Last Breath. Why the Merkel/Sarkozy “Solution” to the European Debt Crisis Will Fail … Miserably

On June 3^rd, 2009 German Chancellor, Angela Merkel, while addressing a crowd in Berlin, rebuked the European Central bank and counterparts in Britain for having gone too far in fighting the financial crisis, which may be laying the ground work for another major financial meltdown. Merkel said, “We must return together to an independent central bank policy and to a policy of reason, otherwise we will be in the same situation 10 years from now.” In other words, it was not the policy of the European Central bank or counterparts to “bail out” failing financial institutions or governments which acted recklessly with lending or borrowing money without justifiable means to repay. It was statements like these that earned Angela Merkel the title of the “Worlds Most Powerful Woman” by FORBES from 2006-2009.
In many ways, Angela Merkel was considered the only true hope for the future of the European Union. Her words were reminiscent of great financially responsible leaders like Ronald Reagan. It was her conservative leadership and policies which centered on fiscal responsibility making Germany an attractive country for investors. We achieved incredible returns in ETFs like (NYSEArca: EWG) iShares MSCI Germany, returning nearly 40% since the lows of 2008. Merkel outwardly opposed using taxpayer money for the excesses of other governments and poor judgment of investors.
In last week’s blog titled “Unraveling: The economic recovery that wasn’t and how to invest through the declines ahead,” I stated, “Europe is a colossal mess, and U.S. treasuries actually looked surprisingly like a ‘safe haven’”, as one of the reasons the U.S. Treasury market rallied. I also stated that German banks, which are the biggest European Union lenders, “will suffer the most through the defaults and bailouts, causing a depression in Germany like few have seen in their history.” I went on to say, “Angela Merkel has consistently opposed the terms of the Greek bailout because she is well aware of the domino effect which could begin after they fully agree to the terms — this making them the guarantor of several irresponsible countries with no ability to pay them back.”
On Friday, Angela Merkel “caved” on her tough stance which involved mandatory participation of the private sector, (banks, financial institutions etc.) and said she would back a “voluntary” participation of banks and financial institutions in the bailout of Greece. This due to the pressure of the threat that it was mandatory that they strengthen the European banking system and support the weaker economies of other European countries to avoid a complete meltdown.
This situation is reminiscent of our bailouts of banks like Citigroup (NYSE:C), Goldman Sachs (NYSE:GS), AIG (NYSE:AIG) and many others under duress from our central bank asserting that the United States had to cough up billions of taxpayer dollars or our economy would collapse. U.S. taxpayers were forced to pay for the stupidity and recklessness of our banks and financial institutions that frivolously lent to individuals with no justifiable means of repayment and then leveraged those loans through complex derivatives which caused the financial collapse of 2008. The banks got the money and we (the tax payers) got the bill while banks like Citigroup hid these complex derivatives by labeling them, short term debt.
The market broke its six week losing streak this week because of what was viewed as “progress”on the European debt crisis due to Merkel and Sarkozy “caving” on the threats of banks who lent irresponsibly to countries, leveraging their European Union status to borrow recklessly. The only thing more incompetent than a country that borrows what they can’t repay is the institution that lends to them and then adding to that stupidity leverages that loan to create other loans. Rating agencies stated this week that a default in Greece or any other weak European Union country like Portugal, Ireland or Italy would cause them to no longer permit that debt to create other loans. Thus, more defaults and a catastrophe in the European Union that, as Angela Merkel stated in Berlin in 2009, “would take 10 years to solve.”
The question is what forced the hand of Angela Merkel and Nicolas Sarkozy to back what will be a European central bank bailout involving what she opposed which was “using taxpayer money for the excess of other governments and the poor judgment of investors (meaning banks and financial institutions).” She became aware that banks and financial institutions have a far worse exposure in lending to these weak countries and if these countries default, the domino effect will begin, causing a large majority of European banks to fail.
The bond and equity markets should not celebrate this “change of heart” by Merkel, but instead should brace themselves for the European Union taking its “last breath.” They should prepare as the inept, undercapitalized European central bank and IMF try to revive an economy that has been on life support, with banks on the brink of insolvency. Banks that have been hiding risky leveraged loans in complex derivatives, revealing the “worst of scenarios” austerity measures which harm individuals along with a failed financial system which catapults economies into turmoil. These loans were made to countries not just individuals or institutions; the aggregate of bailouts to banks and sovereign entities in the European Union will exceed all bailouts of the financial institutions in the United States.
I believe that Angela Merkel regrets Germany entering the European Union in 1990, but since she didn’t become chancellor until 2005, she didn’t have the opportunity to vote.
Even for a truly conservative, fiscally responsible leader as chancellor Merkel, it was Germany’s membership in the European Union which will create a catastrophe even she can’t stem. Merkel and Sarkozy appeared to stand in unity on Friday in developing a plan to rescue the European Union. Instead, they will stand separate and watch the economy of the European Union draw its last breath.

