Running on - running on empty
Running on - running blind
Running on - running into the sun
But I'm running behind
A little more than a week ago a friend said I was being too negative, a real "Debbie Downer," and challenged me to write a piece looking at the glass as half full. Well, after a week of searching I couldn't find the glass (fortunately I'm not opposed to drinking out of the bottle). Sorry, I just can't seem to find enough positives to overcome these massive negatives.
First, the world is in the early stages of working off decades of profligate spending. There is no way around it, for years our governments were able to issue debt to pay for their promises. Buyers were willing to accept Greek or Italian bonds at a slight yield advantage versus German bonds, until they weren't. Now countries are rapidly seeing what happens when the buyers disappear. The end game to Keynesian deficit spending occurs when your interest payments exceed your revenues. See Greece, and soon Italy, Spain, etc.
A closer look at the immediate situation in Europe reveals a very binary scenario. On the one hand, the Germans decide to bail out the rest of Europe. On the other hand they don't.
The German's could allow the ECB to hoover up all the EU sovereign debt that no one else will buy, which would cause a huge rally in euro bonds and global equities. A short-lived rally but a rally nonetheless. Now of course Germany/ECB will have no power to control other countries finances or the ability to tax their citizens, therefore they are just throwing good money after bad. The problems of zero growth and insolvency will remain, in addition to the destruction of the ECB's balance sheet. Inflation will spiral, the Euro will devalue, and the German citizens will have to suffer inflation imposed on them by other Europeans.
On the other hand, the German's can decide to leave their fellow Europeans to the mercy of the markets. Nations and bondholders get crushed, resulting in a severe deflationary recession/depression. This is what debt deflation looks like, this is how you pay for years profligacy. The euro is preserved but liquidity and business go away. Germany will remain Europe's economic power, but Europe as a whole will be much weaker.
In my mind neither of these scenarios looks like a glass half full.
Here in the United States we have the Debt Super committee (doesn't that sound like a name a toddler gives himself before jumping off the couch), meeting to decide what our first step into austerity should look like. I'm willing to bet that the plan will be anything but super. If they agree on anything, it will probably start innocently with a modest tax increase on the rich, the same way you might pluck a turkey before chopping its head off. The simple fact is that this country is out of money, poor people don't have any, rich people do, and the middle class has almost figured out how voting works. It's not that the middle class hates the rich, they've always believed that they had a chance of becoming rich too. But lately, thanks to crushing debt loads the middle class is giving up on their dreams of wealth, and instead opting to transfer money from total strangers to themselves - a process often referred to as fairness. In the meantime the rich are actively looking for escape plans.
Of course the Debt Super committee may also propose spending cuts, which is another way of saying reneging on their promises. Voters don't particularly like politicians who renege on their promises of a good life via someone else's money. For a recent example just look at the untimely end of Papandreou in Greece, and Berlusconi in Italy. No, I wouldn't expect any serious cuts to government spending until the bond market forces them too. Remember there will be a time when investors (i.e. Chinese) refuse to buy our bonds, then interest payments will exceed revenues, and hard decisions will be forcibly implemented. (More than slight irony that we are sending troops to Australia)
Finally the glass half full's greatest hope - Corporate America is doing just swell. OK, I'll admit that earnings for corporate America have been surprisingly strong and that is clearly keeping a bid under equities, especially dividend paying equities, but lets drill a little deeper. Historically during economic recoveries, sales, profits, and employee compensation all grew in tandem. But in this economic recover profits have boomed, sales have grown, and employee compensation has lagged miserably behind. See graphs below.
Some of the best profit margins in history, but how long can corporations squeeze employees in order to grow profits? There is a point where either labor costs go up or sales fall, not sure exactly where that is, but we might be getting a tad close. A half full glass with some very thirsty employees.
We continue to be very defensively positioned with nearly 50% of our assets in cash equivalents, and very minimal positions in Europe (3% in EAFE stocks, 2% Int'l Bonds).
A client recently asked me about buying stuff outside of the financial markets - stuff like real estate, art, or jewelry. I said that it makes perfect sense to me. Faced with zero percent returns and tons of unknowns, there is nothing wrong with buying something that might also give you a zero percent return, but at least you'll get a little enjoyment out of it. In fact I'm buying a painting next week, and am actively looking at some real estate.