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Two concerns for recovery

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by Peter Switzer

Optimists may well see my usual diet of easily digestible economic and company titbits as building the case for an improving stock market this year. But what would keep me awake at night if I wasn’t absolutely knackered when my head hits the pillow?

There are two things. First, it’s this sovereign debt mess that countries such as Greece, Spain and Portugal find themselves in. And this relates to the overall global funding problems that exist nowadays compared to the pre-GFC world.

The second concern is whether the US can start creating enough jobs to bring the 10 per cent unemployment rate down.

US unemployment

Let’s deal with the second worry first.

There is an argument that there’s no sustainable recovery in the US until people start getting jobs again. The first half of 2010 should be driven by manufacturers catching up on demand after cutting back aggressively over 2008 and 2009.

Macquarie Bank’s economics team thinks this ramping up of production to make up for the shortfall in stocks on the shelf will drive the US economy this year and underpin an improving stock market.

But to keep it all going, jobs have to turn up. Overnight, there was a drop in private-sector jobs to the tune of 22,000 in January and records show that this was tiniest loss since jobs started to disappear in 2008. It also beat the experts' expectations.

This revelation came from the latest ADP National Employment Report but, better still, the authors suggested that this result points to February being the first positive month for jobs.

In fact, nonfarm private employment in the service sector rose by 38,000 but losses elsewhere swamped this good result.

The hope is that Friday’s Labor Department report on jobs will also raise hopes that employment is turning positive. However, labour figures can be notoriously stubborn and can have a big lag behind an improving economy.

When unemployment falls it will not only put a floor under the stock market, it could be a turbo-charged rocket up those Nervous Nellies who are still on the sidelines with wads of cash.

As you can see this is a sleep disturber but not a Zs killer.

Funding issues

So, what about Greece and its dodgy debtor neighbours? And what about funding worldwide generally?

Dow Jones Newswires summed up what happens when a government loses it monetary mojo:

“The cost of insuring Portuguese sovereign debt against default using credit derivatives reached a record high Wednesday, after the country sold fewer treasury bills than expected at an auction.”

Portugal's five-year sovereign credit default swap spreads rose to 197 basis points — that’s an extra 1.97 per cent — Wednesday afternoon from 165 basis points Wednesday morning.

It means the Portuguese have to pay more for money and worse still they might miss out on securing funding.

Greece's five-year sovereign CDS spreads also widened significantly Wednesday afternoon, moving back up to 400 basis points, having dropped below 370 basis points at one point Wednesday morning.

To appease the EU and potential lenders, the Greek Government has pledged a fiscally tough budget to sort out its finances. This will slow down the economy and cause unemployment.

But what worried me was the following from Dow Jones Newswires:

“A second strategist said that sovereign CDS markets were illiquid and that this could be contributing to the size of the moves.”

It comes as an ex-banker associate kept warning me over lunch that global funding shortfalls were very bad. He says the Westpac's 45 basis points increase of home loans was not just a case of banks behaving badly. but that he’s never seen funding problems like the ones we’re seeing now.

In a perfect world, you would hope that good risks like Australia would get preferential treatment and lower interest rates while the dodgy debtors would carry the cost of the GFC but these are strange times indeed.

Cautiously confident

As a general rule, if I don’t understand something fully I won’t invest. I have to admit the sovereign debt issue is very fuzzy and it worries me.

I know we have had sovereign debt issues in the past and markets have still gone up. I only hope the Yanks don’t ever tell us they have an embarrassing debt predicament!

So, how do I get past it? I regularly talk to the smart guys and gals at Macquarie, Deutsche Bank, CBA, AMP, NAB and others and I figure they all have a sovereign debt expert on their teams. Most of these have the stock market going up 10 to 25 per cent this year and that’s makes me cautiously confident but not totally confident.

For advice you can trust, contact Switzer Financial Services.

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Published on: Thursday, February 04, 2010