The Greek Situation Still Is A Long Way From Being Resolved

Financial Review

Unsustainable

Sinclair Noe — July 7, 2015

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

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DOW + 93 = 17,776
SPX + 12 = 2081
NAS + 5 = 4997
10 YR YLD – .05 = 2.23%
OIL + .14 = 52.67
GOLD – 15.50 = 1155.30
SILV – .70 = 15.15

These are interesting times. There is the situation in Greece; the Chinese equity markets are suffering a bit of a meltdown; Puerto Rico has fallen into a black hole of debt; negotiations are underway with Iran; and the cherry on top – earnings season starts tomorrow. Traders might be forgiven if they were a feeling a little jittery. This morning the stock market headed into triple digit negative territory, (the Dow was down 200 points earlier) only to get an afternoon jolt of good news; namely, there may be a deal to be had with Greece. So, let’s dig in there.

Greek Prime Minister Alexis Tsipras is in Brussels for an emergency Eurozone summit. Over the weekend, Greeks overwhelmingly voted to reject more austerity. Actually, they voted on a debt proposal that is no longer under consideration, but figuratively they voted against austerity. Greek banks remain closed and ATMs are reportedly running out of cash. The European Central Bank has maintained its emergency loan cap for Greek banks. German Chancellor Angela Merkel said there was no basis for reopening negotiations with Athens. European leaders have all made clear the onus is on Greece to explain how it plans to pull itself out of the crisis.

Before the meeting, President Obama got involved; making phone calls to Merkel and Tsipras. At the meeting, Greece proposed a settlement until the end of the month; an intermediate stop-gap measure, with promises of a more substantive proposal to follow tomorrow. And the longer this drags out, the optics of soup kitchens upon soup kitchens paints an ugly picture of modern day Europe. And Sunday’s “no” vote is already resonating with several other Euro countries, especially the southern tier of nations. And the “no” vote was also a figurative vote to default on Greece’s debt to the IMF, and a defeat for Germany’s Angela Merkel and the Troika of creditors she led that insisted and continue to insists that there is no way out for Greece but to pay back its debt. The “no” vote was also a victory for democracy. We should have greater trust in the democratic process.

Most of the news stories about Greece harp on the idea that the Greeks are lazy and irresponsible; they borrowed money unwisely, they spent too much on pensions and other government giveaways, they didn’t pay taxes, and now they don’t want to pay their debts. The reality is that the effective tax rate to GDP in Greece (even after the tax evasions) was higher than ours. Their work week is higher than ours and Germany. And much of the country’s tax-collection problems stem from the fact that there are two and a half times more self-employed and small-business people in Greece than there are in the average country. And small businesses are expert at avoiding tax. If Greece were more like Germany, with big corporations and unionized workforce, in other words if they were more socialists, then tax collection would be much higher in Greece. And about irresponsibility, remember the banks decided to lend three hundred billion to Greece despite knowing all these facts (corruption, tax evasion). So who was more irresponsible, the banks or the Greeks?

Debt carries risk; risk for the borrower and risk for the lender. That is why borrowers pay interest on debt to the lender. The lender does not get a guarantee; they could lose their money; that’s how free markets work. And if the borrower does not or cannot repay, the lender does not enslave the borrower. We now have bankruptcy laws that allow a borrower to get out from under unsustainable debt and get a chance at a fresh start.

When it comes to loans, it takes two to tango. One party lends and the other one borrows. Both sides take risks and both sides receive benefits. It is incumbent on the lender to assess the risks and set interest rates at appropriate levels to compensate for taking the risk. If the lenders are not well-prepared they can lose. That is how a free market is supposed to work.

Greece’s lenders were not well prepared, and that was their failure. The loans were originally made by private investment banks, such as Goldman Sachs. And when they were staring in the face of losses, the banks managed to unload their bad debts onto the Eurozone governments, who were not well prepared. Germany and its allies should have left the debt in private hands where it belonged, but the politicians have a tendency to kowtow to the bankers, and that was their failure. The IMF’s own assessment of Greek debt, published just a few days ago, states: “Coming on top of the very high existing debt, these new financing needs render the debt dynamics unsustainable.” Germany’s own bankers knew Greece couldn’t pay this back. And yet Merkel persisted, demanding a pound of flesh in lieu of cash.

