debt crisis caused economic growth to stall. 

Registrations in the 27-member European Union plus Switzerland, Norway and Iceland fell 6.6 percent from a year earlier to 1.5 million vehicles, the lowest figure for March since 1998, the Brussels-based European Automobile Manufacturers’ Association said today in a statement. First- quarter sales dropped 7.3 percent to 3.43 million vehicles. 

France and Italy, Europe’s second- and third-biggest auto markets, shrank by more than 20 percent. The regional drop was alleviated by growth at German carmakers, such as Volkswagen AG. (VOW) Paris-based Peugeot is among auto manufacturers forecasting an industrywide contraction of 5 percent in Europe this year. 

“The extent of the beat for Germans is a bit surprising, as well as the extent of the downturn for the French,” Adam Hull, a London-based analyst at WestLB AG, said by phone. 

French car sales plummeted 23 percent to 197,774 vehicles, while Italian registrations dropped 27 percent to 138,137, according to the association, or ACEA.

The bolded items caught my eye.  If people don't want to buy big ticket items due to uncertainty, its understandable that companies are uncertain too.  I will continue to watch the reports from other companies to see if this is simply the beginning.


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Talking the Talk, They will Walk the Walk

You can talk the talk. Do you walk the walk?
- Full Metal Jacket

Well it didn't take to long for things to get dicey again in Europe.  Even though Greece was restructured 3 weeks ago, and the ECB lent ~$1 Trillion of LTRO funds, bond rates in Italy and Spain are climbing higher.  On March 1, the 10 year Spanish bond was 4.87%.  Today Spanish rates hit 6%.  This is important because as the 10 year bond moves towards 7%, it means investors have lost confidence the Spain can resolve its budget deficit and make good on its debts.  7% is the line in the sand as this is when Greece, Ireland and Portugal needed bailouts.

Source: Bloomberg

Almost on cue, the ECB restarts talk about it's bond buying program.  From the Telegraph: ECB may act to bring down Spanish borrowing costs

Benoit Coeure, an executive director of the ECB, said the bank could restart its sovereign bond buying programme in a move likely to antagonize Germany but relieve a spiralling political, economic and social crisis in Spain.

Mr Coeure said that market fears over Spain were "not justified" but he added: "Will the ECB intervene? We have an instrument, the securities markets programme [SMP] which hasn't been used recently but it still exists."

Bond traders were soothed by the comments. The yield on Spain's benchmark 10-year bonds was pulled back from 6pc on Tuesday to 5.88pc, while the yield on Italy's 10-year debt also dropped marginally, to 5.54pc. 

Mr Rajoy delivered a strongly-worded speech to parliament insisting that it was "as clear as day" that Spain would not need a Greek-style bail-out.

Occasionally I'm asked how did I know things were going to blow-up in 2007.  My first clue was when the word "contained" was used by Ben Bernanke and Hank Paulson with regard to subprime mortgages.  Mike Mish Shedlock shred those claims to pieces using examples of Washington Mutual mortgages.  Another clue came from Paulson's claim that the US would not need to take over Fannie Mae and Freddie Mac.  When things are officially denied like that, watch out because it's going to happen.

Rajoy is right in that Spain will not need a Greek-style bailout - it's going to need a Spanish-style bailout because Spain's economy is more than double the size of Greece, Portugal, and Ireland combined.

We've Seen This Movie Before

The movie I refer to is how the ECB, IMF, and EU treated Greece's fiscal problems.  Currently Spain is sticking to cutting its budget though I've read that the EU wants it to raise taxes as well.  I expect to hear more about selling national assets to pay down debt.  When the ECB starts buying more Spanish bonds, then start to watch Spanish banks as they are reported to have been buying Spanish bonds using the LTRO money.  As these bonds have dropped in price, the losses to banks are building.  Worse if there is a Spanish restructuring, remember that the ECB gets paid in full while investors and banks get shellacked.

The only way Spain does not get bailed out is if it leaves the EU first.  What are the odds the politicians go that route?

And in the U.S.

The one direct affect of Spain should be falling bond rates in the U.S. as investors seek a place of refuge.  Ironically when bonds rates rose a few weeks ago, I wondered if people had forgotten that the LTRO in Europe simply bought time - it didn't solve anything.  Maybe most people thought it bought 3 years of time.  Regardless, bond rates in the U.S. should stay lower as questions about Europe and questions of the U.S.'s recovery remain in focus.

