Remember that equity investors tend to enjoy strong returns in the absence of recession, which dents returns, or war and revolution, which can result in a permanent loss of capital. With those caveats in mind, the market gods are presenting patient investors with three gifts from the three economic blocs in the world: the U.S., Europe, and China.
Who needs a market timer during conditions like those? One leading stock-market timer I monitor told me that during the market’s blow-off stage between last November and the late-January peak, he lost 18% of his subscribers. He added that he’d never before experienced a drop in subscribers of similar magnitude — much less over so short a period.With those factors in mind, I analyze some of the scare stories that have come across my desk in the last few weeks and show why they should not be reasons for panic:
Glenn Neely, editor of the NeoWave market-timing service, said 2016 and 2017 were some of the most difficult he’s experienced in a 30-year career.
One example of this is cars and trucks. Spain has long been the second-biggest manufacturer of vehicles in Europe. (The plants are all owned by the major German, Japanese, American, Korean, and French labels, but the cars are made in Spain.) However, the trade surplus has increased since the crisis.In addition, the country is undergoing a productivity boom as the financial excesses of the last cycle have been repaired (emphasis added):
At the 2007 peak, Spain made around 2.9 million cars. Now it makes closer to 2.6 million. Meanwhile, domestic car sales collapsed from about 1.6 million before the bubble to around 900,000 now, although Spanish new car registrations are now growing by more than 20 per cent annually. More than 80 per cent of the cars currently made in Spain are exported elsewhere.
At the peak in the middle of 2008, Spanish banks were sending about 3.4 per cent of Spain’s GDP to foreigners. Now they send less than 1 per cent. Meanwhile, Spain’s banks still receive almost as much income from abroad, as a share of GDP, as they did before. The overall difference between payments to foreign holders of Spanish assets and income received by Spanish holders of foreign assets has shrunk by about 2 percentage points of GDP between the start of 2009 and the end of 2014.
The last point we want to highlight is that, despite the extensive deleveraging in the aggregate, particularly among Spanish businesses, the most productive and export-oriented firms actually increased their borrowing to expand capacity and invest in domestic production. This could help explain the post-crisis Spanish productivity boom.
Researchers at the Banco de Espana have found that the businesses which were relatively less indebted going into the crisis generally had better sales and profit growth since then. Importantly, these firms took advantage of changing economic circumstances by borrowing to boost capacity and hire more workers. By contrast, the businesses that borrowed during the boom generally had falling sales, and had to respond by firing workers, cutting investment, and repaying their debts. (This is sort of similar to what other economists studying the US have found.)
The government of Prime Minister Mariano Rajoy bowed to austerity demands, cut public-sector wages and benefits, and increased VAT to 21 percent (with exemptions) from 18 percent. Had he stopped there, Spain might have bumped along the bottom for a good while longer, rather than seeing the recovery it's now enjoying.The second and equally important part was the micro-economic solutions of structural reform:
But Spain's recovery today also owes a lot to hard reform aimed at particular failings in the economy. The Rajoy government braved street protests and the rise of an anti-reform left-wing opposition and persisted in a deliberate rewiring of the Spanish economy, with an emphasis on far-reaching labor-market and tax reforms.The draconian approaches began to pay off, though there was an element of luck involved.
In 2014, the government said it would gradually lower the corporate tax rate to 25 percent from 30 percent. The top marginal rate on personal income will fall to 45 percent from 52 percent. The government is limiting deductions, broadening the tax base and making a serious effort to curb evasion.
Companies have been given more flexibility to set wages and working conditions. Wage growth that had run ahead of productivity has moderated. The barriers that created Spain's notorious two-tier labor market, with its underclass of workers on temporary contracts, have begun to fall.
Low inflation, a cheap euro, the fall in energy prices and renewed financial stability in Europe have supported consumer spending and lifted Spain's beleaguered retailers. Holidaymakers have favored Spain this season, too -- in part because visiting Greece without bundles of cash has presented difficulties. Put much of all that down to luck.
Spain seems to have done everything right — within the constraints imposed by membership in the euro area and the European Union more generally. Debt is down, reliance on foreign capital is down, exports and productivity are up. And the economy is, finally, growing at a brisk clip. The government is planning on cutting corporate taxes to boost investment and using some of the windfall from faster growth to lower personal income taxes, which ought to help households.Moreover, long-term unemployment remains stubbornly high (via Ian Bremmer):
Yet for all the recent progress, Spanish unemployment remains tragically high. Anything resembling a healthy economy is still years away.
What else could Spain have done? What else can it reasonably be expected to do?
