There was little to be thankful for in capital markets. Stocks declined every day, extending the streak to seven consecutive declines. The primary driver of selling pressure came in the form of strong comments out of Germany voicing opposition to issuing combined Euro-area bonds or the ECB offering to buy unlimited amounts of sovereign debt. Meanwhile, US Q3 GDP growth was revised down to 2%, from 2.5%, the congressional “Super-committee” admitted complete failure on US budget deficit reductions, and economic news out of China was mostly negative.
- Monday – The US “Super-committee” announces it will not be able to offer any legitimate proposal to reduce the budget deficit.
- Tuesday – Q3 US GDP growth was revised downward from 2.5% to 2.0%.
- Tuesday – The IMF revamped its credit line to encourage countries facing pressure to access its credit.
- Wednesday – Newly issued German bonds were met with tepid demand, highlighting that the risk of sovereign debt contagion can spread to even the strongest nations.
- Wednesday – A slew of US economic data releases were mixed. Consumer spending slowed to just 0.1% in October, but incomes rose faster than expected. Initial jobless claims rose by 2000, slightly higher than expected.
- Friday – Hungary’s credit rating was cut to junk by Moody’s.
Sadly, twice in the last three years the global economy has required the type of government intervention that promotes irresponsible behavior and brings significant potential long term negative implications, primarily in the form of inflation.
In the US sub-prime crisis, the federal government and the Fed resisted intervening until after Lehman fell and a looming AIG bankruptcy threatened the core of the financial system. Now, the world is waiting to see if Germany will relent and allow the ECB to effectively print money to sustain the governments of Italy and Spain.
Our view has been that Germany would have little choice but to acquiesce, and probably soon. Most of the rest of Europe (including France) is pushing for this type of remedy, as is almost everyone who is long the global equity market. However, we were reminded this week that every country thinks differently and Germany may not do the obvious. It is deeply engrained in the German culture not to print money recklessly. Therefore, politically, it may be possible for the German government to prevent such an outcome even if the consequences are dire.
We still expect an ECB backed stop-gap will be implemented, maintaining the Euro and buying time for European governments to reduce deficits. Even in this scenario, recession in Europe is probably inevitable in the short term. But recession is short term in nature and equity prices would rise anyway. Why? Because the alternative, which became more likely this week, would be much worse.
Stock, bond and currency prices will continue to be driven by comments out of Berlin for the foreseeable future.