Thoughts from Joe - July 27, 2012

Top Eight

1. Early in the week, the ECB got tough on collateral for its loans. By no longer accepting Greek bonds as collateral, the central bank of Europe is sending a strong signal of denial to the land that invented democracy.
2. European Central Bank President Mario Draghi pledged to do "whatever is needed" to save the euro. Midweek, leaders in the euro region began to strongly signal the potential for sovereign bond purchases internally to depress market yields, supporting member countries.This combined with item number 1 above sends a strong signal that Greece is on its way out.  Will markets accept Greece as a "one-off" situation or will they take the view the euro must fall apart?  I continue to believe the euro must fall.
3.  The Fed's mouthpiece, Jon Hilsenrath, made it clear they are moving toward QE3, though slowly.   Not only has the European situation been causing trouble, but recent economic data in the U.S. are beginning to provide cover for the Fed to initiate QE3 - but only if inflation expectations fall.  I believe we'll get QE3, the "fiscal cliff" debate, and possibly greater involvement of the U.S. in Europe all directly in the middle of the election season.  It should be a fun fall!
4.  Moody's cuts outlook on several Aaa-rated countries in euro-land. Citing rising uncertainty around Europe's debt crisis, the ratings firm lowered its outlook on Germany, Netherlands, and Luxembourg - all currently rated Aaa.  So, Moody's is worried about debt that is in such high demand it is trading at negative yields.  Who do we believe?  The ratings agency or the markets?
5. Home prices rise over 12 months for the first time since 2007. All indices of home prices seem to be bottoming or headed up.  Granted, prices are still down significantly from peaks, but stabilization is good in the short term.  Unfortunately, many of the actions taken to stabilize the housing market are, by definition, making it difficult for the market to find its true clearing level.  Mortgage rates hit an all-time low this week, but qualifying today is a very different experience than anytime in modern history.
6. Gross Domestic Product rose 1.5 percent in the second quarter.Growth came in slightly better than expected, even including some slight boost from the housing sector.  In addition, there were lower realized inflationary pressures than previous quarters.  Unfortunately, revenue growth for S&P 500 companies who have reported earnings this season shows nominal growth of just 1.5 percent meaning growth after inflation is likely nil.
7. Stockton's negotiations with bondholders fall apart.   The settlement mediation, which took place in private, seems to have ended in a stalemate but bondholders are unlikely to recoup their full investment.The historically "safe" muni market is being tested as this is the first American city to impose principal losses on bondholders since the Great Depression.
8. The FOMC next week will include a lot of discussion, but no action.   After strong signals this week the ECB will expand its bond-buying activity, there is a lot of pressure on Bernanke and the FOMC to follow suit.  Unfortunately, inflation expectations in this country remain too elevated for Bernanke to get away with it.  Not that QE3 is the final answer, but it is a shame we are burning so many calories discussing it.

Key Indices

Source: Bloomberg

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