Cravens Brothers Market Flash - August 8, 2011

8/4/2019 Cravens Brothers Market Flash - August 8, 2011

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Jason B. Leach, CFA August 8, 2011

214-234-9464

[email protected]

Market Flash:

Everybody Stay Calm!

Ten years ago, I was on an airplane that had to make an emergency landing in Midland, TX due to an engine fire. I

found myself surprisingly calm during the descent, reassuring myself that the jet could easily fly on the one

remaining engine, and that we had capable people in the cockpit. As we touched down and slowed to a stop,

everything seemed normal. Passengers were chatting, flight attendants were reassuring people that we would be de-

planning shortly and, of course, tray tables were up. Then, the captain of ourinjured bird got on the intercom and

yelled, Everybody stay calm!!! Suddenly, we were no longer calm. I grabbed my briefcase from under the seat in

front of me (the one you are not supposed to grab), and several seconds later the pilot frantically yelled over theintercom, Evacuate!!! I was in the last seat on the plane, which made me the first person at the rear door to watch

the locks pop off and the yellow slide inflate. It was a surreal slide down, and a surreal experience overall.

As I sat in the terminal waiting for our replacement plane, I thought to myself: What type of leadership was that in a

time of crisis? How much experience does this pilot have? How can I trust that he will ultimately get me to my

destination? In short: Where are the adults? I later found out that, instead of keeping us better informed during the

flight, the pilot was allegedly on his cell phone talking to his wife in case he didnt make it. Unfortunately, that

pilots leadership qualities remind me of elected officials and central bankers of today in Washington and the 17-

member Euro Zone. Despite their bestowed trust, they has shown incredible self-interest/self-preservation instead of

leadership and direction for the betterment of their passengers.

The Euro Zone (Just One LookThats All it Took): The monumental failure of leadership on the east side ofthe Atlantic to address the European debt pandemic reached a tipping point on July 21 st. This date marked the last

minute approval of a second Greek bailout after weeks of contentious negotiations between German Chancellor

Angela Merkel, French President Nicolas Sarkozy, and European Central Bank President (ECB) Jean-Claude

Trichet. The deal reached was dubbed elegant, but market participants took one look and immediately recognized

that, amongst other things, the: (i) new enhanced bail-out fund for Greece and other distressed countries was still not

large enough, (ii) new bail-out fund would not be in place until late September, if at all (all 17 member countries

will have to unanimously approve it in separate votes in their home countries), and (iii) ECB was not given lender

of last resort authority until the bail-out fund is in place (targeted for late September). In the days following the

agreement, Italian and Spanish bond yields (their cost of borrowing) soared. Italy and Spain are too big to bail

and too big to fail under the current structure. Even with the ECB given tacit lender of last resort authority

Sunday evening, the 18-month Greek debt saga has finally spread to Italy and Spain, due to failed leadership. TheU.S. and European equity markets began their descent on July 25th (see: Figure 1). Europe has no leadership in its

most harrowing time since World War II.

The United States (Never Say Yes, No, No, Never Say Yes): After a temporary budget deal to fund the U.S.

government was reached in early April, there was little doubt in most market watchers minds that ultimate

brinkmanship would follow. Once Treasury set August 2nd as the date at which the nation would run out of cash,

both sides entered Never Say Yes mode. With every twist and turn of the negotiations over the summer it

became increasingly evident that it would go down to the wire, and it did. The inadequate debt ceiling compromise


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reached on August 1st was met with immediate disdain by the markets (just like in Europe) due to its numerous

failings including: (i) only calling for $2.1 trillion to $2.4 trillion in spending cuts over 10 years (far below the $4

trillion bogey Standard & Poors called for), (ii) the $917 billion in initial domestic and defense spending cuts are

back-ended, with very little in the next two years before election, and ostensibly can be changed by future

administrations, and (iii) the additional $1.2 trillion to $1.5 trillion worth of cuts to be determined by the end of this

year (and imposed over 10 years) will involve a convoluted process whereby a special bipartisan committee will

come up with proposals by Thanksgiving, followed by a guaranteed up-or-down vote by Congress (without

amendment) by December 23rd. If Congress fails to approve cuts on December 23 rd, across-the-board spending cuts

will be triggered to make up any difference between the committee number and the $1.2 trillion savings goal. This

last piece, I suspect, was the straw that broke the markets back as it effectively extended the polit ical fight for five

more months. After a middling day of trading on Monday, August 1st, the S&P 500 fell 7.2% for the week its

worst week in two years. Adding insult to injury, Standard & Poors downgraded U.S. sovereign debt Friday

afternoon to AA+ from AAA, the first time the U.S. has lost its AAA credit rating in 70 years of coverage. The

surreal, disappointing, embarrassing brinkmanship by American politicians that produced a flawed compromise and

a debt downgrade is astonishing. The U.S. has no leadership in the most harrowing economic times since the Great

Depression.

What Comes Next (Uncertainty and Volatility)

The S&P volatility index (VIX), often referred to the fear index, ended Monday, August 8th at 48.00, up

100% from 23.38 the previous Monday, and the highest level since since March 9 th, 2009, the infamous

financial crisis low day for the S&P 500, when it closed at 676.53.

