A lot has happened over the past month involving Greece. What was once something that should have been relatively easy to contain has potentially mushroomed with some interesting consequences. First, France and Germany have more to lose than anyone, and they will likely continue to assist Greece. However, if the Euro Zone helps Greece too much, it might keep Portugal and Spain from making the changes that need to be made within their own economic system. On the other hand, if the terms for Greece are too restrictive, then we will see even more civil unrest. It’s even possible that Greece, Spain, and Portugal might withdraw from the Euro Zone and issue their own currency once again. This would create a great deal of havoc. It would cause the dollar to strengthen significantly against the euro and the pound. Some emerging world economies could also suffer as demand from Europe might decline. When it is all said and done we expect the Euro Zone, the International Monetary Fund, the U.S. and other mature economies to step in to prevent a default on Greece’s debt.
The after effects of the steepest decline in real estate prices in 80 years continue to be felt and seen. Mortgagors who are 60 days or more late with their mortgage payments reached an unprecedented 6.89% in the fourth quarter of last year. That was up over 2% from the fourth quarter of 2008. Until such time as the unemployment situation improves, it is unlikely that this number will decrease much. It isn’t hard to believe that the number might continue to rise for a few more quarters before slowly moving in the opposite direction. (Source: TransUnion)
The earnings season for the fourth quarter of 2009 is almost over. Soon investors will begin looking ahead to April to see if the fourth quarter surge continues, both in terms of GDP growth and in company earnings. Whether it was because of low expectations of analysts, the pessimism of investors, or the under selling of earnings by corporate executives, this current earnings season produced more positive surprises than negative. Whether the first quarter of this year will begin to produce a sustained trend or whether it’s simply an aberration remains to be seen, but early indications point to a more optimistic outlook than most people expected just 90 days ago.
Last week the Federal Reserve Board raised the discount rate which is the rate charged to banks when they borrow money from the Federal Reserve. The Federal Reserve is meant to be the “lender of last resort” and the historically low rate which has been in place for a year is an indication as to just how hard it was to borrow money. Banks didn’t want to lend to each other because they weren’t sure which bank would be there the next day, let alone next week or next month. The rise of the discount rate has no effect on consumers who can be affected when the Federal Funds rate begins to go up. What does the rise in the discount rate really mean? Most pundits would tell you that it signals that the Federal Reserve believes that the worst of the financial crisis is behind us. At the height of the crisis, banks borrowed over $600 billion from the Federal Reserve and now the loans are down to a manageable $30 billion. Perhaps the most significant part of the rise in the discount rate was not the rise itself, but rather the way the Federal Reserve signaled its intentions ahead of time. Could this be a prelude as to how they will manage a rise in other interest rates going forward?
On the subject of interest rates, there continues to be concern about inflation, given the supply of money that has been created. There is an overwhelming concern that between the rising money supply and the rising debt level in the U.S., that major inflation can’t be helped. According to the inflation rates issued last week, for the first time since 1982 the core inflation rate (which excludes energy and food), declined. Although inflation is likely to come back, perhaps in a significant way, it doesn’t appear to be an immediate threat. Unless and until inflation rears its ugly head, it is unlikely that the Federal Reserve will be forced to raise the Federal Funds rate.
China is no longer the largest creditor to the U.S., at least for now, as they sold $34 billion of their holdings in December. Japan regained the number one spot as the largest U.S. debt holder by foreigners. Does this mean that China has given up on the dollar? Probably not, and in fact we will offer a different view. Perhaps China needed cash and the best place for them to raise that cash was by selling the U.S. debt they were holding.
Bull markets are not just made up of positive days. There are negative days along the way. Clearly, since the first of the year we have seen a increase in volatility. Within any bull market there is usually a correction (defined as a drop in the Index of at least 10%). The last time this occurred was on March 9, 2009, or almost a year ago (356 days ago). Since 1928, the S&P 500 typically has had a correction once every 322 days. Thus far, the biggest drop in the Index occurred between January 19th and February 8th, when it fell from 1150 to 1057, an 8.1% decline. As the market moves forward we can expect at least one more of these corrections. It will be important to maintain your long-term focus on the economic fundamentals.
Please tell us he’s not serious! According to President Obama’s new healthcare proposal released a few days ago he wants to extend the existing 2.9% Medicare tax to unearned income, which would include interest, dividends, annuities, royalties, and rent. This would apply to single taxpayers with incomes exceeding $200,000 and to married filing joint taxpayers with incomes exceeding $250,000. As almost everyone knows, the Medicare tax is currently only assessed on earned income, i.e., wages. Adding insult to injury, it appears that the President also wants to add an additional 0.9% to the Medicare tax on unearned income. These increased taxes would produce $111 billion in revenue over the next ten years, according to the Congressional Joint Committee on Taxation.
As always, we encourage you to give us a call if you would like to discuss anything further. We will visit again soon.
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