It doesn’t bode well for the future of the single currency if the country that followed the policy recommendations of Europe’s leaders most closely, and which embraced some of the best economic governance on the continent, requires a decade or more to return to normalcy after a crisis.
It is also the story of two parties talking at each other instead of with each other. The Greek approach, which is top-down and macro oriented, rests with the idea that somehow the country can return to sustainable growth if the macro problem of excessive debt were to be lifted (and hopefully coupled with some form of stimulus plan).Let me expand on those points.
By contrast, the (mostly) German plan is highly bottom-up and micro-economic oriented. Its underlying philosophy calls for getting the right market mechanisms in place, e.g. cost structures, labor market reforms, the right incentives, etc., and growth will naturally follow. The problem with this approach is that Greece, unlike countries like Ireland, has few competitive advantages. The EU mandated solution amounts to forced internal devaluation. It would mean that, in the example of textiles, that Greek wages would have to fall even further to levels that competes with the likes of China, Vietnam or Thailand.
WSJ: Austerity means different things, what’s good and what’s bad austerity?The second is structural reform:
Draghi: In the European context tax rates are high and government expenditure is focused on current expenditure. A “good” consolidation is one where taxes are lower and the lower government expenditure is on infrastructures and other investments.
WSJ: Bad austerity?
Draghi: The bad consolidation is actually the easier one to get, because one could produce good numbers by raising taxes and cutting capital expenditure, which is much easier to do than cutting current expenditure. That’s the easy way in a sense, but it’s not a good way. It depresses potential growth.
WSJ: Which do you think are the most important structural reforms?The purpose of structural reform is to attack the youth unemployment problem by getting rid of the idea of a job for life mentality (emphasis added):
Draghi: In Europe first is the product and services markets reform. And the second is the labour market reform which takes different shapes in different countries. In some of them one has to make labour markets more flexible and also fairer than they are today. In these countries there is a dual labour market: highly flexible for the young part of the population where labour contracts are three-month, six-month contracts that may be renewed for years. The same labour market is highly inflexible for the protected part of the population where salaries follow seniority rather than productivity. In a sense labour markets at the present time are unfair in such a setting because they put all the weight of flexibility on the young part of the population.
WSJ: Do you think Europe will become less of the social model that has defined it?What Draghi outlined in 2012 were micro-economic prescriptions. Get the economic structures and incentives right and growth follows. That has been the template all along.
Draghi: The European social model has already gone when we see the youth unemployment rates prevailing in some countries. These reforms are necessary to increase employment, especially youth employment, and therefore expenditure and consumption.
WSJ: Job for life…
Draghi: You know there was a time when (economist) Rudi Dornbusch used to say that the Europeans are so rich they can afford to pay everybody for not working. That’s gone.
The clue is governance. Professor Kalyvas traces some roots here back to Greece’s emergence from an economically backward, agrarian corner of the Ottoman Empire into an aspiring modern state. Specifically, he notes the considerable challenge of trying to graft liberal and democratic institutions and practices on to such a society. Put another way, public administration, the structural backbone of the modern state, is in Greece’s case unfinished, and in some respects even un-started, business.These kinds of cozy relationships are not unusual in cultures where the population doesn't trust the sovereign (government is the wrong word in this case) because the sovereign can change at any time. In such instances, trust is not formed based on bureaucratic structures such as the rule of law, but on family and clan-like relationships that have been created over the years. These cultural norms are common not only in southern Europe but in much of Asia.
With this in mind, it becomes clearer why creditors have moaned that Greek governments often lacked the capacity to implement reforms properly or, in some cases, at all. In Syriza’s case, the problem of lack of capacity has been accentuated by lack of willingness. This year, both sides argued a lot about debt relief, primary surpluses, VAT rates and pension arrangements. But many of their disputes were bridged or narrowed significantly. What irks Europe most about Syriza is the latter’s inaction with regard to initiatives to overhaul governance. In other words, to improve the capacity to implement reforms by addressing dysfunctional institutions such as administrative capacity, a weak tax system, over-regulation and protection, corruption and the rule of law, and the privileges of oligarchies, professional associations and other vested interests.
Reflecting these flaws, Greece has tended historically to protect domestic sectors, nationalise weak or failing firms, rely on credit creation as a substitute for productivity growth, and use political patronage to expand growth in the public sector. The PASOK government (1981-89), for example, is argued to have created dysfunctional public administration, civil service and wage-setting institutions that were associated particularly with corruption, mismanagement, maladministration, and disregard of the rule of law.
