A New Greek Tragedy

On June 27th Greece broke off negotiations with the Troika (IMF, European Commission, and the ECB), when Greece determined that the terms of a debt restructuring agreement with the Troika was untenable. Greece also announced that they would hold a referendum for voters on July 5th to determine if the terms offered by the Troika would be accepted. The Troika seemed surprised by Greece’s departure, but it was hardly a surprise given that the terms mandated by the Troika would leave Greece in “debtor’s prison” and with something less than real sovereignty. Greece (and just about everyone) understands that their current level of debt and debt service is unsustainable and must be reduced if there is any chance of changing the ultimate outcome of Greece’s financial circumstances.

Greece’s decision to leave the negotiations, just two days before the due date of a payment of 1.6 billion euros to the IMF, prompted the ECB council to suspend further access to ELA (Emergency Liquidity Assistance), which has been keeping Greek banks solvent as worried customers withdrew bank deposits. In turn, Greece was forced to close the banks and implement capital controls that limit customer ATM withdrawals to just 60 euros per day. It was initially announced that the banks would be closed until July 6th, the day following the referendum. (It was subsequently determined that certain banks may open sooner for withdrawals by pensioners only.)

The complex wording of the July 5th referendum, leaves the vote subject to “positioning” by the Greek Government that a “no” vote gives Greece more leverage to gain an improved agreement with the Troika, while the Troika offers rhetoric that a “no” vote means Greece is voting to leave the euro. The fact is there is no protocol for either voluntarily leaving or being forced from the EU, so the Troika’s argument really doesn’t hold water. On the other hand, Troika officials are growing tired of the tactics of the Greek government and may not be in the mood to offer a better deal. However, it now appears that the both sides may be softening in an attempt to find a short-term solution.

As noted above, the issue at hand is Greece’s overwhelming amount of debt relative to the size of its economy and a repayment schedule that cannot be met without the Troika extending additional credit to Greece just to make the payments. In addition to the 1.6 billion euros owed today, Greece has a 3.9 billion euro payment due on July 20th. It is clear that absent additional credit being extended, Greece will not make these payments. Non-payment does not classify as a default from the perspective of credit rating on commercial debts. While this would typically be referred to as a “payment in arrears,” IMF Managing Director Christine Lagarde has said there would be no grace period on the June 30 payment and the IMF would declare a “partial default.” A default triggers a number of other issues, but as the saying goes, “you can’t get blood from a stone.”

The total amount of Greek debt currently outstanding is 243 billion euros, with Germany by far the largest creditor. This figure includes loans of 220 billion euros made in two bailouts from European governments and the IMF since 2010, as well as Greek government bonds that were bought by the European Central Bank. Private investors hold about 39 billion euros of Greek government bonds, the value of which were considerably higher before being written down in 2012. What stands between an agreement between Greece and the Troika is Greece’s insistence that their debt be written down to an amount that is manageable and sustainable over the long term, while the Troika wants further commitment (read austerity) from Greece before further reducing Greece’s debt.

Of course, the Troika is also concerned with the moral hazard of just “writing down” Greece’s debt balance as well as the possibility of contagion throughout the rest of the EU. Greek debt is now far more concentrated in stronger hands than it once was, so the risk of contagion has been greatly diminished since 2012. As such, the EU believes it is in much better shape to prevent any wide and deep contagion. Furthermore, the Troika believes that if contagion occurs they have tools (quantitative easing) to mitigate the situation. As of now, it appears that the EU is more afraid of excess compromise than contagion. However, this story is not over. It should be noted that anything other than a meaningful write down of Greek debt will likely result in the whole ugly issue being revisited in the years, if not months, ahead.

If an agreement is not reached and a “Grexit” happens it will likely occur over an extended time, probably after a long negotiating process with the Troika. Because there is no existing protocol for withdrawal or expulsion from the Euro, all parties would be operating on new ground. Most probably parallel currencies would likely be used, while the Greek banking system is restructured. It is very hard to predict what will happen next considering the myriad of variables. However, most believe that the fallout of a Grexit can be controlled after the immediate reaction from world markets. Control is a relative thing, so caution is the watchword.

