Uber Hellas Deutschland

“Do you mean, to drag our lives out long, that we must yield to the house shamed, and leadership of such as these?”

“No, we can never endure that; better to be killed. Death is a softer thing by far than tyranny.”

-the Athenian chorus in Agamemnon (Aeschylus)

Well, the EU has done it to me again and another MarketWeek edition is late! At about 2:30 AM Sunday night, I threw in the towel on the stream of conflicting reports coming out of Europe – deal, no deal – and went to bed.

Things are not looking good at all for Greece. And not just Greece – things have gotten much darker for the eurozone and Germany as well. The Greek outcome matters, and so I feel obligated to add my bit. While it’s been very easy to find analyses of the Greek problem, it’s been very difficult to find ones that aren’t starting from some ideological conclusion and then working backwards from that to find the best-fitting details.

It appears that another bail-out deal will be done. Appears, because it is not quite done yet, needing to pass muster with some unhappy parliaments. While the markets (and I) have thought that some last-minute deal was more probable than not, to my thinking it was nevertheless not something to bank on, either. A great many Germans are more than willing to give Greece the stick and damn the consequences, regardless of (and even inspired by) the negotiations of recent years.

When the U.S. added its considerable weight at the end of last week to pressure on Germany and its allies to come around – our authorities lack the smug Germanic confidence that a Grexit would be of no great import, as it was just that kind of thinking here that led to the Lehman debacle – I thought that such pressure might tip the scales, but the comments coming out of Brussels over the weekend (e.g., a five-year timeout from the euro for Greece, and then they get to apply again!) gave me real doubt.

Looking at the new conditions coming from Germany, I’m not optimistic about the longer-term future of the eurozone as presently constituted. It’s clear that the German elites – a society that in its degree of formality and social division is closer to Downton Abbey than it is to the U.S. – have been seriously provoked and want to punish the Greeks for their temerity. How dare they behave this way to their betters? How dare they?

If the Greek parliament refuses the now-draconian conditions the German bloc wants to impose, it means Grexit. If the country accedes to the demands, it will likely mean a Grexit within twenty-four months, and under worse circumstances as the weak business cycle ends. Politicians like to make projections based on the never-ending business cycle fantasy, but it’s a dumb template for keeping together the finances of a continent. Greece will fall deeper back into its depression with the whips of austerity on its back, and the business cycle will end long before the supposed curative effects of the new discipline could ever succeed. Who will go with them when the current cycle ends? Here’s a hint – where does the rain fall mainly on the plain?

The press has been full of apt comparisons with the Treaty of Versailles and the two big write-downs of German war debt, but the Germans don’t want to hear it. Why should they? All they were doing was indulging in a bit of lebensraum when some misguided souls got in the way. The Greeks were borrowing money to give raises to their civil servants!

I don’t doubt that most Germans would reject any such treaty comparison (along with the deal) and prefer to recount instead some cherished anecdote about those lazy irresponsible spendthrift Greeks. As for the blame handed out to the latter, there is no doubt that the country has sinned – just as there is no doubt that the six-year austerity program and concomitant depression has made them wretched. The Greek sins can hardly be said to be worse than the ones committed by their neighbors to the north in the previous century – the ones who similarly rebelled against the Treaty of Versailles after six years of misery.

But Germany has also benefited enormously from the zone and the depressed level of the euro – any money the country is contributing to the pot has probably been made several times over in the benefits to the export-based German economy. It’s a fact that carries little weight in the German streets, but the country may come to regret the first step in a path back towards widespread unpopularity on the continent. They should not have been so shocked that the Greeks voted “no” in their referendum – the lines above from Aeschylus, the father of modern theatre, are well-known in the cradle of democracy. To desire punishment for such a sentiment is hubris, and hubris is something that brings down the mighty.

The market’s main concern is what might happen this week – next month is too far away in stock market time. Direct private exposure to Greece is far smaller now than it was five years ago, and smaller than the financial system was relative to Lehman, but if the immediate effects could be counted upon to be obvious, the Lehman outcome would never have happened in the first place. As I wrote last week, the real impact would not be likely to be felt in the first week or month (stocks were up the week Lehman went into receivership), but down the road. Most of all it would be in the damage to the notion that the eurozone is really a permanent union and not some club that ejects members on an as-needed basis.

Looking at other matters, conditions are propitious for a continued rally in markets over the next couple of weeks. Fed chair Janet Yellen gives testimony on Capital Hill this week, and her consistently dovish palette has always inspired the market to paint a bright future. Earnings season begins in earnest this week, and rallies through the first two or three weeks are mandatory – presuming the EU deal doesn’t fall apart. Second-quarter rallies are prone to sell-offs at the very end, but July is still apt to finish up overall.

Second-quarter earnings are a bit of a mystery, though. Usually Wall Street builds a cushion of about 300 basis points into estimates, allowing for the usual positive “surprises” and “beat on top line” headlines. However, while first-quarter earnings growth for the S&P 500 was less than one percent, that was well ahead of the consensus for a loss of nearly five percent. As we come into this quarter, estimates are again for a loss of about 4.5% overall – does this mean we should expect another flat quarter? Time will tell. For now, I note that the Wall Street Journal has been writing about earnings estimates on an “excluding energy” basis, reminiscent of earlier times when housing was excluded, and before that internet companies. It turned out the other sectors followed them down the rabbit-hole. No doubt this time is different.

