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May 30, 2012

Untitled Document

What a month! For a while it looked that not only was May coming to an end but the whole world was coming to an end. It was a reprise of the summer of 2011 with the stock market going down, having a few “fatigue” rallies and ending each week pretty much where it started. The main export product from Greece is still tragedy. The Europeans leaders are once more talking too much and acting too little. The republicans in the USA are threatening not to raise the debt ceiling in December, with the speaker of the house announcing a fiscal brinkmanship. Sounds familiar?

By coincidence this past weekend was the official beginning of the summer in the USA. Similarly to last year, people are wondering what to do with their money. The truth is, now, like last summer, there is no place to hide; all assets classes are affected but risk aversion increases and the stocks are the first to feel the pain.

It is very hard to say something intelligent about risk aversion when investors are willing to buy 10 year Treasury rate under the rate of inflation. When investors are willing to take negative returns it means they want to leave their money where they believe it is safe. How does one conciliate this movement with the fact that we have for the most part, in the USA, companies showing good results on earnings and an economy that it is in fact improving? So, why is the stock market reacting this way in the USA? People are afraid.

This past May will in fact enter history as a month full of news. There was the frenzy about the Facebook IPO and its subsequent failure. Investors were smarter than some thought and realized how much “air” is in the FB valuation. How can a company that does not have one single product be more expensive than APPLE, a company that has great products that people are willing to buy? There was also the 2 billion dollar -and counting- loss announced by JP Morgan. Then there was Obama coming out to support gay marriage, and socialist François Hollande’s victory in the French elections. For Brazilians in New York, it was a special month with the Person of the Year Awards and a week full of events and speeches with different takes on the future of the Brazilian economy - mostly holding optimistic views. Chicago hosted the NATO meeting and the leaders reiterated their commitment to finally leaving Afghanistan after a decade-long war and occupation. According to the allies, “it is time for the Afghan people to take responsibility for their own security and for the United States-led international troops to go home.” The news coming from China was not positive and had added to the grim outlook of the future. When asked, I have been saying that, of the two storms on the horizon - Europe and China - I think the impact of China is worse because it impacts the real world and there is no firewall for it. After nearly 2 years since the beginning of the Greek problems, the market should be prepared.

We read the newspapers every day and read the bad news bit by bit, so consequently nothing seems to really sink in. It is only when we put everything together and see it in perspective, that we ponder how we are so resilient to so much bad news. Maybe it is because we know in the bottom of our hearts that the world is not going to end after all. We know we have good companies with real products, doing good things; some piling up cash, others investing it.

Meanwhile the US economy is doing well and if not for Europe, the stock market would be in a better place. The economic indicators show a slow but consistent recovery that reinforces the argument that some of us have been defending in the past year: austerity is not the answer for crisis. When one looks in perspective, the American economy post-crisis was a better performer not only because there was a stimulus (rather small but a stimulus nonetheless), but also because nobody beats the US in terms of management capacity, entrepreneurship, and problem solving. What prevents the US from reasserting its economic leadership is not just the European mess, but also the American politicians. There is too much uncertainty in the economy and as the months pass, even more uncertainty. Who will win the elections? For an incumbent, the approval rate of Obama is not good- 48%- and the pools show a dead tie with Romney. Uncertainty and expectations are holding back investments and consumer decisions.

Now for the first time there are open talks about a Greek exit from the Euro. I don’t see any other option and I‘ve been saying that for a while. When I say that, I hear the arguments about how difficult that would be, about the Euro denominated debt, and all the technicalities. The fact that matters for the Greek people and their leaders is that there was a decrease on GDP of almost 20% in the past 3 years and unemployment is almost 21%.The Germans want them to stick to the austerity package which will lead to more unemployment and further recession. Greece doesn’t have a diversified industrial economy to support a recovery and it is no surprise that the public sector plays such a big role in the economy. The best for Greece now is to coordinate the exit with the Europeans leaders and make the transition back to the drachma. Of course it would be complicated but what isn’t?

The Brazilian economy is slowing down so the Government is cutting interest rates in an effort to boost growth. Brazil has the opposite problem of China: while the Chinese economy is driven by investment and it lacks consumption, the Brazilian economy is driven by consumption, domestic consumption, and lacks investment. So in the short term the campaign to lower interest rates might result in more inflation and will not necessarily stimulate growth. The success of the Brazilian economy in the past few years made the economic authorities and government complacent – and the population too- and the structural reforms that were needed to go to the next step- a sustainable rate of growth-were not made.

Because Europe is a mess, China and Brazil are slowing down. I am still bullish about US stocks. That’s why I think that one should just ignore all the noise and bet on the long run. In the time being, use strategies to protect your portfolio and most of all…good luck!

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