Monday Smart Points with Jim Kee, Ph.D.


We are anxious to get our quarterly webcast out a little early this week so clients can view it before the holiday. For my part I’ll be discussing the generally weak economic numbers, and why the data suggest that they are likely due to transitory, not permanent, factors. In fact, data glimpses are already pointing to continued global recovery, strong recovery in Japan, and a “soft-landing” in China (JP Morgan). Here are a few thoughts regarding last week’s news flow:

Greece: It appears that an agreement has been reached between Greece and the European community regarding a new Greek rescue plan (Financial Times), though the process is likely to take several weeks as details are ironed out between the EU, the IMF, France (Sarkosy), Germany (Merkel), and Greece’s austerity pledges. On a humorous note, one cynical strategist summed up Greece’s acceptance of austerity measures in return for cash from the European Central Bank (ECB) by saying… "that’s pretty much how Greece has always operated, taking cash up front and dealing with the debt later. Why should anything change?” (Jefferies). Stratfor makes the point that France and Germany and other European member countries are trying to “circle the wagons” around the debt-ridden European periphery through loans while at the same time responding to the populist sentiments of their own people to force austerity measures on the profligate. A decisive vote over the permanent rescue mechanism will take place in the fall. Stratfor forecasts that “Germany and other eurozone countries will give in to the crisis in Greece, and will forward whatever loans are required to get over this political crisis.” That seems pretty consistent with the unfolding developments.

Be cautious regarding reports of U.S. Banks’ exposure to troubled European sovereign debt (Greece, Portugal, Ireland, Spain, and Italy). For example the Bank for International Settlements (BIS) issued a report stating that U.S. bank exposure could be 25% of the European total, smaller than Europe’s but substantial. Much of this is in the form of loan guarantees like credit default swaps. But JP Morgan notes that this appears to be a gross number, and that the net number (which would include off-setting guarantees and collateral) would be much lower. They cite Chase CEO Jamie Dimon, who noted that the bank’s exposure to the five countries was disclosed at over $100 billion, but that “doesn’t include collateral or hedges”; true economic exposure “was $20billion” at the end of 1Q11, and “is now $15 billion or less.” JP Morgan estimated the maximum possible exposure to these five countries of each large US bank and argues that a worst-case scenario would be neither trifling nor life-threatening to the banks.

Finally, I attended a national conference of my peers (other money managers) last week and wanted to share 2 observations in Smart Points:

(1)At the fixed-income panel there was near-unanimous consensus that municipal bonds represented the most attractive fixed-income investment from a risk/reward perspective. This is consistent with the view of our own Director of Fixed-Income, Hutch Bryan.

(2)I am increasingly bothered by international asset allocation discussionsbecause of what is“missing from the narrative.” Specifically, the following 4 points are missing: (1) Because of globally integrated markets, the “home country bias” in which an internationally-oriented domestic company trades in line with its domestic-only peers is disappearing, so you get a bigger diversification benefit from owning these international U.S.- domiciled companies than you used to (2) companies in the same sector from different countries tend to move together, so there might be some truth to the notion that sector diversification is getting to be more important than country diversification (3) emerging markets have primitive, export-oriented (rather than consumer-oriented) banking systems and tend to be concentrated in cyclical industries like manufacturing. That, and the lack of a long-term record of property rights/contracts protection, is why their equity markets traded at lower multiples. At least that’s what we economists thought. But emerging markets are no longer trading at lower multiples, though some of these characteristics still describe emerging markets. Just another thing that’s missing from the narrative (4) managers are fond of pointing out the outperformance of international equities over domestic equities during the past decade. But that decade followed the now-forgotten collapse of the emerging markets in the late 1990s, and the unforecasted global boom that followed. Expectations were low (growth not priced in) for many international equities 10 years ago. That’s certainly less true today.

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Jim Kee, PhD, President & Chief Economist
South Texas Money Management
100 W. Olmos Drive, Suite 100
San Antonio, Texas 78212
(210) 824-8916