Category
Global Markets
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Rising Government Bond Rates Push Eurozone Debt Crisis to the Precipice of Collapse
Rising government bond rates are making it increasingly costly for several key Eurozone nations to borrow money, stoking fears that the sovereign debt crisis has reached a critical stage.
Yields on 10-year Spanish Treasury bonds rose to 6.8% during yesterday's (Thursday's) auction – uncomfortably close to the 7% level at which many experts feel is unsustainable. When the 10-year bond yields of Portugal, Ireland, and Greece passed 7%, each was forced to seek a bailout.
Just last week the 10-year bond yields of Italy crossed the 7% threshold. Though yields dropped back below 7% after Italian Prime Minister Silvio Berlusconi stepped down, the respite proved short-lived. The Italian 10-year bond yield fell back to 6.84% yesterday but is expected to stay in the danger zone for the foreseeable future.
Perhaps more worrisome is the rise in French bond yields. While France is not one of the troubled PIIGS (Portugal, Ireland, Italy Greece and Spain), it has deep financial ties to those nations. French 10-year bonds now yield 3.64%, twice that of equivalent German bunds despite both nations having a top-tier AAA credit rating.
The cost of borrowing is rising even for nations that until now had been outside of the fray, like the Netherlands, Finland, and Austria.
"Momentum is building," Louise Cooper, market strategist at BGC Partners, told MarketWatch. "Ten-year French borrowing costs are now around [two percentage points] greater than Germany, Spanish borrowing costs are rocketing and 10-year Italian debt is yielding over 7%. The hurricane is approaching. Time to batten down the hatches."
Economic Damage
As the Eurozone debt crisis deepens, many analysts worry that the rising government bond rates could put the brakes on lending and lead to a credit crunch such as the one experienced during the 2008 financial crisis.
In the short term, however, the steady stream of scary news is taking a toll on the stock markets. The British FTSE 100 was down 1.58% and the French CAC 40 was down 1.78% yesterday, while the Dow Jones Industrial Average fell 134.79 points, or 1.13%.
"Investors keep thinking that the powers that be in Europe are getting in front of this – only to be disappointed when additional bad news emerges," observed Money Morning Capital Waves Strategist Shah Gilani. "That's why we're seeing these whipsaw trading patterns that are so frustrating to retail investors who've been schooled to buy and hold. The reality is that this will get much worse before it gets better."
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Three Psychological Stumbling Blocks That Kill Profits
Face it, the past 12 years have been horrible for most investors.
This is not necessarily because the markets have been rocky, but rather because the vast majority of investors are hardwired to do three things that kill returns.
You can blame Washington, the European Union, debt, high unemployment, or half a dozen other factors if you want to, but ultimately, the person responsible is the same one staring back at you from your bathroom mirror in the morning.
That's why understanding the bad habits you didn't know you had can be one of the quickest ways to improve your financial wealth.
Here's what I mean.
Dalbar, a Boston-based market research firm, produces annual research that compares the returns of stock and bond markets with those of individual investors. The latest, covering the 20-year period ended last year, shows that the Standard & Poor's 500 Index returned an annualized gain of 9.1%. That stands in sharp contrast with the measly 3.8% gain individual investors averaged over the same timeframe.
Fixed income investors didn't do any better. According to the Dalbar data, t hey gained a mere 1% a year versus an annualized return of 6.9% for the Barclay's Aggregate Bond Index.
In other words, investors' self-defeating decisions contributed to an underperformance that was 58% below what it could have been for stocks and 85.5% below what it could have been for bonds.
Why?
Three reasons: recency bias, herd behavior, and fear.
It's All About Perspective
Recency bias is what happens when short-term focus trumps long-term planning and execution.
It's what happens when somebody yells "fire" and everybody runs for the same exit at once despite having entered through any of half a dozen doors in the auditorium. Simply put, recency is recent knowledge that overrides longer-term thinking and memory.This is why momentum trading works, for example, or the news channels seem to cover the same stocks at nearly the same time – because a huge number of people are focused on exactly the same companies simultaneously. Logically, they then become the subject of increased attention and tend to move more strongly or consistently.
The question of why is the subject of much debate among human behaviorists, but I chalk it up to the fact that human memories tend to focus on recent events more emotionally than they do longer-term plans that are put together with almost clinical detachment.
And the more extreme the events or the news, the sharper our short-term focus becomes.
