Financial Review

The Greek Unknown

Sinclair Noe — July 1, 2015

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DOW + 138 = 17,757
SPX + 14 = 2077
NAS + 26 = 5013
10 YR YLD + .09 = 2.42%
OIL – .02 = 56.94
GOLD – 4.30 = 1169.30
SILV – .12 = 15.65

Let’s start today with some economic data. ADP reports private-sector hiring picked up in June, as employers added 237,000 jobs. The monthly jobs report from the Labor Department will be released tomorrow; it includes private sector plus government jobs. The consensus guestimate is for about 225,000 new jobs last month.

Construction spending rose 0.8% in May to a seasonally adjusted $1.04 trillion. Spending rose 0.3% for residential projects, and 1.5% for nonresidential projects. The Commerce Department revised April’s result to 2.1%.

Manufacturers grew in June at the fastest rate since the start of 2015. The Institute for Supply Management said its manufacturing index rose to 53.5% last month from 52.8% in May, matching its highest level of this year. Readings over 50% indicate more companies are expanding instead of shrinking. The employment gauge jumped 3.8 points to 55.5%. The ISM’s new-orders index edged up to 56.0% from 55.8%.

The second and final Markit reading of U.S. manufacturing conditions in June was revised up to 53.6 from a preliminary 53.4, but the index was still at its lowest level since October 2013.

Overnight, Greece defaulted on its $1.8 billion debt payment to the IMF. That failure means the Greek bailout package has expired. But markets rallied this morning on reports that Greek Prime Minister Alexis Tsipras, in a letter to the country’s creditors, said he was willing to accept the terms presented in a proposal made at the weekend as the basis for more talks. For now, the July 5 referendum is still scheduled, even though the terms to be voted on have been taken off the negotiating table. And then Tsipras addressed the Greek nation saying they should vote no on the referendum, so it doesn’t sound like Tsipras made any real concessions.

European stocks and bonds rose today. The Stoxx Europe 600 index rallied 2.2 percent. Yields on debt from Italy, Spain and Portugal all fell and the euro weakened 0.8 percent to below $1.106.

Now, we hear a lot of speculation about how the Greeks will vote on the referendum on Sunday. The simple answer is that we don’t know. A poll released today shows 47% to 43% in favor of a “Yes” vote; but keep in mind the polling was done by a German polling company.  The referendum was thrown together so fast that there hasn’t been anything that could be considered reliable polling to tell us how the vote will play out. If anyone speculates, it is just that – speculation. Beyond that, we don’t know the consequences. I have heard reports that if Greece votes no, they will be kicked out of the Eurozone. Not so fast.

From a legal standpoint Greece would still be a member of the European Union; even if they start printing drachmas. Greece might want to take control of its own monetary policy and not be bound to contracts denominated in euros. Even if a country violates the treaty, there’s no mechanism for kicking it out. That would create a host of legal and administrative headaches for both Athens and Brussels. Trouble is, there’s no clear legal path for a country to exit the Eurozone without leaving the EU first. EU treaties describe the Eurozone as “irrevocable.” A country can leave the EU, however. Under Article 50 of the EU treaty, a country can withdraw its EU membership. Since euro membership is only open to EU countries, Greece would automatically fall out of the currency area if it left the political union. But here too, there’s a catch: Article 50 stipulates that countries engage in a two-year negotiation with Brussels before they can leave, time Greece doesn’t have.

Now, there may be some legal trickery that could be applied, such as a referendum of all 28 euro countries, or perhaps an agreement outside the framework of the EU treaty. The problem with all of these scenarios is that Europe would tacitly be acknowledging that euro membership is revocable, and that makes the euro a revolving door. Further Greek defaults will leave European taxpayers holding the bag for more than €200 billion-euro in aid. Weigh that against market losses that can grow to the trillions in the flash of volatility like we saw on Monday. Now, weigh that against the optics of elderly Greek pensioners begging for food in modern day Europe, and remember the words of Ghandi, who said: “Poverty is the worst form of violence.”

So, when you hear pundits saying they can tell you how the Greek situation will play out, or how the Greeks will vote on the referendum, or that there will be a Greek exit, realize that nobody knows how this will be resolved.