Unraveling the Economic Recovery That Wasn’t and How to Invest Through the Declines Ahead

Jeffrey Sica predicts a 15-20% correction by the end of summer.

In a quote by Winston Churchill, “We must beware of trying to build a society in which nobody counts for anything except a politician or an official; a society where enterprise gains no reward and thrift, no privilege.”
Stocks have declined for 6 straight weeks with the S&P now down 7% since April. In  my  Forbes blog post dated April 9^th, “Post Interlude how to Invest During the Curtain Call of the Market Rebound”, I stated  we are, in fact, experiencing the  “curtain call” of the market rebound. The market has continued to decline since, with each and every decline becoming more severe, along with some rallies, but overall, a very ugly picture.
My outlook has become increasingly bearish since my February 28^th Forbes blog post entitled “The Law of Unintended Consequences”, where I looked at what our central bank’s easy money policy had created. This policy has been inflating everything from commodities to stocks and bonds while having very little impact on the overall health of the U.S. economy. However, we reached our maximum level of bearishness, lowering equity exposure to around 10-15% with incredibly high levels of cash following the release  of the May 14^th Fed minutes from the April meeting. While not going into full detail, the overriding cause of negativity was that it became clear that our central bank “had taken ownership of the stock market”. Due to their track record of “ownership” of our economy, which has shown virtually no improvement since “QE2”, the markets, inflated by the “easy money” policy, would begin to deflate. At that point, I predicted a 15-20% correction by the end of the summer.
Last week, Ben Bernanke made it clear that QE2 was scheduled to end on time in June. As a result, the bond market responded surprisingly well and rallied with ten year yields declining to a low of 2.9% for two reasons;
1.)    Europe is a colossal mess. Despite severe deficit trouble, Tim Geitner’s threat that “the U.S. will begin to default on its obligations if the debt ceiling isn’t raised by August 2^nd” and further stating that “default could cause a crisis more severe than the one we just came out of”, made U. S. treasury bonds look temporarily attractive, when compared to the alternatives — which shows the desperate economic conditions outside the U.S.
2.)    Investors just do not believe that the economic stimulus program will end in June. Despite statements to the contrary and reflecting back to the Fed meeting in April, the Fed stated that it will “Do what it has to do to stimulate the economy if we experience slowdown”. It is clear that investors are hoping and counting on a QE3 type bail out to save the day.
As QE2 ends, debate of the debt ceiling begins which will undoubtedly show Washington at its worst (perhaps not quite as bad as what Democratic Congressman Anthony Weiner showed us this week), but bad none the less. Republicans and Democrats are so far apart on solving this debt crisis that any agreement will be insufficient in accomplishing the goal of “fiscal responsibility”. As Churchill said, they have become the “all that counts” and free enterprise has taken a back seat. Those businesses or individuals “who have acted with responsibility and thrift are receiving no reward”, are becoming disheartened.
In contemplating the months ahead, I continue to predict a 15-20% correction in the U.S. equity market by the end of the summer and recommend no more than 15% exposure to equities, with no desire to buy and hold. I have decreased or abandoned most prior stock valuation instruments such as cash flow analysis, price earnings ratios and technical, as well as fundamental analysis. This due to the fact that much of the earnings booked last quarter were due to low borrowing costs which cannot and will not last forever. Companies like Johnson and Johnson (NYSE:JNJ) and Google (NASDAQ:GOOG) which are borrowing long term for 1-3% and converting that borrowed money to revenue is just a short term fix if economic conditions don’t improve dramatically.
