In days not so long ago, companies only stayed in business if they could generate profits and pay their debts. GM, with a $61B bailout, terminated jobs of 65,000 human beings, wiped out bond holders by government fiat and received taxpayer backing for its severely underfunded pension plan is now lauded for paying back 13% of taxpayer money with taxpayer money borrowed from TARP! Unbelievable! What is the plan to restore the rest of the money to its “rightful owners?”

 

The financial picture is worse at FNMA and Freddie Mac. President Obama wants to fix the financial market with new regulations, excluding Fannie and Freddy. The proposed regulation gives the Administration powers to apply the GM Solution to any other company without Congressional oversight.  

 

Other companies are doing much better. More than 72% of companies reporting earnings this quarter have exceeded estimates. It is an even higher 78% of the S&P 500 reporting companies. Certainly, the earnings trend remains positive. Consumer Discretionary and Industrials have been among the strongest upward revisions. American Express reported stronger than expected earnings with rebounding use of its card.

 

Last quarter, markets were disrupted by the news from Greece. The risk of a Greek default has continued to rise. The US market, instead of falling, has become a magnet for money, hence a stronger dollar in a strengthening economy.

 

The European Union is potentially faced with a systematic dismantling as ejection of Greece becomes the only financially reasonable solution to Greece’s massive bureaucracy, sovereign debt and underfunded state pensions. Even before this occurs, there will be no buyers of Greek bonds. Then, without funds and facing reality, the government will implement long overdue austerity measures. If ejected, Greece will truly be a minnow in the financial ocean with little ability to raise money at all.

 

This problem will rotate to other EU members. Who’s Next? Portugal? Italy? Ireland? Spain? 

 

Domestically, California, Illinois, Michigan, New Jersey (skipping a $3B pension contribution) and others represent similarly dire circumstances for the United States. We just can’t kick them out of the Union to face the consequences of their profligacy on their own. Nuts! We – that’s you and I – are going to have either our taxes or the federal government’s debt raised – or both. Either way, this is a negative for long-term economic growth. The real solution, lower spending, is politically unattractive to elected officials and to the massive population getting support from government sources.

 

Those taxes are yet to come. We are currently facing 19 new taxes this year due to the new Healthcare Reform legislation.

 

Meanwhile, US stocks continue to price in economic recovery. Bond rates have not done so. Treasury yields have remained abnormally low for a year. The government has been buying a massive amount of bonds and has distorted the normal relationship between “risk free” and “risky” assets. It is unlikely that rates will remain low much longer. As rates turn up, the massive inflows to bond funds should slow as losses mount where investors sought “safety.”

 

We are waiting for higher yields which will slow economic growth as consumer spending turns south from unstoppable demographic trends. Higher long-term yields will provide both attractive cash flow as well as capital gains when rates are lowered again in an effort to “re-stimulate” the economy.