Romney-Obama and the Stock Market

 

As you all very well know, the US elections will take place next Tuesday after an hectic political race for the two contenders. If the consequences of this race for presidency will indeed have a far greater impact on millions of individuals than a simple income change, the economic outlook and program took a major role in the various debates, as the extremely famous "it's the economy, stupid" reminds us. As Governor Romney and Wisconsin vice-presidential candidate Ryan likes to point-out, if the US is slowly paving its way out of recession, it seems to be more of a "jobless recovery" than anything else. The current situation is definitely worrisome : 47 million Americans on food stamps, unemployment at 8% since 2009 and the global financial crisis (according to the Bureau labor of statistics...), a dampened geopolitical role and stance... In this context more and more Americans are looking for facts and measures that are likely to solve their everyday problem : a job and nothing more. 

If in the short-term the elections will bring some relief to distressed markets (the elections are certainly a major uncertainty for investors and other market actors)  it is quite interesting to have a look at each program and analyze its direct outcome on the economy and the stockmarket (disregarding any other considerations) in the short term - :

The Monetary Policy : Fed Chairman Ben Bernanke has been using an extensive monetary easing policy. With ever-low interest rates thanks to quantitative easing measures (increasing the monetary base by 40 billion a month by buying mortage securities), the strategy has clearly been used to spur growth and restore confidence in markets, in particular in the housing sector. If it is hard to appreciate the success of this policy, as it is not possible to say what the growth and general outlook would have been without it.

The main question behind the Fed is, would Bernanke be reappointed if Romney is elected? It seems quite unlikely after Romney stated in September that Bernanke's QE3 was just "another bailout for the Obama economy". Ideologically as well,  the Romney stance seems to stand far from this kind of "public" market intervention. If Romney appoints any other Fed president less in favor of easing policies, it is likely that this will put pressure on bond yields and therefore US bonds will lose their value.

 

Stock Markets :

Stocks markets are certainly harder to forecast : they are more driven by "market sentiment" and are often disconnected from fundamentals (Recently spanish equities have been rallying on bad economic figures..mainly because markets consider such information as a step forward a bailout). However this Barclays study singles out that market expect Romney's stock markets to outperform Obama's :

 

If these polls give a good idea of market sentiments on the election, it is more relevant to look at the effect on individual asset classes :

Gold : Based on Obama's win and the continuation of an expansion of the monetary base, we can foresee gold edging higher, even perhaps breaking the psychological resistance of 2,000$ after a possible QE4. It seems as though at this point only further expansionary monetary policies can increase gold prices, trading more or less at a all time high (see below).

Energy stocks : Romney has a free market ideology and is a defender of the "invisible hand" of markets - and has announced that he will increase building permits for exploitation of oil and gas lands. This is certainly a clue towards higher stock prices for exploration and exploitation of natural resources - coal in particular (After his announcement during the 1st debate, some coal stocks increased as much as 7% intra-day).

"Green" stocks : Energy-efficiency companies are likely to take a big hit if Romney wins the race to the White House. After the GFC, Obama pumped almost $50 billion into energy efficiency companies in the form of tax reduction, subsidies and low interest loans. This is likely to end or at least to be drastically reduced under Romney's presidency.

Health care and insurance companies : The termination of Obamacare under a Romney presidency will trim profits and hugely impact stock prices of health care providers.

In general terms, any company or institution benefitting from taxpayers money would be endangered by a Romney win. The GOP actually declared that there is no need to lower interest rates as the housing market should recover by itself, and that he would not have bailed out GM. Even though I have described the main possible impacts of Romney/Obama possible actions if they were to be elected, it is very likely that their actual program do not differ as much as they claim to. In fact, I believe that the stock market and the asset classes I pointed out will react more because of market sentiment more than any actual fact or difference in government policy. If Romney is elected, will he really let GM fail if they were to be bankrupt again? Would the Fed quantitative easing keep on if Obama gets re-elected? It is very uncertain - in the face of adversity and the fiscal cliff, each candidate will have to make major compromises both because of the congress and the overall situation of the US (fiscal cliff and slow recovery).