Thus far we have been seeing deteriorating economic conditions for the consumer as evidenced by the over 9.1 % unemployment rate, manufacturing, GDP and most recently, the revelation by Robert Schiller (housing market guru), who said that he would not be shocked if he sees home prices decline another 10-25%. Borrowing costs will increase, as any attempt by the central bank to keep rates lower will be met with resistance and QE3 (which will keep borrowing costs low) will not be readily accepted as evidenced by the refusal of House republicans to raise the debt ceiling. Therefore, we will continue to add to our treasury short positions through NYSE:TBT, NYSE:TBZ, and NYSE:TBX.
The more effective strategy is the supply /demand theory which is much more oriented toward the purchase of raw materials, where supply is low and demand is high. We are also utilizing analytics involved in demographics, like weather, currency and supply, base metals, precious metals (NASDAQ:PALL), corn, copper, grain, other agriculturals and oil, as well as initiating sales when these supply/demand numbers shift and prices decline. However, supply and demand analysis is complicated, given that these ratios could shift instantly. Therefore, we are using various stop-losses, expert sources and somewhat unconventional methods of analyzing supply and or demand.
Certain raw materials like grains (NYSE:JJG ) have a somewhat fixed level of supply and no attempt to increase that supply, such as fertilizer improvements through companies like Monsanto (NYSE:MON) have been developed to meet that supply. Utilizing weather experts and direct import/export data is one of our means of deciding which commodities to buy, hold or sell. However, the market is extremely volatile, so we may often be quick to sell.
We continue to be buyers of oil, despite rumors of Saudi Arabia increasing output, we see a substantial upside. Although we may not see the $200 per barrel originally predicted, due to the slowing European economy, which should increase the value of the dollar, we feel confident that prices will continue to rise. Relying on the Saudis and the other OPEC countries to keep oil price low through output increases is something that will not last for very long. High oil prices not only benefit their economy and enhance their stronghold on world economy, but the remainder of the OPEC countries as well. The 10 million barrels a day that the Saudis will supposedly release starting next month will be insufficient to keeping oil prices low.
China’s potential economic slowdown caused by several interest rate increases, will reduce demand, but only slightly since their economic stimulus packages of 2009 (which was far more extensive than ours) will do little to curb demand. The only significant decline in the demand for oil and other commodities will come from Europe as we begin to see the European banking system implode due to exorbitant leverage and the ineptness of the European Central Bank and the IMF to solve the crisis. German banks, which are the biggest European Union lenders, will suffer the most through the defaults and bailouts, causing a depression in Germany like few have seen in their history. German Chancellor, Angela Merkel has consistently opposed the terms of the Greek bailout (Germany being the biggest lender to Greece), because she is well aware of the domino effect which could begin after they fully agree to terms — making them the guarantor of several irresponsible countries with virtually no ability to pay them back.  The European debt crisis will also be an added factor in the global declines we will see this summer and could lead to a revision of our downward projection of our 15-20% by summer’s end.
To quote Alexander Hamilton, “It’s not tyranny we desire; it’s a just, limited Federal government.” President Obama may refer to our recent economic setbacks as “bumps in the road” and Ben Bernanke may promise us that “in just a little while” things will turn around. Tim Geitner may threaten Armageddon if we don’t do what he says, but in the end we should realize that, to quote Ronald Reagan “Government tends not to solve problems, only to rearrange them”, and any reliance on government policy for investment returns may offer only temporary solutions. To quote King Solomon “money can grow wings and fly away”. As Churchill said, it is free enterprise and thrift that will save society, and in our case, our economy. Vigilance through discipline will allow us to profit in these difficult times.

Cheating Gravity. Is The Market Rebound Over?

