Equity markets were quiet again this week. Bonds and commodities rallied, mostly following Wednesday’s Fed announcement that it intends to hold short rates close to zero through 2014 and extend the program to buy longer dated Treasuries. Lingering concerns regarding how to restructure Greek debt hampered enthusiasm for stocks, but the Euro rose anyway. Q4 US GDP growth of 2.8% was the best result in a year and a half, but was slightly below recent expectations. Corporate earnings continue to be mixed, but Apple and Caterpillar both posted stellar results.
S&P 500: 1,316 (+0.1%)
MSCI EAFE: +1.1%
US 10 Year Treasury Yield: 1.89% (-0.14%)
Gold: $1,739 (+4.3%)
USD/EUR: $1.322 (+2.2%)
- Monday – The European Union agreed on an embargo of Iranian oil. It is set to begin on July 1, and is subject to review.
- Tuesday – Obama delivered his State of the Union address. It lacked specific, material policy initiatives.
- Tuesday – Apple reported record profit, exceeding expectations.
- Wednesday – The Fed announced it intends to keep short term rates close to zero through 2014.
- Wednesday – Germany and the ECB rejected calls by the IMF and others to participate in losses in Greek debt.
- Thursday – Caterpillar released earnings, exceeding expectations.
- Thursday – The Conference Board leading index for December rose 0.4%, below expectations.
- Thursday – New home starts for December dropped 2.2%, compared to an expected gain.
- Friday – US Q4 GDP was reported at 2.8%, the highest in a year and a half, but below expectations.
- Friday – Fitch cut the ratings of Italy and Spain by two levels.
- Friday – The Wall Street Journal reported that Facebook is readying for an IPO filing next week.
Despite a lackluster State of the Union address and low approval ratings, it increasingly feels like Obama will be reelected. The capital markets seem not to care much either way. We agree, finding no reason to believe stocks will do particularly better or worse based on election results.. It is a commonly held belief that markets do well in the 4th year of a President’s term because the Fed chairman plays along with accommodative policy in order to be reappointed. Whatever the reason, monetary policy is indeed massively accommodating. This should not be underestimated.
In Europe, not enough progress was made this week in restructuring Greek debt. This is a ticking time bomb which needs to be defused before March 20. We expect it will be. One positive is that leaders are starting to acknowledge write-downs of Greek debt are indeed a credit default and outstanding swaps should be paid accordingly. Last summer, politicians were posturing for a “voluntary” haircut which would not trigger default swaps. The idea was to avoid a liquidity freeze caused by fear of unknown losses in swaps, such as when Lehman defaulted. In our view, preventing swaps from being triggered would be a massive mistake. First, outstanding swaps on Greek debt are much simpler than those involving Lehman. More importantly, if market participants lose faith that their credit default swaps are valid, it could unleash a devastating wave of bond selling with nearly unimaginable results. We try to avoid being drastic, but do believe this was a primary driver of the sharp decline in stocks last summer and that it could be even more serious now, if handled poorly.