Thoughts From Joe - February 22, 2013

Top Eight 

1. New Bowles-Simpson deficit plan would cut $2.4 trillion over ten years.  The democrat and republican have altered their deficit reduction proposal from $4 trillion in order to propose something that might actually get done.  In this day of "kicking the can" it's unlikely the new proposal will get any more traction than the original "grand bargain" version.  Instead, the situation must get much worse, inciting a voter revolt, or the fiscal situation must improve itself, through economic recovery, before any serious deficit reduction will take place.
2. This weekend's Italian elections could set course for Europe.  Silvio Berlusconi is campaigning on anti-German rhetoric, blaming the country for Italy's inability to recover due to austerity measures.  The former cruise ship crooner and four-time PM knows how to work a crowd and has ginned up support from Italians by promising to roll back tax hikes, budget cuts and other austerity measures.  Should Berlusconi win - and be able to form a coalition government - I would expect a widening in the chasm between Italy and the rest of Europe.
3. The M&A pace for the month continued this week.  The latest company in play is Gardner Denver, an industrial equipment maker that is the target of K.K.R. bid.  Aside from the Dell privatization, we don't see much in the large-cap tech space yet, however a fifth year of zero interest rates and high cash balances could change that.
4. Washington budget talks are resuming as we head toward the sequestration cliff.  President Obama called Republican leaders on Thursday to resume talks to delay across the board austerity set to begin next month.   The size of the $85 billion in cuts for this year are somewhat significant, but more important is the way they apply across all government spending indiscriminately.  Since these cuts were designed to never be put in place, there was not a lot of thought into their potential effects back in 2011.
5. Eurozone economists predict recession will continue throughout 2013.  The European Commission is blaming a lack of bank lending and high unemployment on their prediction that the zone's recession will continue.  True, it does take time for recoveries to take hold, but isn't it a little early for the EC to throw in the towel on 2013?  The problem is they don't have the right mechanisms in place to assist any economic recovery, but in order to put them in place member-countries must relinquish further sovereignty to the EC.  This weekend's Italian elections are likely to show great reluctance in this direction.
6. Housing starts fall but permits remain on pace.  New home construction fell 8.5 percent last month, pulled down sharply by multifamily starts, which has been the driving category for some time.  On the other hand, permits to build new homes grew 1.8 percent signifying future construction is likely to remain on track.  Today's homebuyer is constrained by government approval.  Fully 95 percent of them must qualify for government support, or there is no loan to be had.
7. Minutes of the Fed's FOMC meetings reveal opposition to continued QE has been growing.  The Fed's current QE totaling $85 billion of Treasury and mortgage purchases each month was never fully supported by all voting members of the FOMC, but this week's minutes release shows a trend toward curtailing the purchases sometime this year.  Such a move, without a corresponding economic recovery, could drive equity prices down significantly as risk markets have been living off of the Fed's QE program for some time.
8. Gasoline prices are on the rise, up 45 cents per gallon since January 20.  Seasonal maintenance at refineries that is restricting supply is partially to blame.  Interestingly, miles driven by Americans have been relatively stable since 2008 after climbing parabolically since early in the decade.  This implies our demand for gasoline is more a function of the overall economy than price - with so many Americans out of work, commuting distances have shrunk considerably.

Key Indices

Source: Bloomberg

Looking Ahead

• Next week's economic data includes first quarter GDP revision, personal income, durable goods orders, and home prices.
• Earnings releases next week include:
  • Monday: Halozyme, Autodesk
  • Tuesday: Auzilium Pharma, TiVO
  • Wednesday:  Groupon
  • Thursday: Salesforce.com, Palo Alto Networks, Splunk, Isis Pharma
• There is no scheduled IPO activity for next week.