Can Super Merkel save the Euro? - Market update

Nothing really happening recently on financial markets that have been quite snoozy lately. No news is good news? It seems like it. Despite the lack of any update on ECB's (European Central Bank) intervention on markets or any good economic figures, European markets are rallying (Friday : IBEX 35 = +1.94% - FTSE 100 = +0,31% -  DAX = 0.64%) - supported by the financial sector dynamism (Bankia went up  50% two weeks ago due to the fact that the financial aid it needed is to be completed in a very near future). The spanish 10 yr bond dipped from 6.84% to 6.54%, as well as the Italian 10yr bond even though its decrease hasn't been as sharp as the Spanish'.

The main underlying question laying behind this flitting momentum is the following : Will Merkel and Germany allow and proceed to purchases on the secondary bond market by European institutions to lower bond yields. It appears that this option is pretty much the last one that could save the Euro if uncertainty and poor confidence still characterise the market over the next few weeks. In fact, analysts believe that the euro bailout funds would not be sufficient to provide a full bail out to both Spain/Italy, which would cost at least  € 1 trillion  (bail out funds amounts to approximatively  €700 millions.

Hence in this scenario, the only safety net is the possibility of the creation of a banking license to the ESF (European Stability Fund) , which would enable it to create and pump in money in Euro distressed bond markets to lower yields. This is of course a very well-intended proposal despite the risks of inflation - increasing the monetary base would enable the ESF to lower yields in peripheral euro countries  and give them time to reduce their structural deficits (as opposed to cyclical deficits). Sounds nice in theory, and the only thing really left to us is to hope that it will be "enough".

Unfortunately, there is quite a large room of concerns on this ECB "Quantitative Easing for Southern European Countries"

The Bundesbank, Germany and Northern European countries except France are quite strongly opposed to ECB's possible intervention. They consider that those kind of actions should be decided by parlements and not by central banks, and are worried it may become an 'addictive drug' without solving the roots of the problem.

And that's the core of the problem. There is no doubt that bond yields will go down if ECB decides to intervene in the market - at least in the first place.

Markets will even respond positively and rally for a bit. 

But over the long-term many concerns will remain, and risk mitigation is highly unlikely. Why?  :

1.  Will a real fiscal and bank union will take place? This sounds really doomed as both sides stand their ground and do not seem keen on a compromise. Germany and Northern European countries are not willing to increase inflation in their countries (pay rise or any other minimum wage) and the rest of Europe leaders are having a hard time cutting down on social benefits and other public bodies. No compromise = No union = Higher perceived risk by markets. 

2. Lower bond yields are likely to be only a fad. Why? Many hedge funds and other participants in the bond market sell their holdings after public intervention in the market. In fact, if the ECB buys bonds it will be a preferential creditor of Spain. In other words it will be repaid first and before any other creditor (ie : hedge funds, banks..). This creates an additional risk and this result in bonds sell-off, more information here : http://www.businessinsider.com/the-basic-arithmetic-behind-investors-biggest-fear-in-europe-2012-8

Lower yield means a higher bond value - hence many bond holders leave the market after public intervention. Except if growth expectations improve in the long run, nothing will really prevent bond yields to spike up again.

3. ECB buying bonds is likely to spark up some tensions amid distressed Euro countries (Portugal,Ireland..). Those countries have even higher borrowing costs than Spain or Italy (9.45% for the Portuguese 10Y - 8.2% in Ireland and more than 20 in Greece). Their reasoning is the following : Why would this country get the help of the ECB to have lower borrowing rates when mine does not? The role of the ECB is meant to be impartial and not to favour any country specifically - which is particularly opposed to a such intervention.

Breaking up the Banks or Too big to be broken up..?

Some very interesting events in the financial news appeared to have dust off the path to a bank breakup.

In the wake of the GFC and the numberous financial scandals tied to it (Lehman Brothers and the subprimes, Goldman Sachs,AIG..), a strong wave of popular discontent affected the financial sector. Investment banks were pointed out as responsible for the GFC because of their always more dicey bets jeopardizing current accounts of billion of individuals and threatening economies on a broader scale. After massive growth stimuluses of governments and the bailing out of many banks and financial institutions over the world, growth timidly restored confidence into the financial markets. Except few attempts in Europe to regulate markets (such as the Mifid), nothing much came out of our "uninspired" regulators.