One lesson we have learned: as economies crumble, so does the viability of the digital infrastructure that so much of the world has come to take for granted as the way money moves. The harder an economy is hit, the more valuable cash becomes. Basically the economy returns to cash trading as merchants refuse to accept payment with plastic as they have to take the receipts to be cleared at a bank. The less faith you have in the bank’s ability to clear those receipts, the more likely you are to lean on cash. That’s how a modern day bank run works. And in Greece the banks are closed so plastic is worthless, and the ATMs are empty. A reminder that you can’t stuff “ones” and “zeroes” under your mattress; and when times get tough, cash is still king.

Meanwhile Puerto Rico’s junk-rated power utility said it made a full $415 million bond payment due today and reached an agreement to continue negotiations with creditors to restructure its $9 billion of debt. Its bonds rallied.

The Puerto Rico Electric Power Authority, called Prepa, made the principal and interest payment by selling $128 million of short-term debt to the companies that insure its bonds, including Assured Guaranty. It also tapped reserves and used $153 million from its general fund. The utility extended a forbearance pact with creditors until Sept. 15, which will keep discussions out of court. It must negotiate a plan to overhaul its debts by Sept. 1 to keep the deal in place. The talks with creditors may advance the utility’s effort to pare its debt load. There is still a major problem of $72 billion of debt owed by the Commonwealth of Puerto Rico.

And next on the list is Ukraine; they could suspend debt payments almost immediately if an important meeting with creditors ends in stalemate. Ukraine is asking its foreign bondholders to accept a 40 percent write down or “haircut” on the $23 billion of debt they own, but so far they have not agreed.

Meanwhile, gas negotiations between Russia and Ukraine have fallen apart, after the two failed to agree on a pricing plan at talks in Vienna. The European Commission, which mediates the negotiations between Gazprom and Naftogaz, issued a statement Tuesday evening saying the two sides were “still far apart” on a deal. Ukraine has now stopped receiving gas from Russia, but transit supplies to Europe are continuing at the usual rate.

China’s vast manufacturing sector remained lackluster in June, fueling calls for additional stimulus measures to boost the world’s number two economy. The Shanghai Composite, which entered a bear market on Monday, ended the day down 5.2%.

The U.S. and Cuba have reached an agreement to restore diplomatic relations and reopen embassies in each other’s capitals, the biggest step yet toward ending a half century of enmity between the two countries. The historic deal will be proclaimed in a White House statement today, and follows the two countries’ landmark announcement to normalize relations last December. A U.S. economic embargo against Cuba will still remain in place, and only Congress can lift it.

General Motors sales fell 3 percent in June. Nissan reported June’s biggest gain so far with a 13 percent increase. Fiat Chrysler said U.S. sales rose 8.2 percent in June. Ford Motor missed estimates with a 1.5 percent light-vehicle sales gain; sales of Ford’s F-Series pickups fell 8.9 percent last month. Vehicle prices also climbed in June, with the average transaction price up 1 percent from a year earlier to $31,948.

Swiss insurance giant ACE Ltd. will buy property insurer Chubb Corp for $28.3 billion. The deal will create the world’s biggest property and casualty insurer by underwriting income. The deal is expected to close in the first quarter of 2016.

General Electric expects to accelerate the pace of GE Capital asset sales in the third quarter as the U.S. conglomerate retreats from the banking industry. Since the landmark announcement on April 10, GE Capital has announced asset sales totaling $23 billion in ending net investment, and anticipates $100 billion in sales in 2015.

The US government sued to block Electrolux AB from taking over General Electric’s appliance business, warning that the $3.3 billion deal would leave millions of Americans vulnerable to price increases for ranges, cooktops and wall ovens, products that serve an important role in family life and represent large purchases for many households.

By a 2-1 vote, a federal appeals court has upheld a 2013 decision finding Apple liable for conspiring with publishers to fix e-book prices. Apple is now set to pay $450 million to e-book consumers and lawyers through a settlement originally announced last year.

AT&T’s proposed $48.5 billion acquisition of DirecTV is expected to get U.S. regulatory approval as soon as next week. The Department of Justice has completed its review of the merger and is waiting on the FCC to wrap up its own. The move could create the country’s largest pay-TV company, giving DirecTV a broadband product and AT&T new avenues of growth beyond wireless service.