Even in subsequent years, entrepreneurship and industry were left behind. Greece has not developed a vibrant, successful export sector, other than in tourism and a few agricultural products. Unlike, say Poland, the Czech Republic, Turkey, and much of Asia, including comparable per capita income countries such as Vietnam and Bangladesh, it hasn’t got a viable manufacturing sector. The World Bank’s annual Doing Business survey (2015) still ranked Greece at 61 of 189 countries around the world, with positions close to the bottom in the registration of property, and contract enforcement.
Ironically, Syriza articulated a made-to-measure analysis and diagnosis of governance problems in its 2014 Thessaloniki programme, which sought to end “decades of misrule”, and transform Greece’s political system and institutions. It argued quite coherently that this was essential to break the vicious circle between political and economic inequality.A recent article in the Guardian echoed similar concerns:
Yet, since being voted into office, it has offered little and done less to live up to this transformation. It is telling that Europe’s final loan conditions before the referendum laid considerable emphasis on governance enhancement, spanning measures to strengthen transparency, price competition, privatisation, and the rule of law, and to attack corruption, fraud and tax evasion. Alexis Tsipras rejected these and other conditions, and lumped them together, accusing his counterparts of blackmail. But without addressing these crucial matters, Greece cannot hope to succeed inside or outside the eurozone.
What Syriza has done is to bring back some of the worst excesses of its predecessors. The state broadcaster ERT – scrapped abruptly by the previous government under the impulsive and irascible conservative, Antonis Samaras – has been reformed. But instead of fresh blood, the government put ERT’s tainted former leadership back in charge. The return as chief executive of Lambis Tagmatarchis, a television executive associated with the governments who ran up Greece’s debt pile, outraged even the ERT employees who were getting their old jobs back. From prefectures to court appointments, party hacks have been favoured over more qualified counterparts. This is indiscernible from the cronyism of old.So when Europe talks about reforms, that's really code for:
The gap between Tsipras’ rhetoric on social justice and progressive policy and his record in office has left some to conclude that Syriza is more intent on consolidating its power than delivering the reforms-for-cash deal with creditors that he claims to still want. If not a deal, then what does he want, critics ask?
The Formula is timeless and in each and every basic economics text. (It gets less respect because it is a dry-as-dust fiscal equation compared with the steamy romance of monetary math.) In fiscal crises, the best-and-brightest always trot The Formula out. The truth is the dynamic simplicity of The Formula's core -- the (r-g) in the above -- always bears repeating.Longer term, Greece needs growth to be higher than its nominal interest rate. Another way to get relief is to change D(t), its debt to GDP ratio, which is what Athens is seeking.
The relationship is: A nation's debt-to-GDP ratio is equal to the critical dynamic of its nominal interest rate (the "r" in the above formula) minus its nominal growth rate (the "g"), applied to the previous debt-to-GDP ratio and then all of that compared to the nation's overall growth rate. Then take that movable feast and subtract the massive weight of its primary budget surplus. It is a deceptive and simple relationship but, in crisis, there is one key moving part. The key moving part, again, is (r-g). The "g" must equal or be higher than the "r" in The Formula. If the nominal interest rate ("r") is higher than the nominal growth rate ("g") then the government will face an ever-increasing debt-to-GDP ratio.
Can we be more realistic regarding Greek prospects of growth? That's what they IMF is doing now. It forecasts growth in Greece to be input 1.5% in the long term. This is what I would say a very pessimistic number (even if it might still be realistic). It assumes that a country that has a GDP per capita of less than 50% of the most advanced economies in the world will fail to converge to that level, in fact it is likely to get stuck at that level or even diverge.At the end of this debate, we have to ask ourselves as to who is right and who is wrong.
And here is where the Greek government and the IMF projections might be at odds. The Greek government argument is that once debt is reduced and all the reforms are implemented, the Greek economy will take off and start finally growing. But if growth returns, is debt really unsustainable Greek debt is unsustainable because the Greek economy will not grow in the long run (and this is not just about austerity). But if the Greek government is right and the reduction in debt does indeed raise the potential growth of Greece then the current debt level might be closer to being sustainable than what the IMF says. In other words, the IMF tells the Greek government something that they want to hear (debt needs to be reduced) but in an scenario that the Greek government cannot accept (growth is going to be dismal for decades).
Greece faces multiple impediments. The biggest is that financial time moves faster than political time. Greece needed a deal by June 30. Going past that event horizon, as events are going to prove out, tipped the scales decisively against Greece by given the creditors cover to give their real enforcer, the ECB, free rein. Changing values and ideology are decades-long projects, so moral appeals might make for nice op-eds but will not change the power dynamics in time to have any impact. Look at how long it took for women’s rights and civil rights to become accepted in the US, or even with extremely deep pockets and the most sophisticated messaging money can buy, how long it took corporate interests to move values in the US decisively to the right. Greece was far too small and economically weakened to confront the creditors and have any hope of succeeding unless it got support. Its only conceivable allies are nowhere to be found. The Obama Administration has gone all in with the Eurocrats and the European left has been missing in action.Here are the two basic scenarios that I am working with. Either Tsipras' ultimate objective is to take Greece out of the euro, which would also put their EU membership at risk, or there will be a deal.
