Avalon's MarketWeek

Thinking about the Unthinkable


“Annual income twenty pounds, annual expenditure nineteen, nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. ” – Micawber in Charles Dickens’s David Copperfield

This week’s Golden Rule is that you don’t know what you can’t know. The case in point is Greece of course, in particular the people negotiating its eventual fate. Last week’s growing stalemate around the country’s debt dilemma gave me occasion to pull out a favorite observation, namely that when it comes to a crisis, you can never be sure of what tired and sleep-deprived people are going to do. As if on cue, Greece’s Prime Minister Alexis Tsipras made an after-midnight (European time) announcement Friday that the Greek parliament would put the latest EU offer up for plebiscite – and added that he would vote against it.

It was a bold move. Or was it a tired one? Both, perhaps. I put off writing this week’s market essay until the last minute, expecting more developments to follow, and sure enough, the news came late Sunday night about a forced bank holiday in Greece, along with capital controls. Other unpleasantness is sure to follow, and that’s just from the Greek side – over on the EU side, a furious cacophony of indignation and disapproval has been playing in the wake of the Tsipras gambit.

It’s difficult to avoid the impression of watching the latest round in a poker game of escalating stakes, with the bets rapidly getting too rich for all the players at the table. Having failed in his bid to budge the German-led EU bloc off of its agenda of hairshirts and crowns of thorns for his fellow citizens, Tsipras may now in effect be daring the EU to throw his country out for deliberate non-payment of debt: “We won’t pay it. Whaddya you going to do about it?”

It will be an interesting week. Within Greece, days of closed banks (perhaps better for the ruling party than a week of long lines and short tempers in front of ATM machines) are going to go up against a daily cocktail of EU condemnation, indignation and vituperation. My guess is that the bank holiday program ought to scare up some “yes” votes, but should some crisis-fatigued EU minister commit a verbal gaffe in the desire to discipline the wayward Hellenes, it could backfire on all and unite the latter in defiance of the EU, both sides accusing the other of blackmail. Of course.

We can all speculate on what might happen, and what we want to happen, and how this or that inevitably had to happen, but we still don’t know what will happen, and neither does anybody else. For all of the recent talk from the IMF and EU of getting all the adults in the room to sit down and act like grown-ups, it’s just as likely that someone on the EU’s own side starts an avalanche with some impetuous and unforgivable remark.

Nor do we know what will happen to the markets if the situation worsens, and there is some kind of showing of the eurozone door to the Greeks. Certainly there will be some risk-off reflex selling of equities, along with corporate bonds and the euro, and buying up of safe haven bets like the dollar, yen and Treasury bonds. But how much, no one knows as of yet. The EU and European Central Bank (ECB) can brandish backstop facilities and calm demeanors, but should the markets start to get overwhelmed with sellers of sovereign debt issued by the weaker members as the days drag on without resolution, knees might weaken and prices could get ugly fast. It might only take one fund sitting on an over-leveraged bet on Greek bonds or the euro to start massive wave of margin-fueled selling. There might not be any such player, however, and even were one to emerge naked from the receding tide, it might be possible to throw it into the jaws of a survivor, leaving the markets to quickly rebound (the typical reaction) from a day or three of selling. We just don’t know, and it’s important to know that you can’t know.

Let’s not forget the central banks, either. Taking a page from the Fed playbook of intense fear of its own domestic equity markets, China’s central bank pursued further easing over the weekend after local shares took a historic beating. Japan’s bank will not be happy about seeing the yen rebound, nor will a stronger dollar find much favor with U.S. policymakers (or earnings). Might a Grexit finally crash the long-running tandem act of central bank largesse with legislative heads in the sand? Maybe, maybe not. Did I say we just don’t know?

I do know that that last week’s complacent front-runners of the “inevitable” Greek solution are waking up to big losses on Monday morning, so best to stay on the sidelines, keep your powder dry, and remember the ruling phrase from September 2008, “the unthinkable just happened.” Puerto Rico has just announced that it can’t pay its debts either. Sanity would suggest that an orderly debt restructuring for both the U.S. territory and the Greek republic is in the interest of all, but sanity doesn’t always win. This one ain’t over yet.

The Economic Beat

The report of the week was the Tsipras decision, yet after that I really couldn’t say. The data was mixed, supporting both bull and bear outlooks. I will note that the beginnings of cycles are marked by terrible employment data and the slow recovery of manufacturing, while the ends of them look like the current picture of great employment-related numbers, yet eroding trade and manufacturing.

There is no sign of trouble at all in jobless claims data, and personal income and spending is right where you’d expect it to be with peak employment. Income rose 0.5% during May, with spending up a most impressive (and still provisional) 0.9%. The year-on-year data is stable, however, with year-year nominal income growth currently at 4.4%, compared with the average over the last year of 4.3%. Retail spending appears to be weakish outside of autos, but strong with it.

Over on the business side, cap-ex spending is negative again (year-year) for the fifth month in a row, May durable goods orders were weak (-1.8%), and manufacturing surveys were mixed. Durable goods were pulled down by airplanes and were in fact up 0.5% excluding transportation, but the latter was up only after a very large downward revision to April, from +0.5% to (-0.3%). That’s no improvement.

Over on the survey side, the Kansas City Fed region was quite weak again, (-9) versus a neutral level of zero, but Richmond rebounded to a read of plus 6. The Markit “flash” national purchasing survey eased a point to 53.4, with the official ISM result due out Wednesday and expected to show about the same.

The Chicago purchasing manager survey will come out on Tuesday, and it has been weak of late, as has been the Chicago Fed’s current business indicator. The latter was negative for the fifth month in a row, with the three-month moving indicator down a fourth month in a row.

Home sales are improving, though they have not been not reliable indicators of the overall economy in the last two cycles. Both existing-home and new-home sales were better than expected, with the former rising to a 5.35 million annual rate (seasonally adjusted), a 9.2% year-on-year improvement. New-home sales are still very low relative to historic standards, but the twelve-month growth rate has rebounded from a left-for-dead 1.7% last June to a hopeful 13.2% through May.

First-quarter GDP was revised again, this time upwards from a decline of (-0.7%) to a decline of (-0.2%), matching consensus. Four-quarter nominal GDP edged up to 3.8% as a result, in-line with its average over the last three years.

The big kahuna emerges from the sea again in the coming week, with the jobs report coming out a day earlier on Thursday instead of the usual Friday, due to the impending Independence Day holiday. That and Greece will overshadow the rest of the data, which includes pending home sales on Monday, Case-Shiller home prices on Tuesday followed by consumer confidence, construction spending and the manufacturing survey Wednesday, and factory orders on Thursday. All U.S. markets will be closed on Friday.

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