The Unthinkable Becomes Inevitable
The European crisis is giving us all a real-time lesson as the “unthinkable” becomes “possible” and finally “inevitable.” With Greece pushed to the sidelines for now, leaders are dealing with the much-bigger Italian debt problem.
The quandary is this: Italy cannot repay its debts and its highly-leveraged bankers cannot survive a default. In the U.S., the Federal Reserve can create however much liquidity it needs to fulfill its role as lender of last resort. The European Central Bank lacks this ability. Hence, the ECB can lend to Italy and other troubled states only to the extent the ECB can itself borrow money. From whom will the ECB borrow enough to keep Italy solvent? That’s the problem.
Citigroup chief economist Willem Buiter said today a sovereign default, by Italy or someone else, could happen within weeks. According to Buiter, this would provoke “a financial catastrophe dragging down the European banking system and North America with it. So they have to act now.”
Leaving aside the rich irony of such warnings from Citigroup, we have a much bigger problem in the U.S. Starbucks (SBUX) is raising prices! Analysts blame higher commodity and rent costs, though we think consumer caffeine addiction is a bigger factor.
Today, the latest Consumer Price Index was released, showing a fall of 0.1% from September to October but an increase of 3.5% since twelve months ago. Average hourly earnings rose only 1.8% in the same year-long period. Crude oil prices are back above $100. Unemployment and underemployment are still serious problems as year-end approaches. If bull markets climb a wall of worry, as the old saying goes, investors are holding on by their fingertips.
The sector average momentum reading dropped this week, and we observed a few shifts in relative position. Energy maintained the top spot by a slight margin, thanks to crude oil prices climbing back into triple-digits, and is followed closely by Technology. Industrials, Utilities, and Consumer Discretionary remain bunched together right behind. Materials was demoted into the third tier with Health Care and Consumer Staples. Financials edged below Telecom and back into last place.
The Style categories lost momentum across the board, but dispersion stayed about the same. Last week there was a 13-point difference between top and bottom, and now it is 14 points. The line-up changed a bit, however. We now have a near-four way tie for first place between Large Cap Growth, Small Cap Growth, Large Cap Blend, and Mega Cap. Micro Cap is still entrenched at the bottom of the list. Just above Micro Cap we see all three Value categories bunched together, a feat made possible by the elevation of Large Blend and Mega Cap to the top tier. While relative positions can change quickly, Value’s lag does seem to be persisting.
A week ago the United Kingdom’s stock benchmark was second in our Global relative strength rankings, behind China. Now the U.K. is in fourth place and has been surpassed by the U.S. and Latin America. Bank of England Governor Mervyn King said his country’s economy faces a “markedly weaker” outlook, dashing hopes that the English Channel could somehow contain the damage. The EU nations replaced Japan in last place. Canada and EAFE kept their relative positions but also lost considerable momentum.
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
“The European bond market is becoming very binary, and ECB-dependent. Whenever the ECB steps in, the market likes it, when it steps back, you see pressure. There are no real buyers.”
Italian Mohit Kumar, European interest- rate strategist Deutsche Bank, 11/16/11
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