Market Observations

Eventually market prices reflect reality.  There is currently a disconnect between the two.

I have been very good at predicting public policy outcomes, so let me start there.


There are suddenly a long list of experts on the European Union.  If you listen carefully to the talking heads, it seems like most of them could not find Greece on a map!  What most are doing is taking their own political opinions and complaining that Europeans are doing something different.

Let's consider a few specifics.


Facts.  The IMF just issued a report, covered nicely in the New York Times.  Take a look at this graph.


In the G20 countries, about 2/3 of the increase in debt has resulted directly from the recession — revenue loss.  Less than 10% has come from stimulus programs to revive economies.

Prediction.  All of these countries are pursing Keynesian policies to revive the economies.  Those complaining about added debt will be completely incorrect in predicting the policies, and eventually incorrect in predicting the economic result.  Debt will need to be addressed, of course, but it can be better done from a position of economic strength.

European Assistance for Greece

Fact.  It was only ten days ago that the European Union announced the trillion-dollar "shock and awe" package of assistance.  After a one-day rally in world-wide markets, there was a chorus of criticism that the plan merely delayed the recognition of the problem.  (Aren't we all tired of hearing about "kicking the can?")

We now hear confident talking heads opining about European life styles, the need for debt restructuring, and which countries should leave the European Union.  They all agree that the plan "has not worked."

This is interesting, of course, since the plan has not been approved by all countries and the implementation has barely started.

Prediction.  The plan will work.  If it is not completely effective, there will be changes.  It will be made larger.  There will be world-wide cooperation.  There will be currency interventions.

The bearish punditry will be no more accurate than they were in fighting the Fed or the TARP program.  Governments will try different strategies.

Most importantly, delay is good.  One prominent commentator called the program a "Hail Mary" and also acknowledged in the same article that it might take years to play out.  This is silly!  The program is a game plan and the game has not even started.  We are a long way from knowing the outcome.  Probably it will involve a number of compromises on debt and austerity.  The "Hail Mary" title is a misleading symbol.

I also predict that aid to Spain and Portugal will be less than expected.

Moody's Investors Service last week put
Portugal's Aa2
rating on a three-month review for a possible downgrade, but
said that though Portugal's financing costs might rise for some
time because of market pressures, it expected debt servicing to
"remain very affordable in the near to medium term".

It said "the government's debt is neither
unsustainable nor

Diego Iscaro,
economist at IHS Global Insight in London,
said: "I don't think Portugal has liquidity problems, so the
need to apply is surely below 50 percent. All depends on how
this aid will materialise, but I'd say the probability is about
20 percent in a 12-month horizon."

Most are ignoring these probabilities and invoking dominoes as their rationale.

Independent German Actions

Fact.  Germany chose to institute a restriction on naked short selling.  Some market participants did not like this.  Many in the media summarized this as a ban on short selling, a completely different matter.

Prediction.  Financial markets had better get used to independent action by some European countries.  They may find it more effective to lead by example than to take months to negotiate an agreement among 27 nations.

Furthermore, the idea that this reveals some fear about "toxic assets" is an unwarranted and simplistic inference.  Why shouldn't Germany institute a policy that the US already has?  Meanwhile, the Europeans are going to improve over US policies in the crisis by controlling CDS's and by not insisting on mark-t0-market for illiquid assets.  If only the US had been so smart.

Effects on the US

Fact.  There is an ongoing rush for people to predict effects on US corporate earnings.  Fed Governor Daniel Tarullo said the following:

In the worst case, such turmoil (in Europe) could lead to a replay
of the freezing up of financial markets that we witnessed in 2008.

and also

…A repeat of the global financial crisis that followed the Lehman
Brothers bankruptcy in 2008 is unlikely, but "not out of the question."

Please note that this is only one Fed Governor and, most importantly,  he said the result was unlikely.  It was a warning, not a prediction.  The headline was played for scare value on CNBC and in headlines.  It also completely contradicts yesterday's extensive Geithner interview with Maria Bartiromo.

Prediction.  Warnings are useful since they help to galvanize action, but a jittery market overreacts to warnings.