That's why, according to "Mood Matters," a book by Dr. John Casti, one of the world's leading thinkers on the science of complexity, "bombshell events are assimilated almost immediately into the prevailing [social] mood" where as longer-term cycles bear almost no witness to gradual change.
If that doesn't make sense, think about what happened on 9/11. Most of the world's major markets bottomed within minutes of each other on short-term panic and emotion. Then, when trading resumed days later, they began to climb almost in sync as highly localized events once again faded into the longer-term fabric of our world.
And that brings me to herding.
The Herd Mentality
We'd rather be wrong in a group than right individually so the vast majority of investors tend to make decisions, and mistakes, together en masse.
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Five Companies to Avoid Until the Eurozone Debt Crisis is Over
U.S. companies with significant exposure to Europe will take a profit hit regardless of how the Eurozone debt crisis shakes out.
The financial strain of Europe's efforts to avert default among its troubled members – Portugal, Italy, Ireland, Greece and Spain (PIIGS) – has set the Eurozone on course for a recession even if its efforts succeed.
Yesterday (Thursday) the European Commission dropped its forecast for growth in the Eurozone to just 0.5% from its previous estimate of 1.8% in May. The commission blamed austerity measures, which were aimed at lowering budget deficits, but ended up eroding investment and consumer confidence.
"The probability of a more protracted period of stagnation is high," said Marco Buti, head of the commission's economics division. "And, given the unusually high uncertainty around key policy decisions, a deep and prolonged recession complemented by continued market turmoil cannot be excluded."
Falling consumer demand has already begun to affect the bottom lines of many U.S. companies that derive large portions of their revenue from the Eurozone bloc.
"In light of cutbacks in government spending, tax increases and waning business confidence, there already has been some [company] commentary on slipping appliances, bearings and heavy-duty trucks demand," Citigroup equities analyst Tobias Levkovich told MarketWatch. "In many respects, these early remarks are a worrisome sign."
For example, General Motors Co. (NYSE: GM) on Wednesday said the debt crisis would prevent it from breaking even in Europe this year. And Rockwell Automation Inc. (NYSE: ROK) on Tuesday warned of declining capital spending in Europe next year.
Although sales to Europe account for only 10% of revenue for the Standard & Poor's 500 as a group, several sectors have far more exposure to the Eurozone.
The auto sector derives 27.6% of its sales from Europe, followed by the food, beverage and tobacco sector at 22%, the materials sector at 19.8%, the consumer durables and apparel sector at 16.2% and capital goods at 16.4%.
"Europe is a major component to the U.S. economic engine and it is a concern," Howard Silverblatt, an analyst with S&P Indices, told MarketWatch. Silverblatt noted that while a European recession may not necessarily take down the U.S. economy, "it has an impact that will move stocks."
Here are five U.S. stocks that have significant exposure to Europe and leveraged balance sheets high – making them risky investments until Europe gets back on its feet:
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Rising Wages in China Good for Glocals, But Few Jobs Coming Back
Although some economists have predicted that steeply rising wages in China would bring some jobs back to the United States, the biggest winners will be the large multinational companies operating in China.
Last week the Guangdong province, where many of China's factories are concentrated, announced a 20% increase to the minimum wage. Combined with two earlier hikes in April and July, the total increase over the past 10 months is a startling 42%.
And with an eye toward booting domestic consumption, the government plans to keep the raises coming – on average 20% a year through 2015.
That extra money will get spent with domestic Chinese businesses as well as U.S. corporations with a strong presence in China – such as McDonald's Corp. (NYSE: MCD) – but is dramatically raising costs for Chinese manufacturers.
Between the wage increases and slumping global demand, the Federation of Hong Kong Industries warned on Tuesday that as many as one-third of Hong Kong's 50,000 factories could downsize or close by the end of the year.
As China's competitive advantage in wages erodes, some analysts have predicted a wave of jobs returning to the United States from China. A recent study by the Boston Consulting Group (BCG) forecast a return of 2 million to 3 million jobs by 2020.
But Money Morning Chief Investment Strategist Keith Fitz-Gerald doubts any repatriation of jobs will be quite so massive.
"Wishful Thinking'
"That's wishful thinking on the part of Westerners," said Fitz-Gerald, who operates The New China Trader service for the Money Map Press, who noted that "labor rates are still very, very low" in China.
Although Fitz-Gerald said a few "industries with little value-added" could see the return of some jobs to the United States as a result of China's rising wages, other factors will restrain a mass migration of jobs across the Pacific.
Despite reports of major labor shortages in the eastern coastal parts of China, Fitz-Gerald said there remains "vast undeveloped low-wage areas ripe for industrial expansion" in the western provinces of China.
