Week in Review Part I: Europe, Washington and Wall Street

European bond markets once again took solace in some successful auctions in the likes of Spain and France, after positive receptions in Spain and Italy the previous week. But let’s not get too carried away. We still have close to 2 trillion euro in debt to rollover in Europe between the sovereigns and the banks this year so that means you’ll have good weeks and bad ones. So far this year Europe, and the U.S., has breathed easier.

But it was a week that saw both the World Bank and International Monetary Fund lower global and country growth forecasts for 2012 considerably. To wit:

The World Bank cut its global GDP forecast to 2.5% from 3.6% as predicted last June. The IMF cut its forecast from 4% to 3.3%.

The World Bank said the eurozone would contract 0.3% in 2012; the IMF said GDP would fall 0.5%.

Further, the IMF said Italy would contract 2.2% and Spain 1.7% for the year; far worse than their own governments are projecting today.

So the outlook for Europe is not good. The WB warned further, “even achieving these much weaker outcomes is very uncertain.”

“The downturn in Europe and weaker growth in developing countries raises the risk that the two developments reinforce one another, resulting in an even weaker outcome.”

Although contained for the moment, there is a risk of a “much broader freezing up of capital markets and a global crisis similar in magnitude to Lehman.”

In the event of such a crisis “activity is unlikely to bounce back as quickly as in 2008/09, in part because high-income countries will not have the fiscal resources to launch as strong a countercyclical policy response or to offer the same level of support to troubled financial institutions.” [Sydney Morning Herald]

Simply put, Europe’s problems are not solved by any stretch. We’ll find out in the next few days if Greece reaches agreement on a debt restructuring with its private bondholders, who have to accept significant haircuts in a voluntary debt swap, but, if successful, this would be on about 100 billion euro in debt, leaving Greece with almost 250 billion remaining. Considering the economy isn’t likely to grow at anywhere near the rate necessary to keep this new level stable, even with the bailout relief the government would gain from the private holder restructuring, you would never solve the problem. [Ditto Portugal, but that’s for another day.]

It was last Dec. 21 that the European Central Bank injected $630 billion in the form of 1% three-year loans that the banks grabbed off the table like wolverines, racing back to their den to hide it, or they put it right back into the European Central Bank for safe-keeping. Systemic risk was said to be off the table as a result of the ECB’s move, and it would appear this is the case in the very short run. [I just glanced at a Saturday New York Times piece that is bullish on the ECB and the banks. I’ll address this next time.]

You also have German Chancellor Angela Merkel and French President Nicolas Sarkozy’s new EU fiscal treaty that is to be discussed this coming week in a meeting of EU finance ministers ahead of another summit on Saturday. This, too, was unveiled without details last December in an attempt to save the euro and now as details do emerge, there indeed will be tough rules for the euro-17 nations in terms of complying with budget deficit targets, with a European Court of Justice being given the power to fine countries whose balanced-budget laws don’t meet new standards. All 17 nations employing the euro currency have to sign off on the treaty, though Ireland hasn’t decided if it needs to hold a referendum first.

So assume the treaty is implemented. What does that mean? Lots of austerity; and you’ve seen the above estimates on growth for the eurozone. Plus the main problem is unresolved…the sovereign debt levels! It’s about solvency and the recession will do a number on revenues. Plus you still don’t have a bailout fund of any size in place that could handle the likes of Spain and Italy who are far, far from out of the woods. The European Stability Mechanism that is designed to augment the existing European Financial Stability Fund is pathetic, while the IMF asked its members for an extra $500 billion, which requires $600 billion in contributions (the U.S. has already said ‘don’t look to us on this one’), so we’ll see what the reaction is in the various parliaments who have to deal with an increasingly surly public.

At least the S&P downgrades of the nine European countries after the close last Friday, as well as a subsequent downgrade of the EFSF, didn’t hurt the markets nor lead to spikes in interest rates.

Stephen King / Financial Times:

“Too many countries are too optimistic about recovery when all the evidence is now pointing towards a eurozone-wide recession. Contracting output will only exacerbate the revenue shortfalls which have already placed countries on unsustainable fiscal paths.

