If an ET had landed on earth in January 2012, he would not believe that not that long ago we were facing the end of the world, or so it appeared based on the stock market, the riots, and the headlines on the main newspapers. After Christmas, all problems seemed to have vanished and by last Friday stocks were up 4.6% since the beginning of the year.
The measures undertaken by the European authorities by the end of the year helped a lot, providing the necessary liquidity to the financial system and allowing Spain and Italy to borrow at cheaper rates. Everybody was tired of volatility, suffering some kind of a “bear fatigue” and looking desperately for a reason to react.
I don’t want to ruin the party or the optimism but the truth is that the measures undertaken in Europe solved- temporally - the liquidity problems, but the potential solvency problems remained untouched. The Greek tragedy is an ongoing problem. We just had one more weekend of tiring negotiations without a resolution. There is a deadline, though, and that is March, 20, 2012, so at that time a resolution will come, one way or the other. In Portugal the 10 year borrowing rate reached 14% last week; Italy and Spain are trying to implement measures to balance the budget but we all know that in the short run such measures will make things worse by reducing growth and government revenues. Germany is still showing good economic results helped by the weakening EURO, but the future doesn’t look so bright. Last week, the World Bank declared that Europe is in a recession and Egan Jones cut Germany’s rating from AAA to AA. For those who enjoy currency speculation it might be a good bet to expect further depreciation of the euro.
This reminded me of a quote from Ruddinger Dornbusch:
“The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought, and that's sort of exactly the Mexican story. It took forever and then it took a night."
In the United States, there were, for the most part, strong economic reports, and the earnings season, although being the weakest in the last couple of years, has been not that bad. That also helped the stocks on their ride up. This week GDP will be announced and the estimate is 3% annualized. Not bad, mainly if we consider how difficult 2011 was. Another important report was the existing home sales that showed an increase, meaning the inventory is coming down, which is good news. More significant for the economy, however, will be the report regarding new home sales, to be released Thursday the 26th. On the other side there is no indication of price recovering as shown by the Case Schiller index. In New York, news that the bonus season in Wall Street will not be good didn’t help the real estate market. Demand is still weak except for the Brazilians that are buying in Miami like there is no tomorrow.
All in all we are still on a risk-on, risk-off scenario. Last week, without bad news from Europe, was risk-on. This week started as risk-off with the European crisis back to front stage.
The electoral season in the US is full of surprises. Mitt Romney left New Hampshire thinking he had made history, winning Iowa and New Hampshire and arrived in South Carolina thinking he was about to grab another victory, the third in a row. In two days everything changed: on Thursday he learned that he did not in fact win Iowa and on Saturday Newt Gingrich won South Carolina!
The Republican nomination now seems like a long and widening road. The joke was that alcohol sales increased substantially on Saturday in Washington, after Gingrich’s victory: the Republicans drinking scotch to cope with the news and the democrats drinking champagne to celebrate. No news would be better for Obama that having Newt Gingrich as his opponent, and the Republican “establishment” knows that. Gingrich won with the help of the born-again and evangelical Christians and because he presented himself as more conservative than Romney. The next battlefield is in Florida where 60% of the electorate declare themselves as conservatives.
Meanwhile in Brazil everything is okay, thank you for asking….The President is popular and has high rates of approval. The Government promised a fiscal surplus in 2011 and delivered and will probably do it again in 2012. Inflation is a little above the target range but nobody seems to think that 7% is high. Again I don’t want to be the one who ruins the party, but we should know by now that complacency today might become trouble in the future. Despite the decline of the capital flows for the developing countries, Brazil is still receiving positive inflows. The structural problems have not been addressed, but with so many things to celebrate, who cares?