Markets seem to be taking the broader economic news in their stride.
-Christian W. Thwaites, president and chief executive officer, Sentinel Asset Management
May 1, 2012
In March 1925 Lord Beaverbrook held a dinner with Chancellor Winston Churchill, Keynes and a number of pro-gold standard Treasury men. The debate centered on whether a return to gold would:
or mean "unemployment, downward wage adjustment" and "favor the special interests of finance at the expense of production."
Keynes, of course, was in the second camp. He knew of the "paradox of unemployment amidst dearth," when an economy can not clear wages and prices, and falls into a liquidity funk. No matter how much rates are pushed, the desire to delever and withhold purchases prevents growth.
The Treasury position prevailed and reluctantly Churchill went along. One month later, Britain restored the gold standard. It lasted seven lean years. Everything Churchill and Keynes feared came true. Not one of the alleged benefits materialized. Churchill called it the worst decision of his career.
Sounds Familiar: Since the first Greek drama started two years ago, we have had much of the same debate: downsize from prosperity and embrace successive austerity programs in a race to the bottom. Last one standing collects the spoils. But there were none to be had. Rentiers may have garnered a few points on bond holdings but the core economic data deteriorated and, most of all, in the most socially costly sectors: unemployment, youth unemployment, declining asset values and wealth. After five governments lost their mandates, enough people are saying enough. About time.
We had some of that this week starting in Europe, where the Netherlands, with one of the largest current account surpluses in the world, proved unable to deliver concretionary programs that would have shaved about 1 point off the Debt/GDP ratio. The bonds barely moved and remain at the same level of a year ago. Which suggests investors would prefer a systematic program for growth than the water torture of fiscal tightening. Expect Spain next. Then France if there's a government change. And if Germany is the last one to defend the austerity plans, it's going to find itself increasingly isolated.
Bottom Line: Markets seem to be taking the broader economic news in their stride. The FOMC confirmed its policy, so no new buying but also no unwind on the balance sheet. That was enough to keep GT10s below 1.98% for much of the week. The demand for safe assets remains very high and that leads us straight to MBS where we maintain a very over-weight position. Equities are drifting higher, which we like as we increased the position some weeks ago. It helps that positive surprises outnumber negative surprises by 3:1 so far this earnings season. We continue to put new money to work in equities. The market tends to overreact to news which suggests there's lack of conviction. But at least there's no over-valuation. We're at the same multiples as a year ago.