Six-time Grammy award winning Alternative Rock band, The Foo Fighters recently released their seventh album entitled “Wasting Light”. The first two lines from the single entitled “Rope” read; “This indecision’s got me climbing the walls. I’ve been cheating gravity and waiting on the fall”.
These two verses articulate what has been occurring recently with both the equity and commodity markets.  Investors are filled with indecision, “climbing the walls, feeling as if they have been cheating gravity and waiting on the fall”. Most investor indecision revolves around a question that comes courtesy of the central bank; “Will this be the end of “easy money” (QE2) or low interest rates (courtesy of the Fed), as expected in June?”
The outcome can further slow down an economy which has been showing signs of inflation in things like oil prices and commodities combined with sluggish growth in unemployment, housing, and of course, our Gross Domestic Product, which slowed to 1.8% in the first quarter. This is clearly indicating “stagflation”.  The equity market has been “overvalued” for quite some time now, “cheating gravity and waiting for a fall”. The decline has already begun and will continue unless our central bank initiates a creative way to add liquidity. Although they will not call it “QE3”, that is exactly what it will be, causing equity prices to once again inflate considerably to unsustainable levels.  We will, once more, wait for an even greater fall.
The inflation seen in the commodity market began to unravel this week as a result of China tightening interest rates and the dramatic fall of oil prices, which declined nearly 15% last week. This inflation can especially be seen in oil and precious metals and is caused by excess liquidity and global demand in addition to a historically weak dollar.
Furthermore, silver, nicknamed “the devil’s metal” for its tendency to be incredibly volatile, plummeted 35% this past week, after surging 175% from August to a peak of $50.00 two weeks ago. However, for those who can endure high levels of volatility, we continue to recommend the purchase, considering demand is very high, due to the fact that 70% of the silver being mined is being used. Oil prices will continue to be volatile, but move higher due to global demand, weakness in the dollar and Middle East unrest. Therefore, we maintain our recommendation of the purchase of oil.
Still, a strong dollar resulting from rising interest rates, which would add to our overwhelming deficit, would cause us to lower our expectations for price appreciation, as well as any attempt to further restrict trading at the CME – the price controls that were designed to slow what has been termed, “speculation”.
In other words, the Obama Administration does not want to accept responsibility for the high energy prices which are very much their fault and, would like to pass the blame along to these nameless, faceless, “speculators” or who we would call “investors”. Could this be their way of not taking responsibility for the “stagflation” they caused?
The strength of the dollar and the fear of an economic slowdown have been blamed for the declines in the commodity market. The commodity market will continue to be volatile; however, dollar strength will be temporary. Therefore, we continue to recommend the purchase of gold (NYSE:SGOL), silver (NYSE:SIVR), platinum (NYSE: PPLT) and palladium (NYMEX:PALL), due to the lack of faith in currency in general and the complete lack of faith in governments around the world to preserve the value of their currency. The strength of the dollar has been the result of the weakness in Europe, among other things and may continue. However, we would refrain from purchasing U.S. dollars due to the strong likelihood that our central bank will discuss further stimulus, (but not call it QE3), in its minutes which will be released on Wednesday. At that point, we would be buyers of the dollar short (NYSE:UDN) and would anticipate the dollar falling further. We will continue to purchase short U.S. treasury positions like (NYSE:TBX) (NYSE:TBT) and (NYSE:TBZ) and capitalize on the inevitable rising interest rates whether or not the Federal Reserve remains committed to ending QE2 as scheduled in June, along with having no further recommendations for stimulus. However, we feel that the likelihood of this is as remote as our government coming to a solution regarding our national debt by the summer.
Currently, there is still a potential in the commodity market for further advancement and therefore we would be buyers of base metals like copper (NYSE:JJC), which due to the perceived slowdown in China, resulting from several interest rate increases, tumbled last week. China is foreshadowing future conditions in the U.S., which is clear “stagflation”. In this circumstance where interest rates increase but demand factors and inflation remains, a very volatile economy results, confirming a bearish stand on the U.S. equity market. The only trading opportunity is short term and short positioning, with absolutely no willingness to “buy and hold”. Unless fundamentals change dramatically, anticipate a decline in the equity market of 15-20% by the end of the summer, with a potential further decline, should our economy continue to spiral into stagflation.
Another verse from the Foo Fighters’ song, Rope states, “How did this come over me, I thought I was above it all. All of our hopes gone up in smoke”. If we are defensive early, surrender the “above it all” attitude and adjust portfolios early, our hopes won’t all go up in smoke. Instead we can capitalize on the opportunities that exist even in volatile markets such as these.