The Economic Beat

The report of the week for me was the May wholesale trade report. It was ignored about as much as the Fed meeting minutes, though for different reasons, the latter being submerged under a wave of Grexit fears. It would have been nicely symmetrical to write that optimism about a Greek solution drowned out wholesale trade, but the truth is that the wholesale reports rarely attract much attention anyway.

Unlike the higher-profile FOMC minutes and the ISM non-manufacturing survey, the wholesale report is not an opinion survey, making it a more reliable indicator. May sales were up 0.3% (seasonally adjusted, or SA), lower than consensus, while inventories rose 0.8%, well above consensus of about 0.4%.

The real information is, as usual, in the longer-term trends. The year-over-year (y/y) monthly comparison was negative for the fifth month in a row, in this case a 6.9% decline (not seasonally adjusted, or NSA) that is stunningly large to geeks like me. Outside of the 2008-2009 recession, it is the largest single-month year-year decline in the 22-year history of the series, larger than any decline in the 2001-2002 recession!

There are some special factors. May 2015 had one less business day than May 2014, so the SA data is better than the NSA data, for example durable goods sales being up 1.6% adjusted and down 1.9% unadjusted. I’m uneasy about the size of the adjustment, however, as businesses aren’t quite retail stores and ordering tends to be more of a weekly and monthly function than a daily one. Lots of months have a business day or two less than the prior year, yet the 6.9% May decline is still the largest ex-recession y/y decline in the series (back to 1992). Most of the sectors showed y/y declines unadjusted, many remained negative after adjustment.

A big special factor is that most of the decline can be laid at the door of the petroleum industry, which has seen sales crater by a third, with most of that being price-related. Still, fewer dollars are fewer dollars and the other sectors aren’t exactly hitting it out of the park. The inventory-to-sales (I/S) ratio in durable goods, for example has been quite high lately, with the May reading of 1.66 being the highest May read since 2008 and only exceeded since July 2009 (end of recession) by the February 2015 snow read of 1.67.

There are a lot of goods piled up, with I/S ratios up almost across the board from a year ago, pointing to sales weakness at the very least in coming months in order to bring stocks back into balance. The overall I/S ratio stands at a very high 1.29, compared to the post 2001-2002 recession average of 1.19. The ratio has been in this neighborhood January, at the highest levels since the recession, yet the popular economic website Econoday deemed it “relatively lean!” I like the Econoday website, but sometimes its write-ups are Pollyannaish beyond belief. Even Yellen fretted over the low levels of business spending on Friday.

The ISM non-manufacturing survey was also the victim of Grexit fears, with Monday’s related trading weakness overshadowing that morning’s release of a June survey reading of 56, a number that was dead-on the consensus and a slight tick up from the previous month’s 55.7 (the difference is trivial). The growth-contraction score was quite respectable, at 15-3. The prices component, the best leading indicator in this particular survey, did slip by about three points to 53, but the essential is that it stays above 50.

A commonly repeated datum this week was that the May JOLTS (employment turnover) report showed an all-time high in openings (5.4mm). Given that the series is 15 years old and the population keeps expanding, this is what should be expected. Unless you read the report yourself, it was nearly impossible to notice that the hire rate remained unchanged from a year ago (3.5%) and declined slightly from April (3.6%). If the May hire rate holds up, it will be the first month since last August not to show a year-on-year improvement. The labor market conditions index (LMCI) created by the Fed showed a decline from 0.9 in May to 0.8 in June, and that report included a substantial downward revision from an original 1.3 in May.

As you can see from the chart above, courtesy of the St. Louis Federal Reserve, the labor market isn’t showing as much strength as those quarterly letters from equity fund managers would have you believe. Though employment is in general a lagging indicator, the LMCI does wobble in advance of official recessions. On the other hand, it also oscillates a lot between 0 (neutral) and 10, so it would be premature to say anything beyond the obvious thought that the labor market bears watching. In the case of the LMCI, it has rarely put together consecutive negative readings of three or more months outside of recessions or pre-recessionary periods, so the good news is that May and June broke up the March-April negative run.

Trade continues to post weak numbers, with exports and imports declining from April to May, the latter despite a good-sized bump in the price of oil. Nevertheless the balance was smaller, providing a small positive to second quarter GDP.

Next week is a busy one, prominently featuring the June retail sales report on Tuesday. Retail doesn’t look good for the moment, though with seasonal adjustments one can never be sure. Consensus is for an increase of 0.3%, 0.5% excluding autos, a number higher than would be suggested by Redbook sales data but the two do not always align. The report will be accompanied by the monthly release on import-export prices, in turn followed by producer prices on Wednesday and consumer prices on Friday.

There is a big slug of manufacturing data, including the monthly industrial production report on Friday and the two most widely followed regional Fed surveys, New York (Wednesday) and Philadelphia (Thursday). The Beige Book report comes Wednesday afternoon. Perhaps the reports will flavor the Janet Yellen speeches slated for Wednesday and Thursday; homebuilder sentiment (Thursday) and its closely related data on housing starts (Friday) will round out the first week of the earnings season.

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