How about a little math?  The only thing you hear is that Europe is 20-25% of sales for many companies.  Suppose sales fall by 10% in Europe, a huge number, much greater than the expected economic weakness.  That would be a 2 – 2.5% sales loss.  People ignore the offsetting effect of a strong dollar on domestic purchasing power.  These effects are complicated, but the stocks have already declined far more than any expected earnings shortfall would justify.


There are many more points, but it really requires a truth squad to patrol all of the misleading information. 

Many observers are applying their own ideology and standards to Europe.  They will be proven wrong in their ability to predict the policies adopted, and the eventual success of the programs.

Meanwhile, many US stocks with little relationship to Europe or the strength of the Euro have declined significantly.  So many have been waiting for a correction.  Now that we have one, the fear mongers are all predicting a market crash.

Corrections are a natural part of investing, and ten percent is not unusual.  The disjunction between facts and market perceptions is what provides opportunity for investors.  I knew there would be an excessive reaction to Greece, but I really did not expect it to persist after the plan was announced.  As I said in the intro, I have been much better at predicting policy outcomes than how the market will react. Meanwhile …..

Those who wait for every problem to be solved before investing will be buying the top.

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  • heywally May 21, 2010  

    I love your stuff Jeff; you are one of the few critical thinkers in the financial blog-o-sphere and media.
    I just make the assumption now, that most everyone else, with a handful of exceptions is just going for page hits and advertising revenue.

  • Paul May 21, 2010  


  • jdb May 21, 2010  

    Thank you very much. It’s getting very difficult to find anything approaching a balanced approach to economic events. With Europe, all we here is negative. It can overwhelm and the fear builds. Combine that with hair trigger, electronic markets and down we go. Yet, it does seem that the rational investor is periodically given buying opportunities. Yet, we need to do better. We need markets that are less volatile and analysis that is more fact-based.

  • Proteus May 21, 2010  

    Always nice to read your analysis and predictions, Jeff, and much appreciated.
    On a slightly different topic, and maybe it doesn’t mean anything, but I noted a lot of comments today on other sites that could have been taken word for word from late March or April of last year.

  • geckojb May 22, 2010  

    While I agree that in the short term market participants may be over-reacting. More likely this is an echo-panic as people are scared of 2008 redux.
    I do believe that long term the situation in Europe could have more of an effect than you have opined. Its fairly simple and has nothing to do with what % of US business comes from the Eurozone. It all rests on the US consumers confidence. If the events they are witnessing in Europe and Asia cause them to retrench then a double dip is a probability.
    Should that be the case 10,300 on the Dow will seem very expensive.

  • Michelle B May 22, 2010  

    Excellent critical thinking based on evidence, and not opinion. Kudos.

  • Jack Damn May 22, 2010  

    What if you’re wrong?

  • Bill Luby May 22, 2010  

    Nicely done, Jeff.

  • CFD Guru May 23, 2010  

    Your call on the debt issues in Europe being overblown are on the money I think.
    Their debt will be a non-issue once their GDP starts to pick up.

  • Mike C May 23, 2010  

    Oscar believes in the long-term strength of the economy and the stock market. He has a lovable and irrepressible enthusiasm. When things go wrong, he steps back for a bit, but soon tries again. He expects to do better than others during good times. Oscar understands that this approach involves more risk. Oscar is opportunistic.
    Just curious, does Oscar ever take any sort of defensive/hedging action or is Oscar fully invested in stocks at all times with the philosophy of fully riding out any potential drawdowns?
    If Oscar does take defensive action, do you mind sharing exactly what metrics or indicators would cause Oscar to do so?

  • Jeff Miller May 23, 2010  

    Mike C — I have written a lot about the factors in the models, so I do not have much to add there.
    As to the main point, our ETF universe has three inverse funds, gold, and bonds. As of May 9th, Oscar had a fully defensive position — long gold and long the three inverse funds, a dramatic shift from the week before.
    Thanks for helping me to highlight this key point.

  • Jeff Miller May 23, 2010  

    Thanks to everyone for the encouraging response to this article. It is often difficult to take some evening time for a piece like this, and it helps very much to know that some find it helpful.