“Inaction is, perhaps, inevitable for politicians faced with a difficult tradeoff between political expediency and fiscal reality. France, for example, needs to deliver austerity to bring its primary deficit back under control – and also to persuade its eurozone colleagues that Paris is serious about fiscal discipline – yet Sarkozy hopes also to win the presidential election this spring.

“As for omission, the idea of a fiscal pact is all very well but it doesn’t deal with the shortfall of income which led to today’s crisis. Until the 2008 economic collapse, many countries in Europe had good fiscal records. They would surely have met many of the conditions associated with the proposed fiscal union.

“Fiscal conservatives in the eurozone have, up until now, argued that austerity will bring its own rewards: tighter fiscal policy will lead to lower deficits and lower deficits, in turn, will lead to lower interest rates and, hence, faster economic growth. Throw into the mix the gains to competitiveness of lower labor costs associated with austerity and it suddenly looks like austerity really can pay off.

“Within the eurozone, however, the argument hasn’t worked….

“In the months ahead, the eurozone’s difficulties are likely to mount. As the contagion spreads, and as investors lose confidence in the ability of countries to deliver lasting fiscal austerity, countries which, to date, have benefited from immunity will also begin to suffer.

“Next in the firing line may be Germany, not so much because its bond yields are about to spike higher but, instead, because its exporters are hugely exposed to trade with the rest of the eurozone and its financial institutions are groaning under the weight of the region’s financial disorder….

“Germany may end up more like the others, unable to avoid a descent into recession.”

But as Stephen King concluded, this could in turn lead to the European Central Bank biting the bullet and beginning a program of quantitative easing, “using newly-created money to buy government bonds. It won’t solve the crisis – that requires a leap of political imagination – but it would at least make the crisis easier to solve.”

Lastly, watch Romania and the massive protests there over a corrupt government and austerity cuts. It’s also about the gap between rich and poor, that inequality topic that is coming to a head, globally, this year. Hungary remains a potentially explosive issue as well, though here the people are marching against the increasingly authoritarian government of Prime Minister Viktor Orban.

Washington and Wall Street

I get a kick out of those who say the economic data out of the U.S. is much better. Yeah, it’s generally been pretty good, but much better?

To bring everyone back down to reality, the future is probably more as the World Bank and IMF project it to be; growth of 2.2% from the former for 2012 (down from its earlier 2.9% estimate) and 1.8% for the U.S. from the latter. Barring Armageddon in Europe, I do grant you that 2% growth with low inflation can be a perfect environment for stocks, normally, but these are not normal times. The world has zero percent interest rates, for crying out loud, for starters, and the developed world in particular needs to continue to delever, both governments and households. Only in the U.S. the households have been doing their part (thought credit is expanding again) while our government stares at the debt clock like Homer Simpson when he’s stumped.

By the way, I’m as comfortable as ever on my crash scenario for some point in the year when the debt discussion forces the market to examine, far earlier than expected, the fact that we are indeed Italy. Recall, we corrected 20% in short order last year over concerns with Europe as well as our debt-ceiling discussion. I think we crash 30% over a short period of time this year on a wicked change in sentiment. This doesn’t require, by the way, that interest rates shoot up through the roof, but enough of a move, coupled with the ever-present hot spots (Iran being most obvious, but not the only one), will lead to the debacle that will have us cowering under the covers.

A few more specifics in the here and now. Earnings have not been great thus far. They have been so-so. Of course there are exceptions, and as I reiterated last time it helps the market isn’t overvalued. I just see a consumer that will be less than robust early on in 2012 (the National Retail Federation is calling for an increase in retail sales of only 3.4% for all of 2012 vs. 4.7% in 2011), while housing may have bottomed but it is far from staging a strong recovery. Sales of existing homes rose a third straight month in December, so this is good, and it’s encouraging that the inventory figure dropped to 6.2 months, the best in quite a while, but there are still a ton of properties in foreclosure that need to be cleared and the median home price is 2.5% less than in December 2010. It’s a bottom. At a bottom there are real values in some areas. But you still have others where you can take your sweet time, unless you think interest rates are about to skyrocket.

