“Italy is now in a dance of death.”
– Fredrik Erixon
(Head of the European Centre for International Political Economy)
If I never hear the word “Europe” again it will be too soon. The U.S. stock market’s strong 14% rally since the October 4th bottom was stopped dead in its tracks last week on news that Greece’s Socialist Prime Minister George Papandreou refused to immediately implement the domestic austerity plan needed to qualify for $177 billion in Eurozone financial assistance until after it was subjected to a public referendum. I really have no right to complain since the October rally was fueled by a Europe debt deal in the first place. What Europe giveth, it also taketh away.
Fortunately, Papandreou quickly reversed himself on the public referendum and resigned. Both his ruling Socialist Party and the center-right opposition party known as New Democracy have agreed to form a coalition government, but as of this writing cannot agree on a new prime minister because neither party wants the stigma of being responsible for pushing through the austerity plan. It’s pretty rare for a country’s political parties to be fighting over the right not to be in charge! I’m confident that the Socialists and New Democracy will be able to find someone apolitical enough (former European Central Bank Vice President Lucas Papademos?) to avoid stigmatizing either party, so – fingers crossed — Greece finally will be something we can forget about at least for a while.
Italy is Europe’s Newest Problem
But a new and more serious European problem immediately arose to replace Greece: Italy, which is the eighth-largest economy in the world and the fourth largest in all of Europe (after Germany, France, and the U.K.). As I wrote back in July in Italy Debt Crisis, German and French banks have invested $36 billion in Greek government debt, whereas they hold four times as much — $150 billion — in Italian government debt.
Italy’s public debt load constitutes an extremely-heavy 120 percent of GDP, the second-highest level in Europe (after Greece) and worse than either Ireland or Portugal – both of which have already received EU bailouts. Italian Prime Minister Silvio Berlusconi agreed to resign following his failure to achieve a majority vote in parliament for his public finance plan. Many thought Berlusconi’s resignation was a good thing, given his history of finance and sex scandals, but the markets didn’t like the uncertainty and sold off big time on the news. Yields on Italy’s 10-year government bonds skyrocketed to a Euro-era (i.e., since 1997) record high of 7.47%.
It is commonly believed that a 7 percent yield is the “point of no return” for Italy because that was the yield level at which financing costs for the other PIIG countries (Portugal, Ireland, and Greece) became too burdensome and bailouts quickly became necessary. Each additional percentage point in interest Italy must pay causes the country’s annual interest expense to rise by Euro 2 billion. Simply put, the European Financial Stability Facility does not currently have the financial resources to handle a bailout of Italy. That sorry fact may explain why credit default swaps on Italian government debt have hit a new record high of 536 basis points. With nobody big enough to bail out Italy, the need for default insurance is greater than ever.
If Italy weren’t bad enough, an added concern revolves around plans by the French government to implement austerity measures of its own in order to stop what French Prime Minister Francois Fillon characterized as a “dangerous spiral” of public debt from getting worse. Austerity in France – the fifth-largest economy in the world and second-largest in the Europe — is not conducive to a pickup in Eurozone or U.S. economic growth.
U.S. Economy is Stable But Weak
In the U.S., the October jobs report showed a seasonally-adjusted 80,000 increase in jobs along with upward revisions in both August and September. Not terrible, but nowhere near the 125,000 new jobs needed to keep up with population growth or the 200,000 new jobs needed to reduce the unemployment rate. The Challenger report on corporate layoffs showed a 63 percent decrease in October from September, but layoffs in September were at a 28-month high so a decline from such a peak reading is less optimistic than otherwise would be the case. John Challenger’s interpretation of the layoff data was not upbeat:
Job cuts in government and financial services dropped significantly last month, but the two sectors are not out of the woods, by any means. Most of the government cuts this year were at the state level. We have yet to see the full impact of mandated federal spending cuts. Anticipated cuts at the U.S. Post Office alone could result in more than 200,000 job cuts.
More disturbing is news that home mortgage delinquencies rose for the first time in almost two years. A spokesman for the TransUnion credit reporting agency that issued the report called the increased delinquencies “widespread” and warned:
It’s much different than we’ve been talking about the last few quarters. More and more homeowners are likely to struggle. I’m not sure this is a one-quarter blip.
Economic Cycle Research Institute Remains Confident of Sep. 30th Recession Call
How all of these of these disparate economic data points fit together for purposes of concluding whether the U.S economy is falling into recession or not is something I leave to the experts; namely the Economic Cycle Research Institute (ECRI). To the naked eye, ECRI’s September 30th recession call has looked a bit silly given the large stock market rally since October 4th, as well as decent GDP and employment numbers. Virtually no Wall Street economist is backing up ECRI’s recession call which actually makes me feel better about ECRI’s forecast, not worse. Wall Street makes money when investors are bullish so it tries to convince investors to be bullish all of the time.
One could say the same about the CNBC cable channel (more people tune in during bull markets), which on Monday (Nov. 7th) tried to beat up ECRI co-founder Lakshman Achuthan over his recession call and get him to name the single economic indicator that made him bearish on the economy. Achuthan didn’t take the bait and correctly argued that the economy’s direction is based on a multitude of factors and can’t be dumbed-down to one or two anecdotal pieces of economic data. I completely agree with what money manager John Hussman recently wrote about the flawed thinking of most so-called economists:
Most economists and Wall Street analysts seem to analyze the economy as what I’d call a “flow of anecdotes” – weekly unemployment claims did this, retail sales did that, we got a positive surprise here, and so forth, without putting that information into any real structure and without knowing which data points actually matter or in what combination. In contrast, good economists think about the economy as a system - where multiple sectors interact.
Hussman characterizes ECRI as “undoubtedly the best private economic research group we know.”
Anyway, back to Achuthan. On CNBC, he said that neither the recent GDP and employment data, nor the stock market rally, had changed a thing. The year-over-year growth rate in ECRI’s Weekly Leading Index remained very poor at negative 9.4 percent and is just the latest of a string of negative year-over-year readings which have historically almost always led to recession. Almost all of the recent positive pieces of economic data cited by Wall Street are “coincident” indicators that tell you nothing about the future. Achuthan said that people who rely on such coincident indicators are engaged in “nowcasting” rather than “forecasting.” Historically, most recessions have started during or immediately after quarters of positive economic growth, so the fact that third-quarter 2011 GDP was up 2.5 percent means nothing. ECRI’s recession calls typically provide a six-month lead time, so the key quarter to evaluate ECRI’s recession call is the first-quarter 2012 GDP report (ending March).
I was impressed by Achuthan’s confidence in the face of CNBC’s hostile interrogation and it reminded me of the St. Louis Cardinals during Game 6 of the World Series. They were down by two runs to the Texas Rangers in both the ninth and tenth innings and yet — each time that the camera panned over to the Cardinals bench or bullpen — the players were always seen smiling, like they didn’t have a care in the world. Despite what looked like a hopeless situation, the Cardinal players just knew they were going to win — and they did. Achuthan’s confident demeanor reminds me of the World Champion Cardinals, which isn’t good news if you’re a stock-market bull.