The market today feels like a tale of two worlds. In the United States, the holiday shopping season is off to a robust start. The Chicago Purchasing Managers Index came in at 62% – above 50% means the economy is expanding – and ADP reported 206,000 new private sector jobs in November. In Europe, things are deteriorating more rapidly than many expected. Today’s action by the Federal Reserve – and other global central banks – was done to provide liquidity. As the risk of the collapse of the Euro has intensified over the past few days, European banks have been scrambling to acquire dollars. The problem is the cost to get dollars has started to become very expensive as there are not enough dollars in the system to handle European bank demands. Banks in Europe are struggling to survive as depositors drain accounts, as United States money market funds stop buying European commercial paper and lending to European banks stops. In addition, European Companies are looking to protect themselves from a collapse of the Euro by diversifying away from the Euro. The Federal Reserve is trying to unclog the European financial system.
The Federal Reserve’s action is its attempt to assist in stopping the runs on European banks and European money market funds. It took similar action in the United States in the fall of 2008. In September of 2008, the Federal Reserve created the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility. This facility provided funding to allow financial institutions to purchase asset-backed commercial paper from money market funds to prevent the money market funds from defaulting as a result of investors’ redemptions. This action helped to halt runs on money market funds in the United States. The markets reacted positively to this action in the short-term as the stock market rose over 6% on September 19th. Over the next six trading days, however, the market fell more than 11%. We believe the market reacted this way because the Federal Reserve’s action treated the symptoms and not the disease. In fact, the stock market continued to fall another 30% from mid-September through March of 2009. The market finally turned the corner once the problem with the financial stress was finally addressed.
Like the Federal Reserve’s actions in September of 2008, we believe central banks around the world are treating the symptoms of the disease and not the disease itself. We believe the disease needs to be fixed by political action. A large part of the solution to the United States financial crisis was changing the mark-to-market accounting rule. This rule, if you recall, forced financial companies to price assets well below their true market value. The rule change occurred within a week of the stock market’s bottom in March of 2009.
The crisis in Europe is more extensive and more complicated than our financial crisis. To fix the problem, in our opinion, there are basically two options: complete fiscal integration – United States of Europe – or a disbanding of the Euro. Other measures that have been taken to date have not been effective in solving the sovereign debt crisis. The first option would mean a loss of sovereignty and political power, likely create social unrest and require new treaties. The second option likely would cause major financial disruptions around the globe – including United States markets. Either solution adds risk to the financial markets. That is why, even with encouraging economic numbers in the United States, we believe it is prudent to continue to have a defensive weighting to your portfolios.
Sincerely,
Your THOR Team
Note: Please click on the two hyeprlinks in the above update to read a corresponding article addressing our point.