Economic Notes

European concerns continued to dominate other issues.  This is unfortunate, considering that U.S. news has been looking better as of late and is perhaps underappreciated.  Japan, which has also been largely ignored, grew for the first time in four quarters.

The European Central Bank purchased €10 Billion to purchase Italian and Spanish Bonds in order to bring yields in both of those nations back below 7.0%—the often-referred-to “breaking point.”  In response to criticism he could be doing more, ECB President Mario Draghi maintained that ‘price stability’ should remain the institution’s primary objective and doing otherwise might threaten its credibility (note that many central banks, including the ECB, are subject to only a single mandate, as opposed to the Federal Reserve’s dual mandate of stable prices and maximum employment).  Of course, with such a broad mandate, a wide variety of actions could be justifiable. Read more

It was a relatively light week from an economic standpoint, as the highlights were mostly focused on Italian and Greek politics and their role in the ongoing Eurozone situation (see last week’s note regarding drama).  As the pinnacle, we saw a resignation of the heads of state in both nations as part of the negotiation process for austerity and debt reduction measures.  On Friday, Italy’s senate approved a series of these measures, which brought down yields.

The high-profile and closely-watched economics team at Goldman Sachs now believes the Eurozone has entered into recession in Q4, albeit perhaps a shallow one.  The core nations are expected to bounce back next year, while the peripheral countries face a continued rough road for several years, in their estimation, led by difficult by austerity measures.  Whether this is proven true or not, markets already appear to have priced in this outcome.  Read more

We live in challenging times, but when has anything ever been smooth sailing?  The financial markets are aware of outstanding issues in the world, and collectively price them in accordingly.  That’s why the surprises (both good and bad) have the tendency to result in overshoots of market reaction.  For example, despite Tuesday’s “crisis,” markets were already up again Wednesday.  In October, the S&P gained 11%, which helped reverse a good bulk of August and September’s losses.  Despite the high degree of volatility, however, we are not as far away from late July’s level as it might appear. Read more

You know what we haven’t talked about lately? Residential real estate. Why is that? Because residential real estate is dead. It has been dead for about 6 years and isn’t getting any livelier. Well, maybe it could be. Let’s explain.

The trouble with residential real estate was that it got far too expensive given its economic utility. We will define its economic utility as the rent it could fetch. When a house cannot be rented out for enough money to carry the mortgage, pay the taxes and yield some small pittance to the investor, it isn’t likely to go up in value. We got to the point where with funny money mortgages, you could get a home for zero down, artificially low monthly payments for the first few years and maybe even interest only for a long time. That made no sense from the lender’s point of view, but they were just going to dump the mortgage on some unsuspecting investor in the guise of a mortgage-backed security anyway, so they didn’t care. Read more

With so much to talk about and so little time, we are going to waste this week’s rant by talking about what we shouldn’t talk about. We really have nothing to add on either topic.

First, Occupy Wall Street – a bunch of old hippies, young hippies, unemployed art school graduates and dispossessed liberals decided to demonstrate against Wall Street greed. In the initial phases of this movement, a few of them got maced pretty heavily by New York’s finest for occupying the doorsteps of some of the big bank buildings downtown New York. That was a public relations nightmare for the city and the Bloomberg administration, so they stopped the macing and instead let them set up camp in a city park a little ways away. They let them march around and have their drum circles and the chants so long as they don’t interfere with other people’s right to get to work or go to a dentist appointment. Read more

In light of the market volatility in recent months, we thought it might be a good time to check the gauges in our car and provide a periodic review—a summarized highlight of various asset classes we operate in.

Government Bonds

We might have been considered geniuses if we’d decided that an already-low Treasury yield of 3.0% or so wasn’t already low enough and was poised to hit 1.8%.  That was not, in fact, the case.  The probabilities were just not stacked in that direction of lower rates, for a number of reasons, and we were not alone in this view at the time.  The S&P downgrade of the U.S. government counter intuitively caused a flood of cash away from risk assets into Treasuries, causing them to become even more expensive/lower-yielding.  Over the last several years, investments in agency mortgage-backed securities have offered better coupons and valuations, so that is the direction we took—which worked when intermediate-term bonds did well. Read more