“Kee” Points with Jim Kee, Ph.D.


Probably the biggest event last week was the missed debt payment by Espirito Santo International, which indirectly controls Banco Espirito Santo, Portugal’s biggest bank. The Portuguese authorities still have over 6 billion Euro in their financial rescue fund, and the European Central Bank expressed its intent to put an end to any crisis (Gavekal). So the concerns were short-lived, and markets rebounded in general and are back near all-time highs.


But I wouldn’t call Espirito Santo’s problems a “one off,” either, because many European banks suffer from poor corporate governance, inadequate disclosure of related party transactions, and opaque shareholding structures (Gavekal). As Leah Bennett, our Co-Chief Investment Officer points out, some of these banks should and will go under (or more realistically, be restructured), but their interdependence or “systemic” risk appears to be less than what it was a few years ago. I think similar bank-specific events in the future will play out like other European crises....market sell-off and flights to safety, followed by European Union or European Central Bank (ECB) response, and market recovery.


And Europe is still recovering, albeit slowly. At the beginning of the year, I mentioned in our client updates that my biggest concern (following economist Robert Mundell) was a Euro that is too strong, meaning, specifically above $1.35. It’s been above that most of the year, so weakness there is not surprising.


I also mentioned that I felt the ECB would be looser over the next 12 months than expected (partially because of this) and we are seeing that and I expect it to continue. The ECB has a more explicit or mandated inflation target of “below but close to 2 percent” than the Fed, so it is usually tighter than the Fed. But with Euro-area inflation running well below that, I expect – as do my colleagues here at STMM - that the right bet is a continued highly accommodative central bank in Europe.


However, as is the case here in the US, monetary policy is only half of the equation (fiscal is the other). And I see looser monetary policy, like low interest rates, low reserve requirements, lending policies, etc., more from the perspective of "not impeding growth" rather than somehow creating growth. But in Europe, a lot of the action has to take place on the fiscal side (less wage/price rigidity, regulatory morass, etc.). Interestingly, International Monetary Fund  Managing Director Christine Lagarde's speeches are all trying to make that point as subtly as possible for Europeans, just as former Fed Chairman Ben Bernanke did in his speeches here in the US over the past few years. But politically, implementing fiscal policy is a lot tougher than implementing monetary policy, and the world is struggling with that.


Another big news event last week was the National Association of Business Economists’ (NABE) release of a special five question survey that was created specifically to get professional business economists’ response to the -2.9% first quarter US GDP number. The panel’s median forecast was for a solid 3.0% annualized growth rate for the second quarter. Growth expectations for the year were revised downward to 1.6% from 2.5% in June. That means they missed the negative first quarter GDP number big time, and I think that is because quarterly GDP is not forecastable. For example, of the Wall Street Journal’s panel of nearly 50 economists, many with their own proprietary models, none forecasted a negative first quarter. Zero! Again, quarterly GDP is not forecastable.


Two views: And that brings me to an important idea. There are two views of the world that tend to dominate this business. One of them assumes that future events are somewhat preordained from prior events that have already taken place. For investing, that means that you just have to be smart enough to think through it all. At the other end is the view that markets have already priced in (“discounted”) what is knowable, so the only thing of importance to investors are future, unknown events. Now, obviously the truth lies somewhere in between. I tend towards the second view more than the first, but there are plenty of sharp people who are closer to the first. That’s why you diversify…because you don’t know. In the words of Noble Laureate William Sharpe, “Individuals ought to concentrate on using the market more than beating it. Focus on questions of asset allocation, diversification, and changes through time.”