More Like It

More like it.  Stocks rose modestly yesterday on promising news from the vaccine race.  Technology shares rose on no real news as traders returned to old habits.

N O T E W O R T H Y

United states of Europe.  Here is a nice diversion: the European Union experiment remains alive.  Ok, Ok, let’s unpack that highly divisive string of words.  The European Union currently consists of 27 member states.  Its population consists of around 450 million citizens which speak 24 different languages.  The union’s GDP for 2020 is expected to be around $20.4 trillion compared to the US’s $21.4 trillion and China’s $14.4 trillion, making the case for strength in numbers (Germany is the largest contributor to EU GDP at $3.86 trillion).  The case for a European Union has been bandied about for a long time (think Roman Empire) but it started to take form in the years after World War II.  As noted above by the many languages spoken within the Union implies that there are also many different views of nationalism in the territory.  Further, the geographic and economic diversity from one end of the Union to the other (think Germany vs. Greece) makes partnering particularly challenging.  The challenges however were overcome when in 1993, the founding members signed the Maastricht Treaty creating common European citizenship.  The following year witnessed the creation of a monetary union which ultimately included 19 of the states and took form in 2002.  That was the year the Euro (€) was born.  Sounds like the beginning of a great movie doesn’t it? As you probably know by now the Union has suffered its ups and downs since formation, the latest down being the still-occurring BREXIT.  Nationalism is a factor certainly, but the real challenges have had more to do with economics.  How shocking.  As mentioned earlier, Germany is an economic powerhouse which derives its GDP from its well-known industrial, agriculture, and services (banking) sectors.  In contrast, Monaco, also a member of the EU, sports only a $5.6 billion GDP, derived primarily from services, which in their case is tourism.  When economies are expanding, as one might guess, everything runs smoothly.  Who wants to get ID’ed when traveling to see the Monaco Formula-1 GP when traveling from Austria.  Further, it is really convenient not to have to exchange currencies when you want to hit Monaco’s world-renowned casinos after the race.  When economies struggle, the weaknesses in the Union get exposed.

At a high level, the EU utilizes a common central bank (The ECB) which is responsible for monetary policy, while fiscal policy is left up to the individual member states.  So the ECB operates similar to the US Federal Reserve, lowering and raising interest rates in addition to their own version of quantitative easing.  Member states control their own budgets, spending more to stimulate and pulling back to shore things up.  Member states are also responsible for their own borrowing through the issuance of sovereign debt.  Some countries have very strict policies for borrowing, limiting debt to a small percentage of GDP (Germany), while other countries have less-strict policies (Italy).  Similarly, these policies are rarely challenged during times of expansion and prosperity.  The Global Financial Crisis that ended in 2009 left several EU members in a difficult situation.  Namely, Greece, Portugal, Italy, Ireland, Spain, and Cyprus (originally referred to as the PIIGS).  Those countries found themselves unable to pay their debts in the wake of the crisis which posed the first major threat to the strength of the Union.  Member states which were in better financial situations found themselves threatened by the weaker member states.  The challenge however was met when the ECB along with the International Monetary Fund which helped to bail out failing states.  The bailouts however came with spending restrictions on receiving countries, causing political challenges in receiving countries.  So, stronger economies (referred to a donor economies) reluctantly agreed to help the weaker economies (referred to as recipient states).  It was tough going but they made it through.  The next big challenge came with the global trade war which threatened the entire European Union.  The Union’s first response was with monetary policy in which the ECB lowered key interest rates into negative territory.  As I’ve written so often, monetary policy alone is not enough to right a faltering economy.  Carefully-enacted fiscal policy is also critical to ensure success.  Unfortunately, fiscal policy is dictated by politicians and subject to well… politics, for lack of a better word.  In the case of the EU which was in dire need of a fiscal stimulus in the past few years was unable to come up with any unified policy.  As mentioned before, countries like Germany were unwilling to break above their debt-to-GDP limits, while other struggling countries were willing to do whatever was necessary.  Intense negotiations were ongoing, ongoing, and ongoing to no avail until the pandemic hit. Pandemics tend to have that affect.  To make a really long story a little less long (sorry, I tried to make this short): after many, many hours of negotiation, EU member states finally agreed last night to a unified fiscal stimulus package which would include not just lending, but also, actually granting weaker states desperately needed funds.  The holdouts, referred to as the Frugal Four (Austria, Netherlands, Denmark, and Sweden) finally agreed to some grants to avoid adding more debt to already debt-ridden recipient states.  A $2 trillion dollar unified fiscal deal was the result.  Why did I write such a long piece on this?  Because it represents a very positive move forward in the evolution of what is technically, the second largest economy in the world.  What is often referred to as an experiment has just evolved.

THE MARKETS

Stocks edged up slightly yesterday after a softer opening.  Good news from the race-to-vaccine was offset by rising cases in many states.  The S&P500 rose by +0.84% (now in the green for the year), the Dow Jones Industrial Average climbed by +0.03%, the Russell 2000 Index slipped by -0.36, and the Nasdaq Composite Index jumped by +2.51%.  Thank you, tech, once again for pushing the large caps up.  Bonds rose slightly and 10-year treasury yields fell by -1 basis point to 0.61%.

NXT UP

- Chicago Fed National Activity Index (June) is expected to have climbed to 4.00 from 2.61.

- This morning, Philip Morris, Coca-Cola, Lockheed Martin, and Prologis beat estimates, while Synchrony missed.  After the bell, we will hear from Interactive Brokers, Capital One, Snap, United Airlines, and Texas Instruments.

- The Senate Banking Committee will hear from President Trump’s Fed nominees.

daily chartbook 2020-07-21