Karl Marx famously wrote that history tends to repeat itself -the first time as tragedy, the second as farce. The European economic situation can certainly be described as a Greek tragedy that has once again lapsed into farce with a decision this week to "kick the can down the road" by extending the bankrupt country's bailout for four months.
The other farce that played out last week was the U.S. stock market taking the Greek drama seriously enough to use it as an excuse to rally to new highs.
Greece can never flourish economically within the European Union and the four month life-line it received this week won't change that.
And the U.S. stock market doesn't need any excuses to keep rising as long as global central banks keep printing money like drunken Greek sailors.
A Strategy of Self-Interest
Greece is hopelessly insolvent and can never compete economically as long as it is tethered to the single European currency (the euro). It remains in Germany's self-interest to keep Greece and other weak southern European countries such as Spain, Portugal and Italy inside the Eurozone to keep buying Germany's exports with euros.
For that reason, the odds of Greece leaving the Eurozone are very low despite the threats being traded between Greek's socialist government and German bankers. In the end, a deal will be worked out that will keep Greece under the thumb of its northern neighbor and keep the Eurozone intact.
Last week, Germany gave Greece a four month extension to negotiate new bailout terms. Greece was hoping for six months but settled for four. The deal temporarily stemmed a run on the country's banks and calmed financial markets.
Under the agreement, Greece has to present a list of budget cuts and economic overhauls on Monday that will satisfy European officials. Once those measures have been implemented, Athens will receive more money to keep it afloat.
Four months from now, this farce will be repeated and another deal will be cut. In the meantime, Greece will remain in what amounts to a depression and an entire generation of its young people will seek opportunities abroad.
But other than a few contrarian hedge funds, global stock investors don't care about Greece. They only care whether central banks will keep printing money that in turn will keep inflating stock prices. And the answer is that central bankers will keep doing what they have been doing. They don't know what else to do.
Seven years after the financial crisis, they haven't figured out how to stimulate economic growth in any other way. And their fiscal policy mates remain asleep at the switch. They know they are the only game in town.
The Illusion of Stability
Investors are so smitten with the power of central banks to pump up stock prices that they can ignore deteriorating geopolitical conditions around the world. ISIS continues to cut a swathe across the Middle East and pose a serious global threat despite misguided assurances to the contrary from the Obama administration.
The much-ballyhooed truce in the Ukraine has turned into its own kind of farce, allowing Russian-backed separatists to keep fighting while Western leaders demonstrated once again that they have no desire to stand up to Vladimir Putin.
Ukraine poses a much bigger threat to global stability than Greece, but investors' are so desperate for any hint of stability that they fell for Mr. Putin's ruse and accepted a truce that was broken before it began. Ukraine will continue to fester and threaten the future stability of Europe as Europe wants continues to cede its sovereignty to Russia over time.
But as long as central banks keep pumping out money, investors won't care. Last week, the minutes of the January meeting of the Federal Reserve were released with few surprises. As always, this group of former tenured economics professors are torturing themselves over when they should start raising interest rates. If the majority of them had ever managed a business themselves, they might question whether raising rates by 25 basis points in June versus September is truly going to change the course of an $18 trillion economy.
The Fed is so far behind the curve on this that it has driven off the road entirely – rates should have been raised a year ago. Amid the delay, dangerous bubbles have developed in the financial markets. Stocks are not only trading at all-time highs but at near-all-time high valuations, while bonds are trading at both. Fed Chair Janet Yellen testifies before Congress this week and no doubt will offer further reassurances that the Fed is in no hurry to upset investors.
Focus on the Fundamentals
The irony is that investors are probably worrying more than they need to about a rate hike. Both the economy and the markets can handle 50-100 basis points of higher rates over the next year without falling out of bed. Several Fed officials have warned that the Fed is likely to start raising rates around a June time-frame, which is still four months away.
Investors should pick up their dictionaries and look up the word "patient". Four months is a long time in market-time. June remains a good bet for when the first rate hike will come and it won't mean the end of the 6-year bull market. In fact, rising interest rates tend to coincide with higher stock prices since they tend to signal a strengthening economy. And historically there has been more than a two-year lag between the beginning of rate hikes and the start of a bear markets.
A Fed rate hike won't be the reason the bull market ends. That will happen if the economy keeps weakening. Stocks are trading at elevated valuations while earnings estimates are dropping, so investors should proceed with caution and avoid the most overvalued sectors of the market.
The party on Wall Street continues. Last week, the Dow Jones Industrial Average added another 121 points or 0.7% to close at a record high of 18,140.44. The S&P 500 gained 0.6% or 13 points to end the week at a record closing high of 2110.30. And the Nasdaq Composite Index moved closer to regaining the heights of the Internet Bubble, gaining 1.3% or 62 points to close at 4955.97.
In sharp contrast to stocks, bond prices moved in the opposite direction. The yield on the benchmark 10-year Treasury bonds jumped to 2.14% from 1.985% a week ago and is now up almost half a point from 1.67% at the beginning of the month.
This huge 28% move in yields has thrown a wrench into the forecasts of some of the most prominent bond investors in the world who have been betting on lower rates. The ten year Treasury yield is now roughly where it began the year (2.17%). It appears that fourth quarter GDP will come in around 2% and first quarter GDP may also come in around that level (partially hurt by the polar weather hitting the country).
Slow growth is consistent with forecasts for lower bond yields. Slow growth also makes it more difficult for stocks to keep rising even if central banks keep pumping out money around the clock. With earnings estimates and GDP growth coming down, stocks are simply defying gravity.
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.