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The Eurozone Could Be A Problem For Stocks
Submitted by Lance Roberts of STA Wealth Management,
A few weeks ago I asked a simple question: "Can The U.S. Economy Stand Alone?"
"The following chart is food for thought. There are extremely high expectations that the U.S. economy will achieve “lift off” in terms of economic growth eventually achieving 3-4% annualized growth rates. The chart below shows the nominal GDP of the Eurozone and U.S."
Is it possible, that in globally interconnected economy, the U.S. can stand alone?
It certainly seems that the answer to that question is currently "yes" as financial markets hit "new all-time" highs and economic data has rebounded in the second quarter following a sharp Q1 decline. However, as is always the case, the issue of sustainability is most critical.
Sy Harding recently wrote an interesting piece entitled "The Eurozone Is A Growing Problem For U.S. Economy?" in which he cited three very crucial points relating to the issue of sustainability:
- The 18-nation euro-zone is the largest economy in the world, eclipsing that of the U.S.
- The euro-zone is the largest trading partner of the U.S. (the largest importer of U.S. goods, the largest exporter of goods to the U.S.).
- The euro-zone is in an economic crisis.
The chart of GDP above clearly illustrates the importance of Sy's points. Importantly, the economic conditions in the Eurozone are getting "worse" rather than "better." According to Sy:
"It slowed further to 0.0% quarter-over-quarter in the second quarter.
Worse, Germany, the euro-zone’s largest and previously strongest economy, unexpectedly saw its economy contract to negative -0.2% in the second quarter. France, the second largest euro-zone economy, saw its growth slow to 0.0% for the quarter. Italy, Europe’s fourth largest economy, slid back into recession, its GDP at negative 0.8% in the second quarter, its second straight quarterly contraction.
Reports this week indicate the problems are worsening in the third quarter.
Retail sales in Germany plunged 1.4% in July, after declining 0.4% in the second quarter.
Germany’s Ifo business confidence index fell in August for the fourth straight month, to its lowest level since July 2013. Market research group GfK reported its German consumer expectations index 'collapsed' in August to its most pessimistic level since 1980. Perhaps for good reason, since the overall euro-zone’s unemployment rate remained in double-digits at 11.5% in July, just 0.5% lower than its peak of 12% in 2013."
The following chart of wages, labor costs, and price inflation clearly shows the increasing problems facing the Eurozone economies.
The negative feedback loop to the Eurozone economies from declining wages and overall deflationary pressures has nullified attempts by the European Central Bank to spark some inflation across economies. While there is continued "hope" that the ECB will launch further successive rounds of monetary interventions, there is clearly a diminishing rate of return of each dollar spent.
Furthermore, given the fact that the ECB, unlike the Federal Reserve, relies on the "generosity" of its member countries to fund its "coffers," which primarily falls on the shoulders of a weakening German economy, there is a limit to what ECB can achieve. There is also the question of when Germany will just say "Nein" to continued bailouts of its failing neighbors with respect to its own economic prosperity.
The rising deflationary pressures in the Eurozone economy will also reduce the nascent inflationary pressures domestically. The uptick seen domestically was primarily a function increased economic activity during the second quarter rebound which was primarily an inventory restocking cycle. With deflationary pressures increasing in the Eurozone, the feedback to the U.S. will reassert itself in the coming quarters ahead. (Chart below shows the high correlation between domestic and Eurozone inflation)
Given Sy's points with respect to the size and importance of the Eurozone economy, exports comprise roughly 40% of domestic corporate profits; it is unlikely that U.S. profits will remain unaffected. As I have discussed recently, corporate share buybacks have been a major boon to increasing profits on a per share basis over the last couple of years. Share buybacks have also been an important driver of asset prices in conjunction with, and due to, the expansion of the Fed's balance sheet and suppression of interest rates.
"The boom in buybacks also owes much to the Federal Reserve’s suppression of long-term interest rates via quantitative easing and stagnant growth in Europe, an important foreign market for many S&P 500 global companies.
Record-low interest rates in the corporate bond market have helped fund large buybacks, but with the central bank on course to conclude buying bonds under QE in October, fuel for buybacks is ebbing and non-financial debt issuance has slowed.