It’s a Long Way from Wrong to Right

The movie “Crazy Heart” is a story of an “out of control” alcoholic country music star who is trying to get his life together after beginning a relationship with Jean, a young  journalist portrayed by Maggie Gyllenhall. “Bad Blake”, played by Jeff Bridges, enters a treatment center for alcoholism and thus attempts to make amends with his only son who coldly hangs up on him after professing “It’s too late”. In a later scene “Bad Blake” recounts the phone call to his AA sponsor and friend, Wayne, played by Robert Duvall. He said “I was wrong to call my son”. Duvall in the profound wisdom of a good friend says “you were wrong for leaving him 25 years ago and wrong for not trying to find him for 25 years, but you called him and now you’re right – he’s wrong. It’s never too late, son, keep after it”.

The scene can be applied to many aspects of life, including investing.  The fact is that every investor has at sometime sat staring at an investment and said “it’s too late”.  Some buy into the ultimate lie of “buy and hold”. Others just give up and sit in cash. Still others, with the wisdom of Bad Blake’s friend Wayne, make the right decision and move forward — always keeping after it because it is never too late to start making the right investment decisions.

In the months ahead, it will become evident that investors will make investment decisions which leave them saying “it’s too late” or proceed on a path to success by “keeping after it”. The reality is the markets have become irrational. It is apparent that we are at a critical point and the stakes have never been higher.
The recent downgrade of  U.S. Treasury debt is relevant when it comes to the long term outlook of the economy. As a matter of fact, I predicted this downgrade on March 21, 2011 on my blog on Forbes. With news of the downgrade, the market plummeted 200 points but rebounded by the end of the week to reach a 3 year high.

There were two reasons why the market rebounded with such velocity by the week’s end, while ignoring the downgrade. The first is the fact that S&P and Moodys have completely undermined the confidence of investors in their 2008 assignment of the highest credit ratings on sub-prime mortgages along with their failure to warn investors of the risk involved in holding those securities.

This is further exasperated with the recent disclosure by the Senate that they were pressured by Goldman Sachs (NYSE:GS) UBS AG (NYSE:UBS) and at least six more banks. And, according to Senate reporting, they were lessening their standards to accommodate these institutions.  The end result was investors didn’t know what they were buying because the big banks were “paying off” the ratings agencies in order to benefit themselves — investors were nearly destroyed in the process. If this fact doesn’t seriously impair the confidence of investors in the ratings agencies and the “big banks” and large financial institutions who control them, they will inevitably reach a point where it is “too late” by following their most often wrong advice.

The second reason investors are ignoring the negative outlook from S&P on U.S. treasury debt is the “bullish” analysts and financial institutions’ catch phrase “well the U.S. Government could always print more money to pay for those bonds”. The problem with this half-witted strategy is that at some point in time, most likely in the next few months, real inflation will exceed the yields these bonds are paying, rendering them unattractive.

Consequently, this will create an even greater bubble than already exists and subsequently, the vast majority of the diverse holders of our debt will dump their holdings at a rate we have never seen before. Printing more money at this point will only increase the devastation of stagflation and further erode the value of the dollar; making a bad situation worse.

The ratings of the U.S. Treasury bond by several rating agencies could fall to the AA+ at some point during the summer due to several factors. First off, the 2012 Obama budget and the Republican Budget proposal are so incredibly different, second is the lack of potential to reach any agreement, and finally the lack of willingness to address the hard issues. For these reasons, they have created a severe threat to U.S. debt and as a result, ratings agencies have an obligation to respond.

The overall debt to GDP is among the worst world-wide. If there is no action, the debt will compound at a substantial rate in relation to GDP. Without the option to print money, in any other situation, we would most certainly default on our obligations. The only reason rating agencies haven’t drastically reduced ratings as they did in some European countries, is because the U.S. has displayed a willingness to print money.

Of the recent bond issuances since last September, the Federal government has purchased 70% of its own debt, increasing the compounding effect of the deficit. Under these circumstances, a AAA rating is no longer warranted. U.S. Treasury bonds getting downgraded to below AAA rating will have significance to corporations, pension funds, and the like and the implications are too numerous to list causing dramatic declines in both the bond and stock markets.

