"Kee" Points with Jim Kee, Ph.D.

Europe: Last week the European Central Bank announced that it would offer to buy Eurozone countries’ short-term bonds in a program called “outright monetary transactions,” or OMT. Dubbed the Eurozone’s financial backstop “bazooka” by OECD (Organization for Economic Co-operation) Secretary-General Jose Angel Gurria, the intention of the plan, according to ECB president Mario Draghi, is to “be perceived as a fully effective backstop that removes tail risk from the euro area” (Financial Times). As I understand it, this plan allows for potentially unlimited bond purchases by the ECB, which was not the case with the European Stability Mechanism. And the focus on shorter-maturity debt instruments (one to three years) complies with Germany’s insistence on temporary, rather than permanent support (GaveKal). It also possibly serves as a bridge to buy time before a “euro-bond” solution can be implemented. That would require a lot more commitment to austerity measures on the part of troubled member countries (a Eurobond would replace high interest rate sovereign bonds with lower rate European community bonds). Of course, the lower interest rates (borrowing rates) paid by troubled countries would come at the expense of higher rates for solvent countries (like Germany).


Impact: Equities in the U.S. and Europe immediately rallied and Spanish and Italian bond yields fell – a good indication of falling risk premiums driven by the market’s confidence that the ECB plan lowers the probability of a Euro-area collapse and of spreading financial contagion. In the U.S., stocks (S&P 500) have about 10% to go to get back to their 2007 peak. Going back to the 1920s, the market takes on average about 24 months to regain the lost ground from a serious plunge like the 56.8% drop that occurred from the October 9, 2007 peak to the March 9, 2009 trough. That’s an average, which means half take longer, and half take shorter. The current rebound, strong as it has been, is about 42 months in length thus far, and I would say that the European debt crisis is the primary reason for this rebound taking longer than the 24 month average. I think this is corroborated by the unusually low U.S. bond yields, likely a precautionary reflection of the same European risks. Interestingly, in one of those life coincidences, this weekend an acquaintance was explaining to me how much more precarious the world is today than it was in the past, just as I had finished reading a passage from G.M. Loeb’s 1956 Battle For Investment Survival on the importance of geographic diversification for avoiding nuclear bomb exposure! (So is today really that scary?) The market is up over 100% from its March 2009 lows, so clearly the market isn’t signaling a new, dark future.


U.S. data: Friday’s payroll report showing only 96,000 new jobs created in August certainly offset Thursday’s more positive increase in the ISM non-manufacturing (services) Index (53.7, up from 52.6 in July). Like inflation, I find it useful to think of jobs data in terms of a statistical process control chart, with monthly readings bouncing around (above and below) an average or central tendency. The current central tendency is about 100,000 new jobs created per month. That’s consistent with low, 1%-2% GDP growth. A true “break-out” would mean job creation around a new central tendency, with above 200,000 being the norm for expansions. I don’t see that happening this year.


Why no recession? That’s a question I get a lot, and the answer is because the drivers of recessions, the items that drag the economy down into negative growth territory, have already crashed. Here’s some U.S. recession history worth knowing: We’ve had 11 recessions here in the U.S. since WWII. Pulling two of those aside, the 1953 recession is generally attributed to the decline in defense spending following the 1953 Korean armistice, while the 2001 recession is generally attributed to the collapse in private investment spending on equipment and software that followed the tech crash. The rest, the other 9 recessions, were all characterized by busts in housing and autos, which were generally running above trend prior to the downturn (and which were always preceded by increases in short-term interest rates, by the way). None of these conditions hold today. This is according to UCLA Anderson Forecast.