Finance, Insights

Greece….The Sequel

PaulNolte-2Two weeks later and the song remains the same. There is an added melody though, as China’s market decline has been melded into the Greece riff. Will Greece exit? Can their debt be restructured? Is China entering a Depression? Can a government bailout save their markets? The global markets are reacting to every twist and turn in these sagas, first by falling 1-2% as it looks as though the known world will end. Then rising by 1-2% as it becomes evident that more money will be thrown at the problem and everything will be OK. Which is it? Can the world “survive” a rupture in the Euro from an “insignificant” country? Will China’s economy follow their markets lower, imperiling global growth? The answer from the US markets seems to be a loud yawn. While China is a relatively new development, Greece has been in the news for years and the US markets have been rising throughout. China’s issues have caused some of the overseas money to flow into the “safety” of US markets. How long can the juggling continue? As long as there are attempts at a “deal” in Greece and the Chinese government is willing to throw money into their economy the markets will react favorably. However if/when the music stops, the markets will suffer.

The market averages have done a very good job of hiding the underlying deterioration within the component stocks. For example, the SP500 is essentially where it was at the end of the first quarter. Over the past 3+ months, many more stocks have fallen than increased, meaning fewer stocks are holding up the popular averages. Stocks making new yearly lows now average 20 over the past two weeks vs. merely a dozen or so in March. Six of the ten industry groups within the SP500 have declined since the end of the first quarter. Various indicators within the more economically sensitive portions of the markets have done poorly over the last three months as well. Commodity prices have fallen (not just energy), transportation stocks are down roughly 8% from their March peak. If the global economy is strong, why are these economic “inputs” doing so poorly? The silver lining may be that many of the indicators are now at levels that could produce a bounce in the markets, which may have begun with the Thurs/Fri rally. How high and how long that rally lasts, will unfortunately be in the hands of news from Europe and China. Improvement from those countries will mean still higher prices; deterioration could derail the nascent rally. The day to day changes in the markets have been directed by the global news flow, but the longer term trends seem to be predicated on a still growing US economy.

The bond market remains on “rate hike” watch. Bond yields are higher than at the end of the first quarter, even as worries over Greece and China persist. Convinced that the Fed will raise rates this year, investors have already pushed yields higher. However over the past week, various Fed officials (not Ms. Yellen) have talked about delaying the increase in rates until mid-’16. Thus creating “data dependent” environment means having no clear direction and places increasing importance on each piece of economic data. Unfortunately, each data point contradicts each always revised in subsequent months. The very long term expectations are that rates will rise, but how that will happen is pure conjecture. Will investors shun debt? Will economic growth actually occur? Can inflation be squeezed from a (currently) slow growing economy? The answers seem to change by the hour and by each piece of news.

The return to a “SP500 centric” market is once again providing superior returns to a diversified portfolio. As mentioned above, the averages are covering up weakness in many other parts of the markets. The question that really does not yet have an answer is whether the markets catch up (by falling) to the decline in various asset classes and industry groups or do the market internals improve to mirror the SP500 stability. The mid-90’s provided a happy example, where the averages held up while many stocks went through a corrective phase that ultimately led to the decade end rally. Then there is the scary comparison of 2007, when the market internals deteriorated and the markets ultimately followed in a 30%+ decline. The billion dollar question is which will it be this time? Unfortunately the crystal ball is rather foggy at this time, but we are beginning to become more cautious about the markets.

The flat-lining of the major averages is hiding deterioration below the surface. We are becoming increasingly cautious toward stocks and will begin reducing some of our exposure to the equity markets in the weeks ahead. Of course if events change quickly that may force us to shift our views. However, after a six year steady climb, the markets may finally be ready for at least a correction. So far, that correction has come in the form of time, as the markets have carved out an eight month sideways pattern.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.