As we’ve said from early on, many commentators on Greece have wanted to make Syriza into something other than what it is. Despite the bold talk and some Marxist trappings, the core of the party leadership is moderates and its base consists heavily of disaffected Pasok voters, not hard core leftists. And this sadly, is the flaw of the stirring call to action in this post. Even after its incredible suffering, Greece is not as radicalized as those outside Greece would like to believe. The high percentage of Greeks saying, even on the eve of the referendum, that they still wanted to remain in the Eurozone, shows that Greek society is not willing to make a break even from its punitive overlords Syriza’s new coalition with centrist, pro-business parties should dispel any doubt as to what Syriza really stands for, as opposed to what Tsipras would like you and Greek voters to believe.
Of the many unique aspects characterizing contemporary monetary policy, one which may prove very important for the stock market is “how long” the Fed has waited to begin the tightening process. Our concern is not that by waiting so long, the Fed is behind the curve (although that also is possible). Rather, by waiting too long to start the process, the Fed has allowed its traditional exit ramp (i.e., raising interest rates against strong gains in corporate profits) to expire. Consequently, the Fed is now about to begin the process of raising interest rates without its traditional buffer of recovering profitability.Jim Paulsen is no permabear and his views add a fresh perspective on the macro outlook for equities. He has been increasingly cautious on the stock market and his views should be given due consideration.
1. Greece misses its IMF payment on the 30th of June. This could be a trigger but it may not be. The IMF has 30 days to call Greece in arrears so technically Greek government guaranteed collateral, and hence the Greek banks, are still solvent after the 30th. However on the 20th of July the Greeks will surely default to the ECB without a deal. This is the official d day.A weaponized financial system indeed! These kinds of bare knuckled negotiating tactics are likely to push Tsipras into blinking, signing a deal and falling on his political sword. As the time of this writing, Bloomberg has reported that Tsipras has presented Merkel, Hollande and Juncker a last-minute proposal that crosses his own red lines on pension reform. We'll have to see how much ground Greece has given and if the provisions are satisfactory for the Eurogroup.
2. Upon default, the collateral at Greek banks cannot be posted any longer to the Euro system. The Greek banks then become insolvent and the ECB, through the newly created Single Resolution Mechanism (SRM), is obligated to resolve the Greek banks. [Cam: Klaus Regling of the European Stability Mechanism has stated that their loans are linked to the IMF and a default to the IMF is a default to ESM.]
3. So the ECB goes to Tsipras and tells him – we are immediately instituting capital controls [Cam: Actually the decision to impose capital controls is up to the member state and not the ECB, but that's only a minor detail] and we will begin resolution of your banks unless u sign the agreement and re-enter a program. Without a bailout program in place the Greek government, and banking system, are both insolvent. So Tsipras says – what do you mean resolve my banking system? And then Mario explains as follows. First we wipe out all equity and bond holders. And then, as in Cyprus, we bail in depositors. There are 130b in Greek deposits against 90b in ELA. And while those deposits are technically insured up to 100,000 euro, there is no pan European bank insurance yet in place. That only comes in 2016. Right now Greek deposits are only insured with a Greek deposit insurance fund that has about 3b in it. This Is hardly enough for the 130b in deposits. So we take the 130b against the 90b in ela. Any remaining deposits go to fund a bad bank that begins resolving all the NPLs. The good loans of course will go into a good bank which will be funded with German capital and most likely will have a German name. Of course depositors will get 2 to 3 euro cents on the dollar for their existing balances from the 3bio in the insurance fund. So you have that going for you!
4. Tsipras hyperventilates and quickly reaches for a bottle of ouzo.
5. Then it’s basically time for the gallows. He either signs a document cutting pensions, raising VAT and violating all his red lines. Or he takes the Greek people into bankruptcy and out of the euro. Either way he is a dead man. His own party destroys him if he does the former [Cam: and his wife leaves him]. And the 70 percent of Greek who want to stay in the euro destroy him if he does the latter. Of course there is one other choice for Tsipras. He could just resign and call for new elections. In that case maybe the banks stay closed and the ECB does not start the resolution process until the Greek people decide what they want. But in any event, it’s over for Tsipras in that case as well.
The German fiscal disciplinarians have won the battle. Tsipras dies under that bridge. The end!