However, we have recently seen voices being risen for more regulation in the financial sector. The roots of these claims are quite easy to identify - more financial scandals have been revealed lately ( JP Morgan and the London Whale, the LIBOR, tremendous bonuses package given after the GFC..) and the sector seems not to have learnt much from its mistakes and still has many blunders to be fixed. Even Sandy Weil, former CEO of the gigantic Citigroup, has said to be favourable to a bank breakup - stating that "(we should) have banks do something that's not going to risk the taxpayer dollars, that's not going to be too big to fail."

The main advantage of a bank break - up is quite obvious : no more "Too big to fail", in other words bailouts would no longer be necessary to save Banks if those have made "bad bets". Jamie Dimon, CEO of JP Morgan Chase - one of the biggest financial institution of the US and the World - revealed during its hearing of the $5.8 billion "London whale" trade loss the difficulty of clearing position of a such scale. The actual size of banking conglomerates puts extra pressure on clearing trades - the bulk positions that those banks take because of their "balance sheet" size - make it difficult for them to close these positions because of market liquidity. Hedging - more or less taking risk-off on a trade by taking another position - is even more complicated when trades are amounting to billions of dollars (see what Dimons says at 3.00) :

Globalization and the concentration in the financial industry has led to an odd facts : many European banks are now bigger than countries :





On the other hand, a regulation to break-up banks is quite complicated to make and would most likely take years to be put in place. On top of that, some bank CEOs and other economists question the real efficiency of a bank break-up. What are their arguments? According to former U.S senator Chris Dodd on CNBC, breaking up the bank is not the solution. In the short-run, it seems obvious that the banking sector would be substantially less profitable if it was to be broken up in two parts. In fact, the participation of banks in both investment & commercial banking enable them to lower costs (the funds banks need to invest come largely from client's deposits with economies of scale on top of that - even if this is to be restricted by the Volcker rule i.e proprietary trading rules). In addition, being part of the investment business can be seen as an incentive for commercial banking to lower interest rates - obviously having a stake on companies profits and the overall economic performance can  be a reason enough for banks to discount loans or at least not to "make too much" profit out of it. If US banks are eventually split, they will lose a part of their business activity and European banks, who do not have to be split between commercial and investment banking departments yet should logically benefit from the US split.

If a bank split up can definitely bring on many advantages in terms of risk management for individuals and countries economic stability, it will take a long time to be implement. It is not really about how big and how complete the regulation is in the end but about how efficient it is.

Is the financial sector too big? Indeed those last two graphs would need to be compared to some other countries since "developed" countries financial companies' have obtained market share from developing countries (which would explain for the increase on both exhibit) but it is still very interesting to take a look at it :




J.L

The Great Depression (II)


Introduction

This first article will cover a very interesting topic that will certainly have a major impact on our future and the one of the new generation to come : the debt crisis. I enjoyed watching this video because of Schwartz demonstration and the courage and eloquence he has shown during the entire speech. Deconstructing a Nobel prize laureate's book in front of a whole crowd is no easy task, but despite the likeliness of the crowd embracing Krugman's ideas, he developed his arguments very calmly and in an organised manner.

It appears to me that the debt crisis (2010 - now) was caused by many factors, but mainly those two : an "unsustainable" level of debt (or at least unsustainable with regards to markets' criterias) and declining economic growth expectations in southern european countries in the first place and thereafter northern european countries. It is quite simple to comprehend that, as economic growth expectations of european countries worsened , their overall capacity to generate income through tax and other levies decreased. At the same time, their spending remained stable and the deficit created by this situation (the European average deficit in 2011 was 4.5% - due to cyclical deficit for a certain part) affected the credit situation of public governments. This situation spooked markets, creating a massive sell-off of sovereign bonds (investors were more and more afraid that government would be unable to service debt and therefore they have been keen to sell governments bonds) hence increasing bond yields & therefore the interest countries borrow at, and eventually putting heavy pressure on governments' ability to generate income.