The full ramifications of the S&P downgrade will play out over time, but a range of government-related

entities including Fannie Mae and Freddie Mac were downgraded Monday, and hundreds of municipal

bond downgrades (an estimated $150 billion, or 3% of the total market) are probably at risk of downgrade,

according to Municpal Market Advisors. The biggest risk is not to the municipal bondholders, but rather

that the downgrades create a panic and raise municipal borrowing costs. The overall risk of the S&P

downgrade may portend a big hit to consumer and business confidence which may result in a hit to GDP

growth, already subject to downward revision.

The 10-year Treasury yield has been falling for weeks (reaching its lowest point since December 2008 on

Monday) at 2.33%. Part of this decline is a flight to safety, but webelieve the bond market (the smarterof the two markets) is indicating an increased likelihood of another recession, possibly beginning as early

as 1Q12. Annualized real GDP growth for 2Q11 was revised down to 1.3% recently, with 1Q11 revised

down from 1.9% to an astonishing 0.4%. This low level of first half growth leaves us precarioulsy

vulnerable to shocks, such as those seen recently, that could turn the economy back over into recession.

QE 2 is over, most fiscal stimulus to states ended this summer, and payroll tax cuts and unusal long-term

unemployment benefits end in December. The end of Fed-induced stock market pumping, along with

fiscal drag from the final end of major fiscal stimulus, together provide a strong dose of uncertainty as

the economy and markets move to a more organic mode. (Note: The Federal Reserve meets and speaks

with the media today. What I call The Fourth Branch of Government could pull something out of its hat ,

but that hat is growing increasingly tattered.)

After falling for nearly a year after the end of homebuyer tax credit, house prices have stabilized recently

with large investor purchase volumes, but inventories are still very high and there are reams of foreclosures

yet to hit the system. Consumer spending (as reflected in retail sales) is falling and real wages are stagnant.

Unemployment remains extraordinarily high at 9.1%, with average monthly additions to the workforce

below 100,000 when they should be 300,000 to 400,000 at this stage of recovery/expansion. In short:

housing, the consumer, and unemployment are either worse or no better than a year ago.

European leaders are going to have to come up with big solutions quickly to assuage investor concerns. In

addition to the sovereign debt contagion, a second financial crisis is not out of the question if the ECB, in


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coordination with global central bankers, are not able to prevent highly-leveraged, undercapitalized

European banks holding large amounts of Italian and Spanish sovereign debt from collapsing.

Lastly, and most importantly, we now live in a financial world with a non-AAA rated economy at its core.

This has never happened before and we dont know what the changes to our the world financial system wil

be as a result. If that werent enough, further downgrades by Standard & Poors, Moodys, and Fitch are

distinct risks and pose a multitude of uncertainties. Confidence is as fragile as it has been in nearly three

years.

What We Recommend (Stay Tactical, Short-Term, Precious, Safe, and Alternative):

Tactical equity allocation ("buy and sell" not "buy and hold") achieved through active management and

true long/short funds,

Short maturity (less than two years) corporate debt of cash-rich U.S. large capitalization companies,

Precious metals via funds that mandate holding the commodity in physical versus certificate form

(note: we would be aggressive accumulators of gold on big pullbacks),

Other select alternative (i.e., non-public) investments to avoid the frequent dislocations and vagaries of

public markets,

Cash (margin of safety)

Conclusion: We Need LeadershipNot Calming Words

In the wake of this debt crisis sell-off, our political leaders need to come up with long-term structural ideas not only

for budget cuts and tax reform, but for jobs, housing, education, infrastructure, real Wall Street reform, and long

overdue comprehensive energy policy. Our nation is at the point of maximum pain and the time has come for big,

structural solutions, not temporary fixes. Washington must be wrested from the rule of the banking oligarchs and all

manner of lobbyists during this process or we will be digging out of the holes we have put ourselves in for much

longer than we would like. Just as I was on the plane descending into Midland, I am still calm. But, I do fear the

calming words and inaction of our leaders may make investors less so, and their their complacency may continue

to damage our economies and markets. We will get through this is not good enough. Strong action is needed to

change our course.


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Figure 1: Summer Swoons, QE2 Run, Debt Doldrums, and our old Magic Number)

Source: Freestockcharts.com. CommentsCravens Brothers Wealth Advisors.

Cravens Brothers Wealth Advisors is an office of and Securities offered through WFGInvestments, Inc. (WFG), member FINRA & SIPC. Jason B. Leach is a RegisteredRepresentative of WFG. The above commentary is the opinion of Jason Leach and notnecessarily those of Williams Financial Group or its affiliate, WFG Investments Inc. PASTPERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. This market commentary isprovided for informational and educational purposes only. It is not intended as and should notbe used to provide investment advice and does not address or account for individual investor

circumstances. Investment decisions should always be made based on the client's specificfinancial needs and objectives, goals, time horizon and risk tolerance. All opinions and viewsconstitute our judgments as of the date of writing and are subject to change at any time withoutnotice. Information was obtained from third party sources, which we believe to be reliable butnot guaranteed. An index is an unmanaged weighted basket of securities generallyrepresentative of a certain market or asset class. An investment cannot be made directly in anindex.

We have had

wo Summer

Swoons

ollowing the

nd of QE 1 andQE 2.

The 10-

monthQE 2

Run was

ignificant at

+28.1% but

nearly all of it

has been erased

n a little over a

week

Debt

Doldrums have

vertaken us the

ast several

weeks

Our old

Magic

Number from

wo years ago is

ack but now as

ritical support.

A break below

his level would

e significant.

Cravens Brothers Market Flash - August 8, 2011

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