This morning there’s news that Italy’s Prime Minister Mario Monti could be out and former Prime Minister Silvio Berlusconi back in, clouding the future of the eurozone’s third largest economy. With politics at play in many troubled eurozone countries, and as I have been harping on in these pages; the eurozone sovereign debt crisis is far from over and it will be a very long time before we see any economic growth in the region—continued recessions are more likely.
In the U.S., after the financial crisis hit, the idea was to expand the money supply aggressively and force lending so citizens could consume more goods and services, causing a return to economic growth. Similar steps were followed in the eurozone, but to a much lesser degree, as Germany opposes outright money printing.
While not at the pace of the Federal Reserve multi-quantitative easing programs, the European Central Bank (ECB) did manage to pump cash into the financial system and lower interest rates. Since October of 2008, ECB’s official interest rate in the eurozone has fallen from 3.75% to the current 0.75%. (Source: European Central Bank, Accessed December 6, 2012.) And when the sovereign debt crisis was at its peak, banks in the eurozone region borrowed 1.3 trillion euros from the ECB. (Source: Wall Street Journal, December 4, 2012.)
The ECB wants lending to increase in the region. It wants banks, big or small, to loosen their purse strings and loan money out to business and consumers. Unfortunately, this hasn’t happened. According to the ECB, loans to the private sector in the eurozone fell 0.7% in October, continuing their decline from September when lending fell 0.9%. (Source: New York Times, November 28, 2012.)
With all the chaos still present in eurozone, and lending still bleak, some banks that borrowed money from the ECB have said they want to pay it back. If banks start to repay what they borrowed from the ECB, they will be decreasing their funds, which is obviously bad for lending.
The eurozone model is different from what we have in America when it comes to companies raising capital. Corporations in the U.S. economy get 70% of their capital needs from the markets; by selling bonds, for example. On the other hand, eurozone companies get only 20% of their financing from the markets and the rest from the banks.
The ECB seems to have failed in promoting lending in the eurozone. Now, with banks giving back what they borrowed from the ECB, it shouldn’t be surprising to see lending decline; more reason for me to believe recessions will continue for many countries in the eurozone, such as Italy.
What does this mean for the U.S. stock markets? Key stock indices in the U.S. have been greatly affected by the eurozone crisis, as 40% of the S&P 500 companies derive sales from the eurozone. Therefore, as the crisis deepens in the eurozone, it will be reflected in the earnings of corporate America—earnings that are already under pressure.
Where the Market Stands; Where it’s Headed:
Of all the issues we are facing for the economy—i.e. the “fiscal cliff,” decline in real disposable income, decline in the savings rate, eurozone crisis, slowing Chinese economy, record U.S. government debt, and record expansion of the money supply—the most worrisome for me is the contraction in corporate earnings growth.
For the first time in 11 consecutive quarters, corporate earnings growth turned negative in the third quarter of 2012. (See: First Time in 11 Quarters: Earning Growth Turns Negative.) The stock market rises when the companies that trade in the market show their earnings are rising, not declining.
We are nearing the end of a three-year old bear market rally in stocks.
What He Said:
“Home-building in the U.S. will enter a quasi depression state in 2008 and the construction industry will make 2008 a record year for pink slips. I predict a major homebuilder will go bankrupt in 2008.” Michael Lombardi in Profit Confidential, January 10, 2008. WCI Communities, the largest U.S. luxury homebuilder, filed for Chapter 11 protection on August 4, 2008.