Why only Europe?

Interestingly enough, the main focus of the financial market since 2010 is Europe - others political leaders of the world blame those 17 countries of the euro zone for not solving the crisis fast enough (Obama, Hu Jintao..) and if bonds yield increased massively in Southern Europe (Spain's bond yield was around 3.5% on in 2005/6 , it is now close to 7.6%), they remained very low in other international markets (Japan,US..). It is then legitimate to ask ourselves the following question : are those following countries in any better economic shape?

A few figures - Debt to GDP 2011 - US 100% , Japan 211%, Euro Zone 85%
                         GDP Growth - 2011 US  1.7%  , Japan  - 0.9% , Euro Zone 1.5%
                         Public Deficit - 2011 US 9.8%  , Japan 10%, Euro Zone 4.5%

Even if those figures do not represent effectively the overall situation (more data would have to be taken in consideration), my point is that those countries in particular and others "western" economies do not have any healthier financial situations. If Japan is so far sort of protected by the fact that its debt is mainly held domestically and therefore bonds sell-offs are unlikely - the US is in a much more complex situation, with a fiscal cliff threatening to trigger the low growth miraculously obtained from then. The markets are focusing on the most recent news and the most dreadful investment area- thus lower yields on bonds markets in France/Germany/US/Japan..etc is not necessarily a sign of a lower expected risk but a sign of a lower expected risk as compared to other economies. When those other economies will have either defaulted or sorted out their debt issue, I believe the same kind of surge in bond yield and difficulties in repaying debt is likely to happen in those countries if no public policy change is taken on.

At the same time, we have seen the failure of deep austerity in Greece/Spain : the cut in governments spending eventually led to lower economic growth and the government is failing to decrease its deficit & debt. Obviously balancing the government budget of countries where the debt accumulated during decades, with a public sector topping up 40% in the span of a few months seems barely conceivable... If Keynesian economics have been applied to increase debt during crises to artificially increase demand and restore confidence and economic growth, governments have failed to recognize the importance of government surpluses during expansionary phases. The reason? It seems like it is a "bit" easier to get re-elected if you publicly announce that the country will grow in the future, that it will create job, and that the public sector will help everybody (even if taxpayers will eventually have to pay for it, the cost is quite low in the short term so who really cares?..). In the face of such a debt crisis where medias blame no one but the financial industry (which is far from being exempt of scandals ie: GM sachs, Libor, the GFC..), it is quite surprising that nobody questions the sustainability of our growth that has been accumulated for decades. Which part of our debt has been used for sustained long term growth (infrastructure, education, projects..etc) that will drive us for many years ahead? 

Unfortunately, the rules of economics always apply : if the increased income generated by debt (we can consider it as an investment) is lower than its interests, then  debt did not generate any wealth in the long-run. When interests are low (gov.bond yields), many loans can be taken on to balance high unemployment with extra public employment/consumption. But when the debt is too high and private investors show worries... Things slightly change. 

This is mainly what happened for many years - our policy makers seem to have always favoured short-term interests as Mr.Schwartz (demand) depicted rather than long investments that would not show up before years.

Solutions?

Our ever more creative policy makers will have to face a very depressing conclusion : what we do so far does not work. Our countries entered a phase of de-leveraging - and it is very likely that people will realize that growth is not permanent and that the whole economic system needs deeper reforms. Schwartz makes a point - demand side economics are flawed in the long term - credit boosted demand can not be sustained and appears as a way to restore confidence only. Many economists pointed out that high levels of government debts (above 80%) are jeopardizing growth. Likewise, some of the fastest growing economies at the moment have very low government debts (China,Australia,Brazil,India,South Korea and South Africa..). Our countries should realize that savings and long term investments are not opposed to consumption and are key to economic development as well.

Putting in place austerity measures is necessary but is definitely not the solution in the long-run : European reforms to share debt, monetary policy (and in the long term economical structure) and eventually a whole new capitalism taking in consideration the fact that growth is not indefinite will need to emerge...When is enough "enough"?

J.L