At the signing of the Declaration of Independence, Benjamin Franklin reminded his fellow patriots of their critical need for solidarity, saying, “We must hang together, gentlemen…else, we shall most assuredly hang separately.” European leaders, facing the biggest challenge to their own relatively recent political and financial union, appear to have heeded Franklin’s advice. After weeks of bickering, the European Union finally stepped up to meet the Greek debt crisis with a forceful, unified response.
Today, the sixteen countries that use the Euro pledged €750 billion ($955 billion) in an attempt to thwart a growing sovereign debt crisis that began in Greece but appeared to be rapidly spreading to the other PIGS (Portugal, Italy/Ireland, Greece, and Spain). Stock markets around the world rallied dramatically on the announcement, posting their largest gains in more than a year and drawing a sharp contrast to last week’s perfect storm of panic and fear, particularly following Thursday’s market sell-off. Although the exact details remain under investigation, the latest explanation is that a large, bearish options trade on an index by a hedge fund triggered additional bearish trades by high-frequency traders and, at one point, drove markets down close to 10 percent.
The high drama of Europe’s debt woes have overshadowed several very positive developments that point to economic recovery:
–First, the US economy added 290,000 jobs in April, the best job gains in more than four years. Prior months’ job gains were also revised upwards, bringing 2010 employment gains to 573,000 jobs.
–Second, as we discussed in our Fourth Quarter 2009 Portfolio Commentary, although nominal unemployment rose 0.2% in April to 9.9%, the increased level is due to discouraged workers returning to the labor pool, an excellent signal that sustained job growth is underway. (Incidentally, an “unofficial” metric that BSW follows, help-wanted ads, have also climbed to their highest levels since 2008.)
–Third, productivity grew at a 3.6% annualized pace during the first quarter, finally slowing from its breakneck pace of 6.3% during 2009, the largest gain in nearly half a century. This is a welcome slowdown, as it also generally points to coming employment gains.
-Fourth, the housing market continues to stabilize. Home prices gained in nearly 60 percent of U.S. cities during the first quarter of 2010, with double-digit price increases in 29 cities.
-Fifth, according to the US Department of Commerce, wholesale sales rose by 2.4 percent in March, more than double the 1.1 percent increase most economists had forecast; while wholesaler inventories rose again in March for the third consecutive month. Wholesaler data is a closely watched indicator of business sentiment, as growing inventories generally reflect increased confidence about economic conditions.
-Finally, corporate profits have surged (see chart above). Of the companies in the S&P 500 that have announced first-quarter results, 77 percent have beaten Wall Street earnings forecasts, with first quarter 2010 profits on track to grow 56 percent compared with the first quarter of 2009.
Echoing back to Benjamin Franklin’s charge from 1776, the European debt crisis of 2010 may turn out to be one of the key factors in stimulating sustained global growth. Until recently, the European Union was a somewhat loose consortium of independently-minded nations. The Greek bailout has underscored the potential for traditionally lax, undisciplined nations to threaten the financial stability of their more disciplined peers. Euro-zone member states may finally have gained sufficient political capital to push through long needed measures that improve European competitiveness, including reforms to labor markets, wages, pensions, and retirement ages. At times like this, when pessimism dominates, it is essential to remember that Europe is still the world’s largest economic market AND developing Asia’s largest trading partner. Consequently, instead of signaling Europe’s death knell, from a longer term perspective we may now be witnessing the birth of a leaner, revamped Europe 2.0.
-David Wolf, Chief Investment Officer