And about that U.S. recovery, it seems the best we can get is conflicting data.  What I might find humorous, if it wasn't so maddening, is how the good data took hopes of a new quantitative easing program off the table - but then unexpected bad data (in the form of the March employment numbers) immediately raised the hopes for such a program again.  The reason I, as a stay-at-home dad, find this maddening is that it resembles my two year old's temper tantrums.  Give us QE3 or watch the stock market tank.

What's worse is I see the Fed giving in as they have every time the stock market threatened to fall.  From Advisor Perspectives: Fed Intervention and the Market

I'm not the only one who sees the Fed giving in.  From Bloomberg: Gross Cuts Treasuries, Raises Mortgages in Fed Buy Bet

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., cut holdings of Treasuries last month to 32 percent, the lowest since December, and raised mortgages to the most since 2009.

Gross reduced the proportion of U.S. government and Treasury debt in the $252.4 billion Total Return Fund in March from 37 percent of assets in February, according to a report on the company’s website today.

Bill Gross, co-chief investment officer of Pacific Investment Management Co. (PIMCO), speaks during an alumni event hosted by UCLA Anderson School of Management in Beverly Hills on Nov. 17, 2011. Photographer: Andrew Harrer/Bloomberg

He raised the fund’s holdings of mortgages to 53 percent last month, the highest since June 2009, from 52 percent in February, in a bet that the Federal Reserve will buy the securities in a new round of purchases. Newport Beach, California-based Pimco doesn’t comment directly on monthly changes in its portfolio holdings.

The Fed will probably shift focus to buying mortgage securities to keep borrowing rates low when its so-called Operation Twist program ends in June, Gross said in a March 28 interview on Bloomberg Television’s “InBusiness with Margaret Brennan.”

Bill Gross successfully front ran previous Fed easing, meaning he bought treasuries and mortgages at a lower price to sell them to the Fed at a higher price.  Can it work again?  As the Fed has consistently talked the talk and walked the walk, I wouldn't bet against it.

Parting Thoughts

I've read recently that you have to trade (invest) the market you have, not the market that you want.  It made me think if I ever have invested in a market that I want.  Thinking back to when I got started in 1998, that was the final legs of the Internet bubble.  Afterwards, the Federal Reserve slashed rates so low and kept them there so long, that the housing bubble formed and kicked off the debt crisis.  Now global central banks are printing trillions in an effort to get things back to normal.

However what is normal? Looking back, it seems that all I have experienced in financial markets is managed by interest rate setting central bankers. When do bond markets finally say "enough" and start selling (thus raising interest rates)?

Perhaps what I really need to answer is what would make me sell my bond mutual funds.  Quantitative easing 3?  More Congressional stimulus? More tax cuts without offsetting spending cuts?  Maybe even no spending cuts?  More government borrowing?

As it is late, I'm going to let these questions go unanswered though I have a bunch of thoughts swirling through my head.


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Where the Economy is Headed - A Different Perspective

For many years now, my father has told me to watch the baby boomers.  Look at what this large population segment wants and needs - invest in that, build a business model around that he would tell me.  Considering that individuals born between 1946-1964 number approximately 77 million, baby boomers account for practically 25% of the US population.  Indeed if you can find an idea that resonates with this group, your idea would pay off very handsomely.

Yet the reason I've been thinking about the baby boomers recently isn't because of some new investment idea.  Far from it, I keep coming back to the article Worthwhile From the Web: Thoughts on Retirement with Dignity 2.0.  A quick refresher:

Entitled Thoughts on Retirement with Dignity 2.0, the author reviews these baby boomers backgrounds, prospects for retirement, options in achieving retirement, and implications on the economy. Here's a preview: 

The 80th percentile 57 year old household income is little changed from 2 years ago (or 4 years ago, for that matter) and stands at $150,000. They have, on average, a $200,000 mortgage on a home valued in the low $300 thousands. (The value was $370,000 in 2007). If they have a 401K or IRA, the balance is approximately $100,000. ...

Only $100,000 saved? If you haven't read this article before, it gets better. Taking into account other assets and liabilities, this particular subset of baby boomers are $100,000 in the hole. After reading this short excerpt, I think what a baby boomer needs is a realistic retirement plan. Fortunately, the article lays out what is needed:

I came up with 3 primary actions that can be taken in order for these 57 year olds to retire comfortably, if taken together. All of them will have a potentially negative impact on the economy.
1. Postpone retirement to age 70 or older
2. Cut the household budget and save the difference
3. Liquidate debt by downsizing
...
They need to take the $115,000 in spending down to, say, $75,000. Talk about choking the horse. But it certainly can be done. That will facilitate $40,000 in annual savings, but what is really cool is that, after adapting to the pain of austerity and establishing a less expensive lifestyle, the savings goal drops to $1,080,000! 