The stock market has rallied, mostly due to the liquidity the Fed has provided; yet, it is scheduled to terminate in June. Our decision to turn more bearish is due to this “over-inflated” market losing the liquidity which drove it to these levels. Furthermore, any attempt to raise taxes, print more money or invent another exotic method of supporting our economy will only lead to even greater inflation or worse, stagflation.
Oil prices will continue to rise to the $200.00 barrel range as well as other commodity prices as a result of the excess liquidity. Consequently, those who aren’t positioned correctly will, in an instant, realize “it’s too late”.
The movie “Crazy Heart” did not end as most would think. Jean, Bad Blake’s true love and inspiration, the woman he turned his life around for, moved on with her life. Thereupon, he was left alone with his guitar to walk off into the sunset. At first it seemed like it was too late and that he had lost everything he loved or cared about. But, it became apparent that his loss led to his greatest achievement, which was a future with promise, or as someone once said “Maybe life isn’t about getting back what you lost, maybe it’s about getting what you never had”. We could say the same for our investments.

Post Interlude: How To Invest During The Curtain Call Of The Market Rebound

Jeff discusses replacing the U.S. dollar as the world’s reserve currency.
In the 1500s, most theatrical plays were dark and somewhat depressing with a religious theme to essentially make people feel guilty about … just about everything. Unlike today, most entertainment was not meant to help people escape. A play about the “Black Plague” was often considered “the feel good hit of the year”.
To keep the audiences from stampeding out the doors when the despair became too much to endure, the guilt mongers of these dark, depressing dramas added a break in the action called an “interlude”.
They were short, light-hearted, upbeat skits of some sort, such as a puppet show. The father of the interlude was English writer, John Heywood, known for his entertaining and often comical interludes.
The interlude would keep people in their seats and was a great distraction from the dark despair and overwhelming condemnation that they were about to be exposed to in the remaining scenes of the morality play.
As one modern multi-academy award winning producer said, “the only thing worse than people not showing up, is people leaving early”.  The interlude was designed so people wouldn’t leave prematurely and, just as today, entertainment was dependant on putting and keeping people in their seats.
In the so-called recovery in the equity markets since 2008, we have endured what could be considered an “interlude” to a very dark and somewhat depressing story. This “interlude” resembles a not-so-funny puppet show of government bureaucrats, central bankers and Wall Street illusionists, who have systematically destroyed the value of the dollar and inflated everything from stocks and bonds to commodities — especially oil.
Furthermore, for the first time in history they have borrowed and spent our country into an unprecedented deficit, which will almost certainly cause “the first credit rating down-grade of our national debt in history”.
These same reckless bureaucrats are apparently willing to entertain the possibility of embracing a foreign currency to replace the U.S. dollar as the world’s reserve currency, as illustrated when Tim Geitner said he is “quite open” to  Chinese proposals for the gradual development of a global reserve currency run by the international monetary fund. This statement should depress every hard-working, taxpaying American.
In the events of the last few weeks, it has become evident that we are nearing the end of an “interlude”. Much like the English theater goers of the 1500’s, who could either brace themselves for the upcoming events, or leave, we too have a choice.
We can adopt a strategy to invest in those things which will appreciate in value; things like precious metals, gold (NYSE:SGOL), silver (NYSE:SIVR), palladium (NYSE:PALL), platinum (NYSE:PPLT) or commodities — especially those which will be used to help rebuild Japan, such as base metals copper (NYSE:JJC) and aluminum (NYSE:JJU), global water (NYSE:PIO) and oil.
The alternative, those investors who are still investing in bonds and bank stocks, would be likened to the theater goers of the 1500’s, who, after enduring the pain and misery of the matinee, are choosing to sit through the evening show, with the hopes that maybe the end will be happier the next time around.
Theater has dramatically changed since the dark days of the 1500’s.  A new form of entertainment has emerged in the theater and movies of today.  Films such as “The Fighter” or “The Kings Speech” depict overcoming great adversity to triumph.  Investing in this challenging environment will involve much of the same diligence, or, to quote John Heywood, “nothing is impossible to a willing heart”.