At least Citigroup (C), Wells Fargo (WFC), Bank of America (BAC) and, earlier, JPMorgan Chase (JPM), all have announced their strongest loan-growth numbers since the financial crisis, though the percentage increases are far from anything to write home about and what gains there are can in no small part be attributed to problems in Europe, where banks are burrowing ever deeper per the above. Forget trying to find a loan officer there.

Lastly, you have the issue of the Keystone XL pipeline that was to take oil from Canada’s tar sands and transport it down to the Gulf Coast, crossing six states in the process. President Obama ended up caving to his environmentalist supporters, even though the project has been under study, and re-routed where requested, for three years. Nonetheless, the president blamed “the rushed and arbitrary deadline insisted on by congressional Republicans,” as part of the payroll tax holiday and unemployment benefits compromise of last month, that “prevented a full assessment of the pipeline’s impact, especially the health and safety of the American people, as well as our environment.”

Oh spare me.

This was truly one of the stupider political moves in recent memory (Newt Gingrich called it “stunningly stupid”), though the Republican Party is itself so dysfunctional these days, with the worst lineup of presidential candidates in my lifetime, that it’s anyone’s guess whether the elephants can take advantage of Obama’s blunder.

I really hope Canadian Prime Minister Stephen Harper sticks it to us and builds a pipeline to Canada’s west coast for the purposes of exporting the tar sands oil to China. Harper is going there in February and he just might be signing a deal after getting dissed by the U.S. It’s in his best interests, after all, to diversify his customer base.

Harper’s office issued a statement following the White House’s move that read in part:

“The President explained that the decision was not a decision on the merits of the project and that it was without prejudice, meaning that TransCanada is free to re-apply. Prime Minister Harper expressed his profound disappointment with the news. He indicated to President Obama that he hoped that the project would continue given the significant contributions it would make to jobs and economic growth both in Canada and the United States of America.

“The Prime Minister reiterated to the President that Canada will continue to work to diversify its energy exports.”

Hel-loo Beijing! Take a face mask, Mr. Prime Minister. The pollution is awful, but their money is good.

Editorial / Washington Post

“On Tuesday, President Obama’s Jobs Council reminded the nation that it is still hooked on fossil fuels, and will be for a long time. ‘Continuing to deliver inexpensive and reliable energy,’ the council reported, ‘is going to require the United States to optimize all of its natural resources and construct pathways (pipelines, transmission and distribution) to deliver electricity and fuel.’

“It added that regulatory ‘and permitting obstacles that could threaten the development of some energy projects, negatively impact jobs and weaken our energy infrastructure need to be addressed.’

“Mr. Obama’s Jobs Council could start by calling out…the Obama administration….

“There are far fairer, far more rational ways to discourage oil use in America, the first of which is establishing higher gasoline taxes. Environmentalists should fight for policies that might actually do substantial good instead of tilting against Keystone XL, and President Obama should have the courage to say so.”

Editorial / New York Post

“Yes, Obama’s decision means that the TransCanada company can submit a new Keystone proposal with a new route through Nebraska.

“And who knows – maybe Obama will even approve it.

“Once the election is over, anyway.

“After all, he only promised hope and change – not political courage.”

Editorial / Wall Street Journal

“The central conflict of the Obama Presidency has been between the jobs and growth crisis he inherited and the President’s hell-for-leather pursuit of his larger social-policy ambitions. The tragedy is that the economic recovery has been so lackluster because the second impulse keeps winning….

“The State Department, which presides over the Keystone XL review because it would cross the 49th parallel, claimed the two-month Congressional deadline was too tight ‘for the president to determine whether the Keystone XL pipeline is in the national interest.’ The White House also issued a statement denouncing Congress’ ‘rushed and arbitrary deadline,’ which merely passed with overwhelming bipartisan support.

“This is, to put it politely, a crock.

“Keystone XL has been planned for years and only became a political issue after the well-to-do environmental lobby decided to make it a station of the green cross….

“Such green delusions are sad, and Mr. Obama’s pandering is sadder, though everything the country stands to lose is saddest. If Mitt Romney and the other GOP candidates have any political wit, they’ll vindicate the Keystone’s ‘national interest’ and make Mr. Obama explain why job creation is less important than the people who make a living working for the green anti-industrial complex.”