What Has Killed Any Debt Relief Rally?

8/02/11: In the markets, as in life, there are no guarantees but everyone is entitled to their opinion. Here’s my opinion on the financial markets today.

The Nitty Gritty Details:

Apparently, a likely path to a debt deal through Congress is not enough, at least for now, to assuage investor concerns that the U.S. could lose its AAA credit downgrade.  In addition, recent data, including June personal spending reported this morning, is suggesting that the economy may be in worse shape than previously thought.  Market participants will also be looking to auto sales later today as an additional economic barometer.  European markets are lower on ongoing worries about Italy and its debt load, while key Asian markets lost about 1%, tracking Monday’s U.S. losses.  Growth concerns are weighing on cyclical commodities, while supporting strong gains in silver and gold.  Gold also garnered support after the Korean central bank bought bullion for the first time in 13 years.

Looking back at Monday, in an “up and down” day to say the least, stocks rallied at the open by about 1% after the agreement in Washington over the weekend before reversing sharply lower after the weak ISM report.  The ISM not only missed consensus expectations, but also the low end of the range of economists’ forecasts.  Meanwhile, concerns that the deal may not be enough to avoid a U.S. downgrade from AAA and remaining doubts as to whether the deal would get through Congress also kept bulls in check.  The S&P 500 fell about 1% at its lows of the day before paring those losses to end 0.4% lower – the sixth straight down day (seventh for the Dow).  Only the defensive Telecom and Utilities sectors finished higher, while reimbursement cuts weighed on Health Care.  Agriculture commodities were broadly higher, while most crude and metals sold off on growth concerns.

Around our financial planning services firm this morning, we were discussing four items that we thought would be of particular interest to our readers:

The Markets Broken Down:

1. Here is our current perspective on corporate layoffs and jobs. We will get the July reading on layoff announcements tomorrow morning.  The past 12 months have seen the fewest layoff announcements in any 12-month period since 1998, when the unemployment rate was around 4.5%.  The layoffs are not the problem, the lack of hiring is.  Employment does lag the overall economy, and lags the financial markets as well.  For example, in the current cycle, the equity markets bottomed out in March of 2009, the economy troughed in June 2009, but the labor market didn’t bottom out until early 2010.

2. Personal income and spending falls short of expectations in June. The June personal income, spending and inflation data were already incorporated into the second quarter GDP report that was released last Friday, and is not likely to move markets much.  The report revealed that personal incomes were up 5% in June 2011 versus June 2010, a solid reading, but well below what is typical for this point in the cycle.  The savings rate increased as personal spending was up only 4.4% from a year ago.  Consumers continue to spend a little, save a little and pay down debt.  The inflation data in the report, the core PCE deflator, which is the Fed’s preferred measure of inflation, revealed that at 1.3% year-over-year, core inflation remains below the lower end of the Fed’s unofficial 1.5 to 2.5% target range for core inflation.

3. In our view, deleveraging risk is overstated in the event of a Treasury downgrade. Despite a new debt limit, Treasuries remain at risk of a downgrade to AA.  Fears of a new wave of de-leveraging similar to 2008 are misplaced, we believe.  In terms of leverage, the market has already witnessed roughly $1.5 trillion in write-downs.  In addition, the asset-backed commercial paper market, a key source of funding for leveraged investors in 2008, is only one-fourth of its former size, transaction volume in the repurchase agreement (repo) market is down by one-third versus 2008, and banks have record amounts of cash on hand to protect against asset price declines, unlike 2008.  In terms of the potential for forced selling, our view of investment mandates reveal a great deal of flexibility with money market funds, bond funds, and institutional investors allowed to hold “government securities” regardless of rating and therefore suggests no need for forced liquidations that would fuel a wave of deleveraging.

4. Corporate bonds remain resilient. Despite renewed economic fears, corporate bonds reflect a different view of the economy.  Investment-grade corporate valuations are higher now than during mid-July when debt limit discussions first broke down.  High-yield bond valuations are roughly even with mid-July levels and an average 5.9% yield advantage to Treasuries.

As always, email me here with your questions or comments.  I love to hear from you and thoroughly enjoy the “intellectual debate” with our clients and friends that these opinions generate.


Greg Powell, CIMA
Wealth Consultant

Note: The opinions voiced in this material are for general information and are not intended to be specific advice. Any indices such as the S & P 500 can’t be invested into directly. Past performance is no assurance of a future result.

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