"They have a 50-year initiative called the "Go-West' program that is designed to push labor from the eastern regions to the western ones," Fitz-Gerald said. "If the jobs are pushed west, there will be no great exodus of jobs from China."
The majority of jobs that do leave China, he said, will probably go to areas with even cheaper labor, such as Indonesia, Thailand, Vietnam and Mexico.
"That should make U.S. manufacturers very nervous," Fitz-Gerald said of Chinese jobs moving to Mexico. "The Chinese would be building stuff on our back doorstep."
With a factory just across the U.S. border, a Chinese manufacturer would save a lot of time and money on shipping.
"They could become even more competitive than they are now," Fitz-Gerald said.
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MF Global Bankruptcy Exposes Vulnerability of U.S. Banks to Eurozone Debt Crisis
The bankruptcy of MF Global Holdings (NYSE: MF) was a distressing signal to investors that it is possible for U.S. financial institutions to fall victim to the Eurozone debt crisis.
MF Global filed for Chapter 11 bankruptcy Monday after credit downgrades led to margin calls on some of the $6.3 billion in Eurozone sovereign debt the bank held. The position was five-times MF Global's equity.
Although the major U.S. banks have less exposure relative to available capital, their many tendrils in Europe – particularly to European banks – will inevitably drag them into any financial meltdown in the Eurozone.
Even the U.S. banks' estimated direct exposure to the troubled European nations of Portugal, Ireland, Italy, Greece and Spain (PIIGS) is disturbingly high – equal to nearly 5% of total U.S. banking assets, according to the Congressional Research Service (CRS).
And according to the Bank for International Settlements (BIS), U.S. banks actually increased their exposure to PIIGS debt by 20% over the first six months of 2011.
But the greatest risk is the multiple links most large U.S. banks have to their European counterparts – many of which hold a great deal of PIIGS debt.
"Given that U.S. banks have an estimated loan exposure to German and Frenchbanks in excess of $1.2 trillion and direct exposure to the PIIGS valued at $641billion, a collapse of a major European bank could produce similar problems inU.S. institutions," a CRS research report said earlier this month.
Of course, the major banks say their exposure to the Eurozone debt crisis is much lower because they've bought credit-default swaps (CDS) to hedge their positions. Credit-default swaps are essentially insurance policies that pay off in the event of a default.
Unfortunately, this same strategy was one of the root causes of the 2008 financial crisis involving American International Group (NYSE: AIG) and Lehman Bros.
"Risk isn't going to evaporate through these trades," Frederick Cannon, director of research at investment bank Keefe, Bruyette & Woods Inc., told Bloomberg News. "The big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who's ultimately going to pay for the losses?"
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This Birthday Is Nothing to Celebrate
The world's 7 billionth person is likely to be born today (Monday).
However, this birthday isn't something to celebrate.
Since the global population passed 6 billion only in late 1999, we've added more than 80 million people each year on average. And the environmental footprint of those people is expanding rapidly as emerging market populations modernize.
The planet may be able to accommodate these extra people and their consumption – but then again, it may not.
And if it can't, the drain on our planet's resources could harm us all.
So we'd better find a way to reduce population growth – fast.
Of course, if you think I'm about to propose something along the lines of China's one-child policy, you couldn't be more wrong.
We have economic means of population control that are neither coercive nor costly. And the sooner we implement them, the better.
A Disaster in the Making
When Thomas Malthus warned of overpopulation in 1798, the global population was approaching 1 billion – a level it reached in 1804. It had grown in the previous three centuries from 500 million in 1500. Thus, if the gradually increasing prosperity of 1500-1800 had continued – without the Industrial Revolution increasing world production capacity artificially – it would have reached 1.62 billion by 2011.
There is a very good case to be made that 1.62 billion is today's natural population, and that the growth since 1800 is artificial, caused by the Industrial Revolution removing previous limits on production. At that level, almost all serious environmental problems would go away. Even if all 1.62 billion of the world's inhabitants enjoyed Western living standards, the global warming and pollution effects of their output would be easily absorbed by the planetary ecosphere.
Around 2004, U.N. population projections had us reaching a population of 8 billion by 2027, then peaking at around 9.3 billion just before 2050 and declining slowly thereafter. Alas, the latest projections are not so sanguine. They have no peak in population this side of 2100, with population passing 10 billion and reaching 10.12 billion in 2100.
At this level, an environmental disaster is very likely.
