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Archive for May, 2010

The next post will be June 1st.  Have a great Memorial Day weekend!

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Last week I posted an article about the enormous debt problems in Europe and how they went to great lengths to fix those problems (for the time being) with a major bail-out.  The whole idea of the bail-out was two-fold.  First, it was supposed to stop the decline in Europe’s currency, the euro.  Second, it was to re-build confidence.  Thus far, none of that has worked.  Today as I write, the value of the euro is lower than it was before the bail-out occurred.  Plus, there is probably less confidence in this situation getting worked out than before.  Imagine rolling out a huge bail-out that no inspires no confidence at all.  As the value of the euro goes, so does the value of the stock market.

It is the same level of confidence that we have in British Petroleum every time they say the oil leak will be fixed in 7 to 10 days.  I wish that I would have kept track of every time they made that statement. I struck me that what is occurring in the Gulf and what is occurring in Europe are very similar.  If Greece were to default on their debt, it possibly would create all types of unintended consequences throughout all of the financial markets.  The same is true with the oil crisis in the Gulf.  If that oil slick gets picked up by the Gulf Stream, the Gulf problem would potentially be an east coast problem.  That, of course, has unintended consequences as well.

The problem in Europe is just like the problem in the Gulf in that there are no good solutions.  There is one main difference between Europe and the Gulf.  The stock market is paying attention to what is happening in Europe and not to what is happening in the Gulf.  In my opinion, investors should be paying attention to both.  There is no arguing that the crisis in Europe has a bad end game to it.  The possibilities range from Greece defaulting on their debt to the destruction of the euro (many analysts are suggesting that this will happen).  The crisis in the Gulf has a difference type of end game.  The worst case scenario would affect the tourist industry, the seafood industry, wildlife, growth of the economy, gas prices, and the East Coast.  BP seems as if they are trying to solve a problem that they fear is unsolvable. 

Although we are seeing some recovery in the economy and earnings reports have been great, none of that matters if these two problems get out of control.  The risk level continues to accelerate.

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I could write volumes on what happened last week.  I am just going to stick to the most recent news which is the almost 1 trillion dollar bail-out of Greece and everything that ails Europe.  No worries – After last week’s market decline, we wake up to find that the Europe Central Bank is delivering an almost 1 trillion dollar bail-out to solve the problem.  In other words, they are going to fix the debt crisis by issuing more debt.  It gets even better.  The Federal Reserve is also assisting in that bail-out package. 

Taking these enormous steps to save the system just goes to show how close to the brink the euro might have been last week.  Does it solve the problem?  Does the market just go up from here?  

There are several points to consider.

The Europe Central Bank is not the Federal Reserve – The United States can pull something like this off.  It is very suspect that the ECB has the ability to pull the same “solution” or push the problem off into the future without a hitch.  Just like the US, they have no room for mistake and the EU is in an environment where mistakes can easily happen.

The US Government made their big bailout attempts in 2008 first on September 19th and then the TARP on October 3rd.  Following those heroic methods to save the system, over the next 6 months the stock market dropped -40%.  Initially after the bailouts started, we saw the same type of positive stock market action as we are seeing on Monday.  However, it gave way to further large declines.

There are still a lot of European politics to get around.  Politics, the euro, and cultures are vastly different than here in the US.  This solution is not a done deal.  In addition, Greece and some other parts of Europe will still have to deal with the social and civic unrest and backlash. 

If this gets pulled off, we are maxed out as a world economy when it comes to creating more debt to handle current debt problems and pushing current crisis out into the future.  Thus there is no room for any other problems while walking this financial tightrope.  Utilizing the vast majority of the IMF (international monetary fund) to bail-out Europe (of which the US funds 18%) is the last resort.  There are many more countries that could potentially need help.  Further, if this thing doesn’t work (and I believe the odds are that it will not work) look out below.  Debt might end up being Europe’s kryptonite and Superman might not save the day.

Don’t be fooled into believing that the problem in Europe is fixed.  This is an area on the globe that is walking a tightrope.   This is a much bigger problem with many moving parts that connects all of us.

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I could go a lifetime without seeing the word unprecedented.  It seems like we have faced our share of unprecedented events over the past 3 or 4 years.  Now, we face unprecedented again with the oil tragedy in the Gulf.  Sure there have been other oil spills in the past.  Not with the perfect storm elements of this one.  This has the potential to be a complete disaster.

The impact of this oil spill could be a true tragedy.  Their best case scenario is trying to stop the leak using a method that has never been used before and only tested in shallow waters.  They are attempting this in 5,000 feet of water. 

David Kotok of Cumberland Investors, a much-watched CNBC market analyst, put out a very gloomy analysis of the economic impact of the BP offshore oil spill.

“This spew stoppage takes longer to reach a full closure; the subsequent cleanup may take a decade. The Gulf becomes a damaged sea for a generation. The oil slick leaks beyond the western Florida coast, enters the Gulfstream and reaches the eastern coast of the United States and beyond. Use your imagination for the rest of the damage. Monetary cost is now measured in the many hundreds of billions of dollars….

We expect that the Federal Reserve will extend the timeframe that we have come to know as the “extended period” in the making of its monetary policy. We do not expect the Fed to raise interest rates at all for the rest of this year, and maybe well into next year. We expect to see the deterioration of the economic statistics for the US to reveal the onset of this oil-slick crisis in May, and the negative impact will intensify during the summer months. A “double-dip” recession probably has been made more likely by this tragedy.”

This is just one of those outlier risks that this economy cannot tolerate.  The economic effect on the economy is immeasurable.  Potentially the tourist and fishing industries would be gravely affected from Florida to Texas.  Obviously, that is worst case scenario.  My concern is that it is tough to derive any scenario where the damage would be minimal.   This also couldn’t come at a worse time from a seasonal standpoint.  There is always pressure on gas prices this time of year.  This has the potential to really affect gas prices. 

If this looks to have the potential to drag us through a double dip reccession, the effect on stock prices will be felt shortly.  The stock market acts as a barometer for things to come.

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