Financial Review

Pick Your Poison

Sinclair Noe — June 29, 2015

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB)

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DOW – 350 = 17,596
SPX – 43 = 2057
NAS – 122 = 4958
10 YR YLD – .15 = 2.33%
OIL – 1.30 = 58.33
GOLD + 5.90 = 1181.10
SILV + .01 = 15.86

Late Friday, Greek Prime Minister Alexis Tsipras called for a July 5 referendum on whether to accept the latest offer from Greece’s creditors. That meant that Greece would not pay $1.8 billion to the Troika due tomorrow. The European Central Bank responded by halting emergency lending to Greek banks.  With emergency aid to the country frozen, Athens has imposed capital controls to halt bank runs and confirmed that the country’s banks would remain shut for six working days; Greek banks are closed and the Greek stock market is closed, possibly until the July 5 referendum. ATM withdrawals are being capped at €60-euro-per-day.

We’ve been watching the problems in Greece for a long time. A few years ago, we knew Greece had a debt problem; that was back when they were lumped together with Portugal, Italy, Ireland, and Spain. They were called the PIIGS. The Troika of the European Central Bank, the International Monetary Fund, and the European Monetary Union, decided to crack down on the PIIGS; prescribing a big dose of austerity; the cure has been debilitating. Spain is dealing with 22% unemployment, Italy with 12.4% joblessness, Portugal at 13% (with youth unemployment at 32%), and Greece has an unemployment rate of 25.6%. Those are numbers comparable to the Great Depression. And now they have a bank holiday to match.

The ECB couldn’t wait until July 5 for voters to decide on a referendum; they shut off funding and effectively closed the country’s banks. And they are now moving to the punishment phase off the negotiations. The message is clear; accept austerity or the ECB will crush the Greek economy. The Troika made Tsipras an offer that was unacceptable. The only option for Tsipras was to reject the offer or put it to a referendum of the voters. By shutting down the banks the Troika has spit on the democratic process.

Earlier in the year, I thought the Troika and Greece would come to an agreement because the cost of default and possible Greek exit from the EU would be much more expensive than a settlement. Greece may be a small country with a small economy but it is geopolitically and geographically important. The Troika feared that leniency would encourage Spain, Portugal and Italy to seek leniency; what they forget is that Greek default may also encourage the peripheral countries, or scare other countries. And even though there is a form of depositor insurance, it is woefully underfunded. If the bank runs in Greece spark bank runs in Italy and/or Spain, the Eurozone could be facing huge problems. We’re not there yet, but it has been a wild day.

There was quite a bit of market turbulence. The Euro Stoxx 50 Index fell more than 3 percent. Greek 10-year notes plunged by the most since at least 1998, driving the yield to 14.6 percent, the highest since December 2012. German bunds rose the most since 2011, sending the 10-year yield to 0.74 percent, as money flowed out of Spain, Italy, and Portugal. The euro fell 0.6 percent to $1.1093. The currency pared its loss following purchases by the Swiss National Bank to curb gains in the Swiss franc.

Few think a Greek default will lead to a scenario similar to one that played out in 2008, when Lehman Brothers collapsed. For one, international banks have far less exposure to Greece than in the past; they have also had more time to prepare. We have seen this slow motion train wreck coming. It is not a black swan event that surprises everyone. There has been plenty of time to “ring-fence” assets; plenty of time to prepare. Still, the cost of insuring corporate debt against default surged by the most since the day Lehman collapsed. The Markit iTraxx Europe index of credit-default swaps on 125 investment-grade companies jumped 20 percent this morning to the highest level since March 2014.

And then to pour gasoline on the fire, the Bank for International Settlements warned in its annual report that the world will be unable to fight the next global financial crash as central banks have used up their ammunition trying to tackle the last crises. The BIS claimed that central banks have backed themselves into a corner after repeatedly cutting interest rates to shore up their economies. Rather than simply reflecting widespread economic weaknesses, ultra-low rates have contributed to the slow recovery in the global economy by entrenching the excessive reliance on debt and causing large-scale misallocation of capital. Now imagine the Greek problem causes a downturn in the Eurozone; in normal times, the ECB could cut interest rates, and Greece would be nothing more than a minor downturn. The ECB can’t cut rates much lower than the zero bound.

