The Euro Zone, United States and Investment Opportunities & RiskSubmitted by Antaeus Wealth Advisors on June 1st, 2012
- Excluding their primary residences and pension plans, 60% of American workers have accumulated retirement savings of less than $25,000 (Employee Benefit Research Institute).
- The U.S. Government pays $1 billion of interest expense on its outstanding Treasury debt every 40 hours (Treasury Department, February 2012).
- Year of last increase in federal tax on gasoline: 1993 (The Economist, 04/28/12).
- Largest tax expenditure in fiscal year 2012: Employer health insurance tax deductions, $171 billion.
- Consecutive years of ethanol tax credits: 33.
- Total U.S. Student Loan Debt March 2012: $904 billion (The Wall Street Journal).
- USA personal savings rate March 2012: 3.8% (U.S. Bureau of Economic Analysis).
- Year to date and one year total returns (05/31/12): Barclays U.S. Aggregate Bond +2.6% and +7.1%; S&P 500 +2.6% and (0.6%); MSCI Europe Australasia Far East (EAFE) (5.3%) and (21.5%); S&P GS Commodity Index (10.7%) and (12.6%).
Even with Greece’s private debt holders taking a 72% haircut, Europe is far from out of the woods. In Spain the private sector has excessive debt, many bank loans have turned sour, and unemployment has reached 24%. The United Kingdom technically has returned to recession status with a second quarter of negative GDP growth. And the European real estate bubble seems to be following the United States with declines ahead.
An ideal deleveraging process balances three options: austerity, debt re-structuring (i.e. creditors get paid less or over a longer time frame or at a lower interest rate), and printing money. The formative experience for the European Central Bank (ECB) was the hyperinflation in Germany in the 1920s, which has steeled central bankers on the Continent against printing money to pay off debt. Understandably, Germany does not want bigger liabilities on the ECB’s books and thinks that Eurobonds create moral hazard for its profligate neighbors. Oppositely, voters in Europe are electing leaders who are balking at Angela Merkel’s austerity measures (e.g. Francois Hollande in France). This lack of consensus as to how to balance austerity and printing money is the fundamental cause of the uncertainty in Europe.
Europe is approaching a decision point. It will have to decide whether it wants to create a sufficient central government that has the ability to collect taxes from the whole and the ability to issue debt that obligate the whole, or not. When a debtor, like Greece or Spain, is not able to print money and depreciate its currency (European labor costs are 50% higher than those in the U.S.); that country becomes stuck in a self-reinforcing terrible economic situation. What ultimately will happen across the pond is anyone’s guess.
Opposite the ECB, Ben Bernanke’s greatest fear is Japanese style deflation. He knows that a collapse of credit led the banking system to implode in the 1930s: few would spend with falling prices (i.e. their dollars would be worth more in the future) and few would borrow because they would have to repay their debts with more valuable dollars. Bernanke’s legacy will depend on whether he fully exits from the mortgage debacle without bequeathing a new one, or lighting an inflationary fire that becomes uncontainable (think of the $2.9 trillion on the feds balance sheet as kindling if banks started to lend aggressively). Combined with an unemployment rate over 8%, this fear of deflation has pushed the Federal Reserve to commit to keeping rates exceptionally low until late 2014.
Regardless of the Fed’s policies, as our society continues the process of deleveraging after four decades of expanding credit , we soon may get a dose of the austerity medicine sweeping Europe. While obviously our 8%+ deficit of GDP is unsustainable – and credit agencies (not to mention many of you) are losing patience with Congress –the American economy faces some significant threats to our GDP growth starting on January 1, 2013: an end to the Bush era and payroll tax cuts, a $100 billion reduction in government spending, and a return to pre-recession unemployment benefits.
Despite the above, Antaeus’ baseline scenario is that the American economy avoids recession, cranks out a small amount of GDP growth in 2013, and does not become Japan. Similarly, without the credit growth, money multiplier effect, and disposable income growth Americans experienced in the 70s and 80s – we do not anticipate runaway inflation, despite the Fed’s actions. We suggest keeping realistic expectations: our economy’s structural employment now may be close to 7%, and residential real estate prices may remain flat for 5 to 7 years. Consider that a large portion of Echo Boomers – those born between 1980 and 1995 – have little interest in owning a house. This generational aversion to real estate reminds Antaeus of the avoidance of stocks exhibited to this day by many who grew up during the Great Depression.
The NASDAQ March 2000 like peaking for the Treasuries “risk off” trade may have been today when the 10 year yield fell to a record low of 1.40%. As mentioned last quarter, annualized 10 and 20 year returns for equities have been at their most negative for more than a century, suggesting that stocks will outperform bonds over the coming decade as the equity risk premium normalizes.
While real estate is very expensive in many areas of the world, reinforced by low interest rates – Canada’s real estate is 20% higher than 2007, and Hong Kong’s is 72% higher (vs. -30% in the U.S.) – there is a huge spread between quality U.S. commercial real estate capitalization rates and the 10 year treasury: roughly 5%. This spread indicates that U.S. commercial real estate may be a great investment over the next decade. Further, gold has come down 16% from its peak in August 2011, making it more attractive to investors skeptical of debt ridden currencies like the U.S. Dollar. Keep in mind, however, that gold’s correlation to the stock market is at best chaotic, it generates zero cash flow, and its 10 year chart looks eerily similar to asset class bubbles of the past.
Evan P. Welch, CFP®, AIF®
Chief Investment Officer
Disclosure: Indices mentioned are unmanaged and it is not possible to invest directly in an index. No single strategy can assure profit or guarantee against loss. Past performance does not indicate future returns. The opinions expressed in this commentary are those of Antaeus Wealth Advisors, LLC and are based on information believed to be reliable; however, these views may change as information changes or becomes out of date.
The opinions expressed in this article are those of Antaeus Wealth Advisors, LLC. Securities offered through Cambridge Investment Research, Inc., a Broker-Dealer, and member FINRA/SIPC. Investment advisory services and financial planning offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Antaeus and Cambridge are not affiliated companies.