Five years ago the financial world was coming to an end. The stock market tanked and interest rates went negative due to the unsurpassed flight to safety in U.S. Treasuries. Most of this was due to greedy lending practices that claimed to be championing President Clinton’s thesis that everyone in America should be able to own a home. Lax lending requirements that were intended to get lower income earners into their own homes travelled up market and allowed upper middle and upper tier earners to refinance their houses at artificially low rates to buy second homes and Harley’s. Once again, misguided bureaucratic endeavors have been perverted by greed. The roaches in China are beginning to surface and the banking system stress tests in Europe are uncovering the depth of this five-year-old issue and once again, the primary beneficiary of these actions will be the U.S. Dollar.
The election is over, the dust is settling and the economic landscape is coming into focus. The fiscal cliff and the Federal debt ceiling dominate the immediate foreground. Both of these issues come down to the business practices of revenues and expenditures. However, since this is the government and not a business it will be subjected to gamesmanship and hyperbole as both political parties spin their solutions in an attempt to come out, “a winner.” Unfortunately, the reality is that regardless of the spin, you and I will end up paying more for the year that’s already past as well as the coming years.
The post election stock market selloff is no aberration. Wealth, for many has come through the ownership of equities. When it comes to the vast ownership of equities we can quickly narrow the demographic to investors who’ve chosen wisely over the years and benefitted from their patience in the market. However, the economic crisis of 2008 saw the equity markets halved in the blink of an eye. When global market uncertainty is combined with rising estate and capital gains taxes, its no wonder that investors are pulling money out of a stock market that has very nearly recovered to 2007 levels, especially when the rally appears to have run its own natural course.
The estate taxes and capital gains tax increases may seem a bit out of touch with the everyday person but the alternative minimum tax (AMT) is something that will affect more than 70% of U.S. tax payers, according to the New York Times. Here’s the real world perspective you need prepare for. The Washington Post stated that the average income tax refund is $3,000. The expansion of the AMT will levy taxes on individuals earning less than $200,000 and married couples earning less than $250,000. The cost as applied to the middle 20% of all earners will be $888. The net effect will be nearly a $4,000 adjustment to your lifestyle. Furthermore, there will be no tax refund. In fact, odds are you’ll have to pay more taxes instead.
The combined effects of the tax increases for the middle 20% of earners ($40k-$65k) will be an increase of about $2,000. However, it is important to understand that this is an additional pay in, on top of the tax refund you probably won’t receive. Therefore, the net change in your spending habits will have to account for about $4,000 less in 2013. The same numbers for the top 20% (more than $108k) is about a $14,000 difference.
The second part of the fiscal cliff is the debt ceiling. Most of us are now familiar with this term thanks to the political standoff last summer that brought about the first credit downgrade of U.S. Treasuries in history. The debt ceiling is currently set at $16.4 trillion Dollars. The argument over the debt ceiling is the same as our family deciding which bills to pay except, rather than laying out a course of action, the politicians simply ask the Treasury to print more money. These arguments are about funding the same programs that they already passed (but shouldn’t have) in the budget. Technically, if Congress doesn’t raise the debt ceiling then the government has to decide who gets paid and who doesn’t, just like the rest of us.
The debt ceiling has, historically, been a non-event. It has been raised 76 times since it was first enacted in 1962. However, the economic welfare of this country and its citizens is being held hostage by both political parties as they attempt to find a deal that works best for themselves individually, rather than us collectively. Currently, there is talk of forcing the U.S. off the fiscal cliff in order to gain a political advantage as one side blames the other. The sad part is that it really would come down to whom has the best spin-doctor to sell the U.S. population on their version of what happened. After all, it’s not like someone is going to stand up and take responsibility. I believe the reality is that the truth is usually somewhere in the middle and most decisions aren’t as black or white as they first appear. Therefore, very little will be done, just enough to keep us rolling. Alarmingly, that may be the biggest problem of all as we are tossed back and forth between Scylla and Charybdis.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Trading the markets is sometimes like being a relationship counselor. There are times when it’s easy to see how one thing done or said affects the other’s actions. We use a fancy term for it, correlational analysis. When the correlation is positive, both things move in the same direction and when it’s negative, they move in opposite directions. Pretty straightforward stuff like when the Dollar falls, gold climbs. That’s a negative correlation based on inflation. Similarly, the stock market rises as interest rates decline because businesses find cheaper money for expansion and capital equipment acquisition. Unfortunately, every good therapist knows that relationships change over time. These markets, in particular, are not performing true to pattern.
Fortunately, in the financial world, we have tools that let us quantify these relationships. Now, it’s true that over the last year, gold has rallied and the Dollar has fallen. However, over the last couple of weeks, both the Dollar and gold have rallied. I think there is a significant change in the underlying nature of their relationship that could cause this to continue throughout the summer.
The primary reason for the Dollar’s strength has not been the domestic economy. The strength should be attributed to the global fear of a collapsing Euro, which attracts money to the U.S. as a flight to safety. We’ve talked at length about the troubles in Ireland and Greece. Well, Spain and Portugal are right behind them. The global credit markets are already pricing in the pending defaults. Greek 10 year bonds are yielding north of 16% and Ireland and Portugal are both above 9%. This compares to the U.K. Gilt 10 year yield of 3.3% and the U.S. 10 year Note’s yield of 3.1%. The European Union is caught between balancing what the Union’s lenders will accept as payment versus what rights of autonomy the borrowers will relinquish to remain in the Union itself.
The new catch phrase is a, “reprofiling” of debt. This word isn’t even in Microsoft’s spell check. However, this invention by the European Central Bank is really a synonym for, “default.” They want to extend the maturity dates of Greek debt. The Euro has fallen 7% as we’ve hunted through Webster’s Dictionary for, “reprofile.” The reprofiling or, restructuring of Greek debt would seriously devalue the 50 – 80 billion the ECB has already contributed monetarily and devastate the value of the European Union’s political solidarity.
The same fear of a Euro collapse has attracted money to the gold market. This week, gold hit an all time high priced in Euros. Investors are looking for a safer holding facility for their liquid cash than the Euro currency can provide them with. This move has been extended as the ECB has chosen to cancel its June meeting while reprofiling studies are being completed for their newly scheduled July meeting. Consequently, there have been four trading days in the last ten where both gold and the Dollar have rallied more than half of a percent. This compares to six days in the last twelve months when this has happened.
The rise in the Dollar has also coincided with a flood of money into U.S. Treasuries and a decline in the U.S. stock market. Commercial traders are aggressively rotating their positions from stocks to bonds as the Euro Zone drama is playing out. This is taking the classic low yield/high growth stock market relationship and turning it into a low yield/no growth scenario more consistent with times of fear. We’ve seen commercial money buying 10yr Notes in six of the last seven weeks and selling in the stock indexes in each of the last four weeks.
Reconciling relationships means being able to cope with change and allowing the relationship’s participants to grow in their own directions. Being able to recognize these changes in the marketplace as they are happening requires a sound combination of reading the back-stories and quantifying the participants’ actions.
This blog is published by Andy
Waldock. Andy Waldock is a trader, analyst, broker and asset manager.
Therefore, Andy Waldock may have positions for himself, his family, or, his
clients in any market discussed. The blog is meant for educational purposes and
to develop a dialogue among those with an interest in the commodity markets.
The commodity markets employ a high degree of leverage and may not be suitable
for all investors. There is substantial risk of loss in investing in futures.