 

We are keeping a close eye on this situation and how it may impact our portfolios. In the meantime, please feel free to reach out with any questions or concerns.

 

David Post

Chief Investment Officer

 

 

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. This market commentary is a matter of opinion and is for informational purposes only. It is not intended as investment advice and does not address or account for individual investor circumstances.  Investment decisions should always be made based on the client’s specific financial needs, goals and objectives, time horizon and risk tolerance.  The statements contained herein are based solely upon the opinions of Telemus Capital, LLC.   All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Information was obtained from third party sources, which we believe to be reliable, but not guaranteed.

GDuP?

According to the U.S. Commerce Department, GDP contracted at a 0.2% seasonally adjusted annual rate in the first quarter of 2015. This was revised upward from the previously reported decline of 0.7%. The revision upward was fueled by stronger-than-estimated consumer spending as well as an increase in firm inventories. Consumer spending, which represents roughly two-thirds of economic output, grew at a rate of 2.1% in the first quarter as opposed to the previously estimated 1.8%. While this is a decline from Q4 2014’s 4.4% pace, revisions that are upwardly revised suggest consumers still have a greater capacity to spend. As Q2 2015 quickly draws to a close, be mindful to keep an eye on the level of goods and services produced across the economy to see if there is more economic activity occurring just below the surface.

Greece Kicking the Can Further Down the Road

As noted previously, Greece is functionally bankrupt. Greece’s debt load is insurmountable under normal conditions, let alone under current conditions. Greece’s GDP now sits 25% below 2009 levels, unemployment is at 25%, and youth unemployment is 50%. Irrespective of how Greece got to where it is today, it is virtually impossible for Greece to implement a policy of austerity that would come close to rectifying their circumstance of excessive debt. Markets rallied today on optimism that a deal could be struck to extend further credit to Greece, enabling them to limp further along. It appears that Greece presented a last minute proposal that addressed the hot-topic issues of lowering pension payouts and increasing taxes. The EU finance ministers agreed to meet later this week after Greece has time to work through terms of a prospective deal with the IMF, the EU and the European Commission. However, any deal that fails to recognized the futility of debt repayment by Greece and does not address their longer term economic viability is tantamount to kicking the can further down the road. The world seems to be getting quite proficient at can kicking.

Separating the Wheat From the Chaff…

The financial world is myopically focused on when the Yellen Fed will raise interest rates, as if on that particular day the financial and investment landscape will forever change. We know with relative certainty that when “liftoff” does occur the Fed will raise rates by 25 basis points, hardly noticeable in the big picture. Far more important will be the pace at which rates will rise over the next several months, which will remain as data dependant as the timing of the liftoff. The data upon which the Fed is most focused are the employment metrics and the rate of inflation. Of course, there are so many economic metrics released each week it is easy to get lost in an overwhelming amount of statistical data. Accordingly, focusing on the right things helps separate the wheat from the chaff.

 

It is most important to remember that the our economy is led by consumer spending, which from 1960-1981 represented approximately 62% of GDP, and has since risen to just over 70%. There are a lot of opinions as to how consumer spending is measured, what is included, and what real value-add it has to sustainable economic growth. However, there is little doubt that a financially healthy consumer is highly correlated with a strong and growing economy. Accordingly, a significant amount of energy is spent following unemployment, job creation, consumer sentiment, retail sales, etc., those things that either determine how much money will be in consumers’ pockets or track consumer spending. Retail sales have long been the measure of whether consumers are spending and the recent report of retail sales for May reflected an unexpected 1.2% jump from April, news that had some economists suggesting that “all’s clear ahead” after a frigid winter-induced slowdown. A closer look at consumer thinking and spending leaves plenty of room for a contrasting opinion.

 

Seven years of zero bound interest rates and Fed bond buying have driven equity and bond markets to all-time highs, benefiting those lucky enough to own financial assets. However, the average worker upon whom we depend for economic growth is not among the lucky owners of stocks and bonds. Instead, the average worker is dependent on income (and credit) for their spending and while real median household incomes are higher today than they were in 2011, they are 4.7% lower than they were in 2008.[1] As for credit, the consumer is close to capacity as to how much debt they can or are willing to take on. So, it is not surprising that retail sales have been lackluster. Notwithstanding the May uptick over April, retail sales are up 2.7% year-over-year on a nominal basis and closer to 1% adjusted for inflation. In either case, these numbers normally denote weak or recessionary economic environments.

