Investors are worried. They are worried that the end of QE II will spell disaster. They are worried that European bank woes will spill over onto our shores. They are worried that the economy is stalling and inflation is trending higher. Yet, with all these worries, the markets have held their own over the last few weeks.
I’m not going to dismiss these concerns, although we need to remember that markets often climb a wall of worry. Admittedly, there have been so many downgrades of sovereign debt lately that it’s hard to keep track. The PIGS (Portugal, Ireland, Greece, and Spain) have had to make room this week for Japan. That island nation joined the ranks of downgrades in large part due to the economic impacts of the recent earthquake and tsunami.
The governments of the PIGS countries, in the meantime, have responded by implementing austerity measures, hiking taxes and selling off state assets.
These belt-tightening policies have not had the desirable effect either in the economic or in the socio-political arena. Anger and fear among the population have spawned demonstrations, strikes and political upheaval.
“Just say no,” has been the message of various opposition parties within the region.
The voters are listening. Spain’s Socialist Party, for example, was hammered in recent elections. Ireland kicked out its Prime Minister, Greece’s opposition parties are making it impossible for the government to make deeper austerity cuts and demonstrations have replaced dancing as a national pastime.
Although “no” sounds good, especially to the youth, it unfortunately provides little in the way of solutions to the PIGS financial crisis. But regime change (or the threat of one) has made ruling parties drag their heels in implementing reform. In the meantime, the debt continues to pile up and the financially sound countries within the EU are becoming increasingly impatient.
Readers may recall that I expressed serious doubts over a year ago when the EU first announced that in exchange for a bail-out, the PIGS would need to agree to stringent spending cuts and higher taxes. My hesitation stems from a similar debt crisis I experienced in Latin America during the 1980s.
At that time, it was the International Monetary Fund (IMF) that was calling the shots. The same deal was foisted on countries throughout Latin America. All that effort accomplished was massive unemployment, a rapid decline in economic activity and a whole bunch of socialist revolutions from one end of the continent to the other. We called that period the “Lost Decade”.
In the end, when the problem threatened to topple some of our own banks, we did what had to be done. We swapped debt for equity at 10 cents on the dollar. We also forgave a lot more debt than we swapped and, as a result, we have the Latin America we have today—dynamic, entrepreneurial and growing far faster than most regions. God forbid, that today’s brilliant economists and politicians learn a lesson from the Lost Decade!
As for the rest of these worries, I’ll handle them in order: the end of QE II at the end of June will be a non-event. The Fed has our back and will continue to have it. Europe’s woes will be contained, most likely by allowing some countries to re-negotiate their debt along the lines I have suggested. The “DD” (double dip) won’t happen this year and inflation expectations will begin to decline as investors realize the peak in the commodity bubble has come and gone.
So that leaves a market that is down less than 5% from its highs. Recall that I expected a pullback into the 1,300-1,325 range on the S&P 500 Index. Well, we dropped to 1,311 this week and in my opinion we are scraping along the bottom. So quit worrying.