Did you catch the most important point?  Here it is again: All of them will have a potentially negative impact on the economy.  Let's review a few potential consequences of these actions.

By postponing retirement to age 70 or older, I foresee an impact on college graduates because fewer jobs are available.  Without good jobs, these individuals will struggle to start their lives.  Indeed, how can we expect these individuals to buy a starter home when they're trying to pay off college loans from a minimum wage job?  Postponing retirement works for those baby boomers, but negatively impacts the next generation of workers.

Cutting the household budget and saving more leads to less growth, or worse, a contraction in the economy.  If there's less growth, that means less job opportunities.  In a contraction, layoffs may follow as companies strive to remain profitable.

Liquidating debt by downsizing their home is another option, but it comes during the largest housing slump since the Great Depression. Thanks to postponing retirement, baby boomers limit the number of starter home buyers in the market.  Additionally these buyers need a 20% downpayment in order to qualify for a mortgage.  Furthermore this leads to a dearth of move-up buyers who cannot buy until they sell their current home.  Finally with more foreclosures projected to come on to the market, home prices can best be expected to stagnate due to an increase in supply.

Looking at All Baby Boomers

Even though the above article zeros in on 80th percentile 57 year old baby boomer, the three actions apply to all baby boomers.  This made me wonder about the overall retirement readiness of this generation.  I found the 2012 Retirement Confidence Survey from the Employee Benefit Research Institute.

A few quotes from this report:

... nearly a third of older workers reported savings and investments of less than $10,000.  

Despite approaching retirement age, half of workers age 45 and older have not tried to calculate how much money they will need to have saved so that they can live comfortably in retirement. 

Workers of all ages appear to be planning to retire later, on average, than similarly aged workers were in 2002. In particular, the percentage planning to retire at age 66 or older has increased significantly for every age group.

The decline in confidence about having enough money to live comfortably in retirement is statistically significant across all age groups between 2001–2011.  

Workers age 55 and older are more likely than younger workers to be very confident that Social Security will continue to provide benefits of at least equal value to the benefits received by retirees today.

Peak Spending

I've been watching the stock market continue to rise since October wondering what does it see that I am missing.  I found myself questioning my own logic as I read reports of the growing economy.  However, I still believe that the headwinds that the US and world economy face are present.

Baby boomers are not ready for retirement. They need to curtail their spending and save more. Thus baby boomers are not going to aid economic recovery by going on a shopping spree.  Indeed Doug Short from Advisor Perspectives agrees in his article, Demographic Headwinds for Economy and Markets: The Decline of Peak Spenders.

Demographer Harry Dent was recently a featured guest on Bloomberg TV in an interview that was promoted with the frightening tease "S&P 500 to Fall 30-50% in 2012." The video clip is available at YouTube here.

The rationale for Dent's grim forecast is primarily based on the demographics of the peak spending years, an age cohort he refers to in the interview as ages 46 to 50. If we use the Census bureau five-year data groupings, the cohort in question is Age 45-49 (which is the range Dent normally refers to in his publications).

...

Let's study a graph of the Census Bureau historical and forecast data for the peak-spending cohort population in the US from 1980 to 2050.

With baby boomers now exiting their peak spending years, the economic ramifications are going to be felt for many years into the future. The Census Bureau doesn't see growth in peak spenders resuming until 2022.  When I read analysts saying that the US cannot experience a stagnant economy like Japan, I wonder why not.

I encourage you to click the link to the above article as there is a PDF file that provides the buying habits of different age groups.

Parting Thoughts

As it's getting late, I'm going to wrap up by saying it's tough sticking with a plan while the market is doing the exact opposite of said plan.  Still when analysts (like Goldman Sachs a few weeks ago) talk about this is the best time to buy stocks in 30 years, it's critical to look at the picture from every angle.  I think the economy can and will muddle through (to borrow a phrase from John Mauldin), but that's not the same as a legitimate secular bull market.

From the perspective of what baby boomers need and how it impacts the economy, caution is called for in today's markets.


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.