 

Considering the financial circumstances of the average worker we don’t expect consumer spending to meaningfully improve. Adding to our concern is the fact that retail sales growth is now 40% below the average from 1993 to 2015 and consumer sentiment is now 11% above its historical average. The current dynamic may be reflecting a change in consumer behavior as baby boomers reign in spending in anticipation of their underfunded retirements. Moreover, millennials have been very slow to form households and have generally shown less appetite for buying “things,” both of which lighten their contribution to retail sales and overall consumer spending. There seems little on the short to intermediate term horizon that will change the current growth trajectory of consumer spending and unless something replaces the consumer as the driving force for economic growth, our conclusion is that going forward economic growth will be challenged and the Fed will be very slow in raising interest rates once liftoff occurs.

 

Accordingly, our message today is that focusing on when the Fed will raise rates is entirely misdirected. Rather, we believe that our attention is better spent understanding the current level of sustainable economic growth and positioning portfolios accordingly. As always, we appreciate your continued partnership with us and welcome your questions, comments, and insights at any time.

 

David E. Post

Chief Investment Officer

[1] Nominal and Real Median Household income in the 21st Century. www.dshort.com

 

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. This market commentary is a matter of opinion and is for informational purposes only. It is not intended as investment advice and does not address or account for individual investor circumstances.  Investment decisions should always be made based on the client’s specific financial needs, goals and objectives, time horizon and risk tolerance.  The statements contained herein are based solely upon the opinions of Telemus Capital, LLC. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Information was obtained from third party sources, which we believe to be reliable, but not guaranteed.

Who Will Revere the Last Three Fed Chairs?

Paul Volcker was named Chair of the Federal Reserve Board in 1979 and subsequently broke the back of one of the worst inflationary environments ever seen in the US, for which he has been revered ever since. Volcker was replaced by Alan Greenspan, who was succeeded by Ben Bernanke, who in turn was replaced by Janet Yellen. Whether by economic circumstance or Keynsian doctrine, Greenspan, Bernanke, and Yellen have together inflated the Federal Reserve balance sheet from $200 billion to $4.5 trillion. Yes, in the 27 years since Alan Greenspan took over as Fed Chair, the balance sheet of the Federal Reserve has grown 23X. David Stockman recently took a look at how some other constituencies fared over that same 27 years period and the results follow[1]:

  • Warren Buffet’s net worth went from $2.1 billion to $73 billion. – 19X
  • The value of non-financial corporate equities rose from $2.6 trillion to $36 trillion. – 8X
  • Nominal GDP grew from $5 trillion to $17.7 trillion. – 3X
  • Median nominal US household income went from $26,000 to $54,000. – 2X
  • Aggregate labor hours to the non-farm economy rose from 185 billion to 235 billion. – 27X
  • Average weekly wage of full-time workers went from $330/week to $340/week. – 03X
  • Real median family income went from $51,700 to $52,000. – 27 years of no growth!

Alas, we should not be surprised to read that retail sales are slow and retail chains are closing stores. Who will revere the last three Fed Chairs? Certainly not the average worker.

[1] Inflation adjusted (1982=100)

The OECD reduces its global growth forecast once again

The OECD, which has a history of cutting its growth outlooks, has done it again, reducing its global forecast due to lagging investment and risks, including a possible Greek default. Despite “monetary accommodation, less fiscal drag and a reduction in oil prices,” we’re not getting growth that is “matching the average of the past two decades,” Chief Economist Catherine Mann said in an interview. The OECD now expects the world economy to expand 3.1% in 2015, down from 3.7% predicted in October. Last year, the world economy grew 3.3%1. Second-quarter U.S. economic data should provide some insight as to whether the OECD will further reduce its global growth forecast given the impact U.S. growth has on the world economy.

1 http://seekingalpha.com/news/2558616-oecd-lowers-global-growth-outlook?ifp=0