The IMF analysis also suggested the Europeans would have to accept a principal writedown. As a member of the so-called troika of creditors that included the European Commission and European Central Bank, the fund’s hands were tied from the start, and the analysis was little more than an admission of the inevitable; the bloodletting failed to cure the patient. An internal review in 2013 concluded that the IMF should have pushed earlier for a restructuring of Greece’s debt, which would have eased austerity and limited the economy’s contraction. As it turned out, Greece plunged into a much deeper recession than anticipated, with unemployment surging to about 25 percent. So, it wasn’t surprising that the Greeks voted against more of the same.

The Greek situation still is a long way from being resolved, but if Greece gets kicked out of the Euro, it wouldn’t be the worst thing that could happen.

Wiping out much of yesterday’s rebound, Chinese shares fell yet again today, casting doubt on the slew of recent support measures unleashed by Beijing. Traders are also getting increasingly nervous about the unusually large number of Chinese companies asking for their shares to be suspended. About a quarter of the roughly 2,800 companies listed in Shanghai and Shenzhen filed for a trading halt by the close on Monday, and another 200 announced a suspension today. In the face of a big sell-off, the Chinese answer is to stop the trading, and the logical next step is to forbid talking about selling. Shanghai -1.3%; Shenzhen -5.8%; ChiNext-5.7%.

Iran and six major powers will keep negotiating past today’s deadline for a long-term nuclear agreement as they try to tackle the most contentious issues, including the continuation of a UN arms embargo on Iran. The spokeswoman for the US delegation said the terms of an interim deal between Iran and the six would be extended through Friday to give negotiators a few more days to finish their work. The negotiations have been impacting the price of oil. Yesterday, US crude oil futures dropped by 7.7%, or $4.40, to close at $52.53, almost rivaling the price decline in the aftermath of OPEC’s decision to not intervene in oil markets last year.

Lawyers for Puerto Rico have asked the U.S. Court of Appeals in Boston to reinstate a law to help it deal with $72 billion in debt. The court resisted, agreeing instead with a San Juan judge who threw out the statute in February. The dispute centers on whether the island, which is excluded from federal bankruptcy code regarding municipal entities, can make its own rules for allowing public agencies to seek protection from creditors. In a majority decision, the appeals court wrote: “In denying Puerto Rico the power to choose federal Chapter 9 relief, Congress has retained for itself the authority to decide which solution best navigates the gauntlet in Puerto Rico’s case.” Barring help from federal lawmakers, the decision means Puerto Rico will have no other choice except to continue piecemeal negotiations with creditors.

We have a couple of economic reports today:
Corelogic reports home prices increased 1.7% in May, while year-over-year growth rose to 6.3%, the fastest annual pace since last July. CoreLogic expects home prices to slow to annual growth of 5.1% by May 2016.

The US trade deficit widened in May as exports declined by the most in three months, showing businesses were having trouble drumming up sales to overseas customers. The gap grew 2.9 percent to $41.9 billion from the prior month’s revised $40.7 billion. Domestic crude production reduced America’s imported fuel bill, which dropped in May to the lowest level since February 2002. While persistent US household spending led to record automobile imports.

Job openings at U.S. workplaces rose to a record high of 5.36 million in May. Compared with same period in the prior year, May’s job openings rose 16%.  With 8.67 million unemployed people in May, there were about 1.6 potential job seekers per opening, matching April’s ratio. In May 2014, there were about 2.1 potential seekers per opening.

Alcoa kicks off the second quarter earnings reporting season tomorrow after the closing bell. A recent report from FactSet examines expectations for second quarter earnings as reporting season approaches. According to the report, year-over-year earnings and revenue for the S&P 500 are expected to decline by 4.5% for the second quarter of 2015. If that happens, it will mark the largest year-over-year decline in earnings since the second quarter of 2009. The last time the index reported a year-over-year decrease in earnings was a 1.0% dip in the third quarter of 2012. Companies that generate more than 50% of sales inside the United States are anticipated to have an earnings growth rate of 0.3%. Companies that generate the majority of their sales abroad, however, have an estimated earnings decline of 11.4%.

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.