Andrew Lapthorne at Société Générale says companies have exploited the generosity of financial markets to fund their share buybacks and as that fades, the equity bull market faces losing a key source of support.
Share buybacks have grown by $1.56 Trillion since 2011, but those repurchases peaked during the first quarter of this year at 159.28 billion before sliding back to $120.21 billion in Q2. The risk for the markets here is that with the Federal Reserve reducing the flow of cheap liquidity, and potentially raising borrowing costs in 2015, two of the major supports of the markets will be removed."
The correlation between the Eurozone financial markets has been, and remains, extremely high. As shown in the chart below.
The current divergence between the two markets, and given the underlying weakness in the economic underpinnings of the Eurozone itself, brings the question of sustainability into focus.
I have to agree with Sy's conclusion:
"It has also been more than three years since the market experienced even a normal 10% to 15% correction, while on average it does so every 12 months. And of the 25 bull markets of the last 100 years, this is the fourth longest running since 1929.
You do have to at least ask yourself if that is justified, especially given the still anemic economic recovery. The market is higher than in 2000 and 2007. Even in those years of booming economic conditions, the market was not able to drive even higher, the S&P 500 instead losing 50% of its value in those apparently forgotten bear markets.
I know, it’s all about the Fed’s easy money policies and near-zero interest rates. But still, at those market tops, and indeed all market tops, there were also reasonable explanations of why ‘this time is different’."
While anything is certainly "possible," given the weight of evidence, keeping a watch on the "probable" seems to be the more prudent course of action.
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OT, but funny . . .
"Fed: US consumers have decided to 'hoard money'"http://www.cnbc.com/id/101963821
most of the article isn't OT, just the idiotic headline.
"The Fed pair go on to make a fairly stunning indictment of sorts about Fed policy"
you can expect the next news on 'the pair' to be an unceremonious ouster from positions at the Fed.
then again, hasn't the deteriorating money velocity been one of the trends ZH has been following? have 'the pair' been phoning it in, using Tyler's analysis? or spending too much time on ZH?
OT, but funny . . .
"Fed: US consumers have decided to 'hoard money'"http://www.cnbc.com/id/101963821
Lance we are in some deep dodoo. The markets and economy aren't going to matter.
Damn Lance, the markets and the eCONomy haven't had a thing to do with each other for a long time. As far as Europe goes, it's nothing that printing a few trillion Euros won't hide.
couldn't have said it with more timidity if i tried. love the tap dancing act:
...buybacks and as that fades, the equity bull market faces losing a key source of support.
...cheap liquidity, and potentially raising borrowing costs in 2015, two of the major supports of the markets will be removed."
I know, it’s all about the Fed’s easy money policies and near-zero interest rates. But still, at those market tops...
This piece just screams out: PLEASE DON'T MAKE FUN OF ME FOR PREDICTING A CRASH!! (but it could, and then i will be smug if it does, but if it doesn't i still have all those namby pamby caveats built in)
"Can the US economy stand alone?"
Stopped reading right there.
Poor fool believes the Bureau of Lies' numbers, so he isn't qualified to occupy 30 seconds of my time.
"exception" means stand alone, no?
SOMETHING is going to happen in the markets soon. They need to squeeze some profits from someplace. Stay nimble.
The US will never again be a unipolar hegemon in the world; except if we go towards WW3, in which case nobody today can forsee the outcome.
Assuming that WW3 is not a realistic scenario, all the while asymmetric wars stay a permanent agenda, during the transition away from Western dominance to greater Eastern dominance of world scene, what is the interim scenario for this transition during the 21st century?
The Euro project is blocked basically because of WW2 legacy and Nato/Us dominance on the military front and basically because Euro federation post WW2 has not occurred fully to resolve nation-state incompatibility fed on centuries of rivalry. The federation, which is now essential to allow the euro culture to stay a universal reference as in the past, therefore needs to create more unified norms of economic and cultural integration. The monetary union is a failed half baked concoction that requires both fiscal and legislative union; aka political union should also occur.
All the more so that the globalisation, now irreversible, as technology and its impact on nomadic human aspirations on all continents, has virtually abolished frontiers and made intercontinental rivalry the yardstick for future regional competition.
