Friday, May 25, 2012

Blame it on the Greeks – AGAIN!

From the Desk of Joe Rollins

Since May 1st, the S&P Index of 500 Stocks has gone down 5.25%, but on the positive side, it’s still up 5.6% for the year so far. The market is in turmoil again due to Greece’s anticipated exit from the euro-zone. Every positive component that causes an increase in the stock market is being realized and the U.S. economy continues to improve, yet stocks continue to fall.

While I struggle sometimes to understand the reasons for the extraordinary moves we are seeing on the U.S. stock market, some investors find themselves so mystified that they fear for their long-term retirement assets. As far as the economic crisis surrounding Greece is concerned, I find it hard to make a legitimate argument for those ongoing concerns to cause such a dramatic loss in value on the U.S. stock market.

A recent report reveals that Greece’s entire 2011 GDP stands at $312 billion, which reflects 100% of every dollar spent by every resident of Greece and is commensurate to the GDP of the small state of Connecticut. It is now estimated that the market capitalization of the U.S. stock market is roughly $55 trillion. Since the 1st of May, the market has gone down 5.25%, meaning it has lost $2.9 trillion in value – eight times Greece’s entire GDP! The reaction we’re seeing is way out of proportion to Greece’s potential impact on the global economy.

Greece has been unable to dig out of its current debt woes by the austerity measures it has taken thus far. The will to reduce their standard of living just doesn’t seem to exist. With a goal to cut Greece’s government debt from 160% of GDP to 120% of GDP by 2020, Greece has pledged to cut the minimum wage and make labor markets more flexible. They have also instituted a new property tax and are placing 30,000 civil servants on partial pay. By and large, the Greek public has grown tired of the bailout conditions, with a wave of protests and strikes over the last week. Even so, Greece has collected very little tax revenue and spends a percentage well in excess of their revenues. As such, it is unlikely that these austerity measures will ever work – the deficit is just too large to overcome.

It’s important to remember that even if Greece were to exit the euro-zone, it will likely have little effect on profitability in the U.S. In many regards, I do not see Greece’s return to a new drachma currency as having terribly negative consequences. By reverting to the drachma from the euro, Greece could effectively and quickly devalue their currency. This truly should not have a negative impact on the U.S. economy.

Even with the reduced economic activity in Europe, earnings are continuing to accelerate in the U.S. Since earnings are the paramount reason for higher stock prices, investors should be more focused on that good news. As an example of how strong earnings have been, they are already at the highest level ever recorded in American finance. U.S. based earnings grew 15% in 2011, and for 2012, they are expected to grow another 10%. Believe it or not, earnings are anticipated to increase 12.5% in 2013. Even if earnings grow at only half of those projections, higher stock prices are very likely.

Don’t drink the Kool-Aid! As I heard one trader say on the financial news this morning, “Maybe the European contagion was overstated.” Duh!! The reality is that stock markets don’t go down endlessly when earnings are accelerating like they are today.

Since my last blog, there has been a wealth of good financial news. Check the headlines and you’ll see these positive trends:

  • The price of oil has fallen from triple digits to approximately $90/barrel, which is a gigantic movement in the oil market over a relatively short period of time. While gasoline is still expensive, it is dramatically less expensive than it was three weeks ago, and this positive economic stimulus is just starting to be felt.

  • Interest rates on long-term mortgages fell this week to the lowest ever recorded in the history of U.S. finance. Now you can obtain a 30-year mortgage for less than 3.8%. At no time in U.S. history have interest rates ever been this low.

  • For the first time ever, German Bunds – the German government’s federal bond – are now trading below 2%. The U.S. 10-year bond is currently trading at 1.72%. Never in the history of these two government-issued bonds have they ever traded this inexpensively.

  • U.S. earnings for the first quarter of 2012 exceeded all prior earnings records. It’s anticipated that earnings will increase in every quarter for the remainder of 2012 and 2013.

  • Even though the GDP for the first quarter registered at 2.2%, most economists are forecasting that GDP in the second, third and fourth quarters of 2012 will be at least 2.5%. There is no current evidence of any major downward moves in GDP so far in 2012.

  • At the end of the day, there’ve been no changes in true economic barometers since my May 1st post. If investors are confused as to why the market would drop 5.25% in only a three-week period when the financial news is no worse than it was three weeks ago. It can only be explained by how traders make money in financial markets. Traders can’t make a decent living without high volatility in the stock market. If the market goes straight up or straight down, then it’s virtually impossible for traders to compete with long-term investors. Therefore, it’s imperative for them to move the market in one direction or the other even if the basis for that movement is misplaced.

    What we’re seeing now is a classic case of irrational fear. I see nothing in the financial markets today to justify this negative swing, and therefore, I feel the market will quickly recover. As I’ve said so many times before, when you invest in the market for the long-term, it’s possible for there to be 10% movements in either direction. I believe that’s what we’re seeing now.

    As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

    Best regards,
    Joe Rollins

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