There’s Knocking at the Gate

“Foul whisperings are abroad.” – William Shakespeare, Macbeth

by M. Kevin Flynn, CFA

We’re doing a shortened, holiday issue this week, in observance of the Memorial Day weekend in the U.S: All domestic markets and banks will be closed on Monday the 28th. So we want to note the most important thing, which is that a messy ending in Europe isn’t priced in yet. What’s more, it won’t be until if and when it should happen.

To be sure, a certain amount of fear and loathing has landed and taken up residence, moving equity prices down and Treasury prices up in recent weeks. Be certain, however, that prices haven’t moved nearly as much as they will if there is an ugly exit by Athens.

If you want to know why the bad stuff isn’t really priced in yet, it’s for a mix of reasons. Institutional fund managers aren’t going to sell unless and until redemptions force them to. They don’t go to cash (“we consider that a client decision”) and a 5% cash holding is the usual limit. Tier-one traders, the guys who can spend money in eight- and nine-digit chunks, are as afraid of missing a big relief rebound as they are of getting sucked into the downdraft.

You can lay the blame for part of that on 2011. Most of the stock-picking money and most of the fund management money posted red results last year, while the S&P and Dow managed to eke out black numbers, thanks to an improbable late run-up the last two weeks of the year. Managers came into 2012 smarting from complaints and vowing to put every nickel of fresh money they had to work, and keeping it there.

Those who are allowed to hedge are trying to figure out strategies that can guard against disaster and yet go up with everyone else if, for example, Greece should decide over the weekend to become the southernmost province of Germany. It isn’t easy, though, and hedging is never cost-free. A lot of prominent, smartest-in-the-room managers are again in the red so far in 2012 (though to be fair, just about every equity market around the globe – be it domestic, foreign, emerging or developed – is down over the last twelve months).

Another factor is the eternally upward-looking perspective of the markets, but even more than that is the first fundamental truth of investing: as bad as it feels to lose money, it feels even worse to see your neighbor make more than you. Markets rallied in August of 2008, they rallied up to the edge of the Asian currency crisis-Russian default in 1998 (a quick 28% haircut for equities ensued), they rallied furiously up to the crash of 1987. They rallied in 1929, for that matter. The intolerable feeling of being left out of easy money is how bubbles get to be bubbles.

All markets are ready to move sharply on rumors of any European fix or breakdown. Greece is in, Greece is out (though the real problem is Spain); eurobonds are in, eurobonds are out (they would have to pry eurobonds out of Merkel’s dead and lifeless hands, but rumors of compromise bonds fly); the (fill in name of central bank) is going to (print money, lower rates, buy the Acropolis), etc.

Any solution isn’t priced in either. Traders will leap like gazelles at the Carnivore’s Ball at anything that smells like a fix. Feel free to trade it, but the only solution that can endure over time is to write off all the bad debt in the European banking system and recapitalize it. Everything else is just another kick of the can.

For better or worse, June is going to be a volatile month. The unfortunate part is that we can’t tell you in which direction, the fortunate part is that we can present the schedule you need to know:

June 1st: May employment report, plus ISM manufacturing survey. If job growth is either over 200k (“U.S. growth is unstoppable”), or negative (“the Fed has to act”), expect a rally, probably a big one.

June 6th: European Central Bank (ECB) policy decision and statement. Markets will be crossing their fingers for an interest rate cut or another round of liquidity injections.

June 17th: Greek elections (“Goodbye, Yellow Brick Road”)

June 20th: FOMC (Fed) decision and statement: (“Please Mr. Chairman, look and see, if there’s some easing in your bag for me.”)

June 28-29th: European Union Summit Meeting (“The Tussles in Brussels”)

Next week is also quite busy for U.S. data. Due to the Monday holiday, most of it is back-loaded onto Thursday and Friday. Happy Memorial Day weekend to our U.S. readers, yet spare a thought for those who fell for us all.

The Economic Beat

Consumer sentiment hit a fresh post-2008 peak at 79.3. It also rallied sharply heading into September of 2008, then bottomed in February 2009. Draw your own conclusions.

The totals of actual new homes sold (i.e., not seasonally adjusted) in the first four months of 2009-2012, beginning with 2009 are in thousands, 116, 128, 109, 117. Those are the four lowest such four-month totals (first third of the year) since record-keeping began in 1963. The financial press talked excitedly all week about the recovery in the housing market. Draw your own conclusions.

The Richmond Fed added another disappointing manufacturing survey to go with the Philadelphia decline the week before. Durable goods in April got the quarter off to a rocky start with a decline in new orders where a gain was expected, and a second consecutive drop in business investment orders. The ISM national purchasing survey is next Friday; it surprised to the upside last month after a string of weak regional reports. Kansas City and New York both reported improved results for May.

Weekly retail sales reports are so far predicting a weak May, but the big shopping weekend is still to come.

Next week has consumer confidence and pending home sales in the first half of the week (Monday, Tuesday), and then a heavy slate the last two days. Thursday reports include May same-store sales, the ADP payroll report, another estimate of first-quarter GDP, and the Chicago Purchasing Manager Index.

Friday will see the May jobs report along with personal income and spending, the latest ISM manufacturing survey and April construction spending. Enjoy the long weekend – all U.S. markets, banks and government offices will be closed.