The July 5 Greek referendum will ask Greek voters: “Should the agreement plan submitted by the European Commission, European Central Bank and the International Monetary Fund to the June 25 eurogroup and consisting of two parts, which form their single proposal, be accepted?” Greek PM Tsipras says a “no” vote will give him more leverage in negotiations. Euro Commission President Jean-Claude Juncker says “no” vote would lead to a Greek exit from the Eurozone; he described it as committing suicide. Not exactly. The Maastricht Treaty of 1992 which formed the Eurozone does not include a provision for expulsion of a country. There does not appear to be a legal basis to kick Greece out. The only thing they could do is squash the Greek economy, which might come off as a bit sadistic.

Greece is not the only one in hot water. Puerto Rico’s long-simmering debt crisis is about to come to a boil. The commonwealth’s governor, Alejandro García Padilla, says “The debt is not payable,” and investors should be prepared to sacrifice if they want the cash-strapped island’s economy to grow. Puerto Rico is in the midst of a decades-long economic struggle fueled by years of recession and slow economic growth. As a result, its government has taken out massive loans from creditors to cover its costs. Many also anticipate Puerto Rico’s electricity provider, which has borrowed $9 billion, to miss a payment to creditors this week, in what would be one of the largest municipal defaults ever. Padilla called the situation a “death spiral.” And he wasn’t exaggerating: Puerto Rico’s debt is four times that of Detroit’s, and the island has more debt per capita than any American state. Analysts believe the central government will run out of cash as soon as July, which could lead to a government shutdown, emergency measures and an unpredictable crisis. Greece can’t file for Chapter 9 reorganization. The White House today said there would be no bailout for Puerto Rico but did say there should be a change in the bankruptcy law.

And while Greece and Puerto Rico struggle with debt, China’s equity markets have slipped into a bear market. The Shanghai Composite slid 3.3% today to levels more than 20% below its June 12 close of 5,180, meeting some investors’ definition of having entered a bear market. The smaller Shenzen Index is already in a correction and it closed down 6.1% for the day; and the ChiNext board, which consists of small-cap companies, ended the day down 7.9%. The plunge comes despite a rate cut by the PBOC over the weekend. Chinese regulators are now considering suspending initial public offerings to stabilize the country’s tumbling equity markets.

Contracts to purchase previously owned U.S. homes rose in May for a fifth month. The National Association of Realtors said the pending home sales index increased 0.9 percent after a revised 2.7 percent advance in the previous month. Purchase contracts rose 8.3 percent in the 12 months ended in May.

The Supreme Court ruled today that Oklahoma’s lethal-injection procedure does not violate the Eighth Amendment ban on cruel and unusual punishment. The decision was 5–4, and Justice Samuel Alito wrote the majority opinion. He argued that the inmates on death row in Oklahoma who had brought forward the case did not prove that a less painful alternative existed, so I guess now it is up to the inmates to pick their poison.

Hours after the Supreme Court finished its term on Monday, the justices put on hold the Fifth Circuit’s ruling allowing Texas’ draconian anti-abortion law to go into effect. The decision grants a last-minute reprieve to over half of Texas’ remaining eighteen abortion clinics. Under the new law, which forces clinics to meet incredibly stringent standards unrelated to women’s health, all but seven of these clinics would have been forced to close. The court stayed the ruling by a 5-4 vote.

The Supreme Court ruled 5-4 that the Environmental Protection Agency needs to consider costs when regulating pollution caused by coal-fired plants.

The U.S. Supreme Court today rejected appeals from BP and Anadarko Petroleum over fines related to the 2010 oil spill in the Gulf of Mexico. The companies had argued that oil had not leaked from a well they co-owned, but from a broken underwater pipe owned by Transocean Ltd. The justices let a lower court’s ruling about fines stand.

The Supreme Court ruled that Arizona’s voters were entitled to try to make the process of drawing congressional district lines less partisan, upholding an independent commission set up by Arizona voters to draw congressional districts. The 5-4 ruling rejected contentions that the Arizona law, approved in a 2000 ballot initiative, strips state lawmakers of power reserved to them by the US Constitution. The decision opens a new path for efforts to limit gerrymandering, the practice of drawing irregular district lines to gain a political advantage. The Supreme Court has previously refused to put constitutional limits on partisan districts. The ruling applies only to congressional redistricting and doesn’t affect the Arizona commission’s role in drawing state legislative maps.