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Comstock Partners, Inc.
Rough Sledding Ahead For 2012
February 09, 2012

There's a reason the EU settlement with Greece is taking two years to work out-----the necessary fiscal, monetary and economic measures are just too painful for both sides to bear.  And the alternative is a disorderly default that would be even worse.  Today's outline of an agreement among the various Greek political parties to accept some harsh austerity measures has been presented to the EU, which is meeting in Brussels tonight.  EU officials have already indicated that there will be no final approval today, and we think the negotiations may still drag on until close to the March 20th deadline for repayment of 14.5 Euros of coming due.  Although a settlement by that time is more likely than not, the results will further weaken an already deteriorating European economy, and ensure slow growth for years to come.  With the global economic growth slowing down as well, the fragile U.S. recovery is also in jeopardy.

The Greek governing coalition had an exceedingly difficult time coming to an agreement as they were pulled in a tug of war from two different sides.  On the one hand they realized the necessity of getting the funds they needed to avoid default.  On the other hand they are facing elections within two months and have to ensure that their successors would not renege on the agreement that is certain to enrage the majority of the population that has already undergone major government spending cuts, layoffs, wage decreases and tax hikes.

For its part the EU wants assurances that Greece, which already failed to meet the conditions of its first bailout, will comply with this one.  One high official of the EU said "It's up to the Greek government by concrete actions through legislation and other actions to convince its European partners that the second proposal can be made to work."  Another stated that "We want to see real implementation of the measures needed by the Greek government and also full commitment of all leaders in Greece for further measures."

Even after a final agreement is reached the Greek government may have trouble implementing its provisions.  The nation has already made sharp cuts in government spending, jobs and wages while increasing taxes.  All of this has devastated the economy.  The November unemployment rate was 20.9% and December production dived 11.3% from a year earlier.  Another dose of austerity can make this even worse and actually increase deficits rather than reducing them.  So even with a debt agreement in place, we probably have not seen the end of the problem.

While European markets generally have calmed down lately, we've seen this movie before.  Portuguese bond yields have soared and the economy has weakened significantly.  ECB bond buying has helped to lower yields on Spanish and Italian bonds, and, as a result, both nations have been able to place new debt.  However, the calendar of upcoming financing remains quite heavy, and economic deterioration caused by austerity can cause rates to rise again.  Overall, much of Europe is either in a recession or about to enter one.  In this connection we note that the OECD leading indicator is below a year earlier, a condition that has always led to recession.

At the same time the global economy appears to be weakening.  Chinese electric production in January was down 7.5% year-to-year.  Japan has entered a recession and its trade balance has turned negative.  Deteriorating economies in Europe, China and Japan means lower purchases of commodities, the key to growth for most emerging nations.

The U.S. will not be immune to the downward pressures.  In the weakening global environment, exports will drop.  Consumers have increased spending by reducing their savings rate as wages continue to stagnate.  Since the 2007 economic peak most of the increase in consumer disposable income (DPI) has come from higher transfer payments, while wages, as a percentage of DPI, has dropped off a cliff.  And unlike the period of 2003 to 2007, consumers cannot make up for the shortfall it by converting rising house prices to ready cash.  Corporate earnings, too, are becoming less positive.  Only 59% of companies exceeded their 4th quarter estimates, the lowest since early 2008.  Last June year-to-year 1st quarter earnings for 2012 were estimated to be up 12.7%.   Now the estimate is for an increase of only 1.9%. 

All in all, both the U.S. and global economies are likely to encounter rough sledding in 2012, a factor not discounted at current stock market prices.     


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