The nation state has become dépassé, as the 20 th century and two world wars have already shown.
American power ruled because it was a continental sized behemoth swimming in a pool of minnows. Today, China, Russia, Brazil and India are more aligned to that dimension, not the Euro nation states; they are like the Italian city states of the Renaissance faced with the nation states of the size of France, Spain and England.
We know who won that contest.
If the Euro zone federation does not occur as a result of the current crisis, Europe will regress just like the Italian city states did then.
As for the relative rivalry of the three zones of the American unipolar age; aka the Trilateral created post 1971 BWr cum petrodollar hegemony; it is evident that both Japan and Europe have to find their own way once Pax Americana loses its sway of past hegemonical power plays.
Yes, during that interim period there will be much pain and decoupling on the agenda and surrogates who do not change their own game will stay surrogates.
Eric Cantor geting into finance is the market sell signal we've all been waiting for.
There are a lot of people who can blow me. Eric Cantor is one of them.
Import / Export is what is messing up the United States.
We are taking about a 100 billion dollar hit each year trading with Europe.
1.5 fucking trillion deficit since 1997. What the hell is this author talking about. We have basically given the Eurozone 1.5 trillion dollars plus all the crap money as aid we send over there the last 16 years.
This article is nonsense total garbage crap.
It has caused a major account deficit and skewed the balance of jobs.
Lets face it. America is only friendly with the rest of the developed world they talk about problems with the Eurozone. America seems to be a small part of the Eurozone. In fact our trade deficit with the Eurozone is probably higher than all the rest of the trading deficit of the imbalance of trade within the Eurzone itself.
1. Give major tax credits to manufacturers conducting business overseas. Substanial tax deductions based on imbalance of labor. prices This will give them a reason to bring the labor back and not exploit tax "loopholes" and cheap labor to expand their markets overseas. This can be amplified to stop the losses and have a positive effect. Not all taxes are good taxes.
2. Restrict stock buybacks and instead force companies to invest in workforce and capital expenditures in the USA not China and investorrs in companies
3. Create tax credits for demolition of housing creating new housing.
4. Give huge tax breaks to American car companies, and tax breaks for junking vehicles
5. Increase government borrowing rate. Discourage wasteful government spending, decrease government.
6. Build a better border and end the welfare state forcing people to work
7. Not force college on everybody as a means to a better high paying job.
8. Create higher inflation. Savers are already screwed why not eliminate debt for those in debt (half the country)
It is not that hard to envision. If you cannot afford to go out and eat you make your food at home. If you cannot afford new clothes you make your own. If you cannot afford something frivolous you should not risk credit on it. Retail is a mess. Prices are too cheap but at the same time too high.
Our problems are fairly simple and if they are just stated simply planning by the government can fix all of them. Lets face it the service sector is not doing much for our economy. Nothing is being created.
It will take a while maybe 10 - 20 years, but now while the rest of the world is in shambles is the time to start.
We are taking about a 100 billion dollar hit each year trading with Europe.
a 50 billion dollar deficit with Mexico because of cheap labor.
a 70 billion dollar defcit with Japan because of automobiles
a 318 billion dollar deficit with China because of cheap labor.
We could easily delete the deficit in 20 years with a trade balance. 700 billion (annual deficit) times 20 = 14 trillion - deficit wiped out. Who cares about the rest of the world. They are not looking after us. Thats for certain. We have the military and the means to do it and not have to worry about the consequences.
Both people and governments have lived beyond their means by taking on debt they cannot repay. Over the last several decades we have created entitlement societies built on the back of the industrial revolution, technological advantages, capital accumulated from the colonial era, and the domination of global finances. Promises were made on the assumption that the advantages we enjoyed would continue.
Ever greater prosperity and entitlements were to be sustained through debt financed consumption growth. In that eerie fantasy world, debt fueled consumption was to be the catalyst to bring about evermore growth. Now reality has begun to come into focus and it is becoming apparent that this is unsustainable. The entitlements and promises that have piled up have become overwhelming. More on why this system will fail in the article below.
http://brucewilds.blogspot.com/2014/08/modern-monetary-theory-is-wrong-d...
Uber is prohibited in Germany.