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Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Sep 7, 2012 10:12:29 AM

and tagged Politics and the Economy, Yesterday's News

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Two big stories today. The Democratic National Convention (DNC) made the front page of the New York Times (NYT) and the Wall Street Journal (WSJ), but not the Financial Times (FT), and the European Central Bank’s (ECB’s) bond-buying plan made all three.

The DNC coverage is fairly vanilla, with “Obama Presses Plan for US Resurgence” in the WSJ and “Obama Makes Case for Second Term” in the NYT. More interesting is the accompanying analysis. “Campaign Confident It Has Roads to Re-election,” on the front page of the WSJ, discusses the race from an Electoral College perspective, pointing out that there is a structural advantage for the Democrats and breaking down the swing states—pretty good article. The WSJ has another note-worthy analysis piece, “Jobs Gauge Carries Election Clout” (p. A2), that talks about the importance of today’s employment figures to the election; we will discuss jobs a bit later in this post. The FT did touch on the U.S. election indirectly with a front-page article, “Draghi helps out Obama campaign,” pointing out that a European financial collapse would definitely have a negative drag on his chances for reelection.

The other big story is the ECB bond-buying plan announced yesterday. (I told you we would be discussing it today.) It made the front page, above the fold in all three papers. It was the lead headline in the FT with “ECB signals resolve to save euro,” top left in the NYT with “Huge Step Taken by Europe’s Bank to Abate Crisis,” and top right in the WSJ with “Stocks Jump on Europe Action.” The plan essentially commits the ECB to unlimited market intervention to keep government bond yields down, provided—and here is the catch—that the governments in question are in European rescue programs that require substantial changes to ensure fiscal stability. In other words, if a country essentially surrenders its financial sovereignty, the ECB will back it up.

The plan itself is reasonable. It has side effects, of course, potentially serious ones. On its own terms, however, it appears to be able to settle the problem it is aimed at. In many respects it is not unlike the Federal Reserve’s quantitative easing programs here in the U.S. I am not surprised at the positive reaction of the bond markets.

I am surprised, though, at the extent of the effect on the equity markets, which melted up on the news. That alone was a story of note, with “Stocks Jump on Europe Action” on the front page of the WSJ, “Buoyed by European Commitment to Buy Debt, Markets Soar to Four-Year High” (NYT,p. B1), and “ECB bond buying plan drives risk appetite” (FT, p.22). The perception is that the problem is solved, which is simply not true. Headlines like “ECB Gives Markets Conditional Love” (WSJ, p. C10) highlight the conditions and requirements of the program. “Europe’s Pillar, Germany, Is Seen at Risk of Recession” (NYT, p. B6), “Rajoy stance sets stage for stand-off with EU” (FT, p. 3), and “Merkel seeks to hold line amid deep divisions” (also FT, p. 3) all say loud and clear that, as solid as the plan is economically, politically there are still cracks that can’t be papered over. The FT reinforces that perspective in “Weidmann isolated as ECB plan approved” (p. 2), making the point that the German financial establishment is definitely not on board for the first time in the history of the euro. At the end of the day, the ECB plan deals with symptoms, not the underlying disease. The cure is going to be unpleasant, with fiscal constraints driving the whole eurozone into a deeper recession, and no amount of bond-buying will eliminate that.

I am not the only skeptic. There is a good article in the WSJ, “Stocks Cheer Stimulus—For Now” (p. C1), that outlines previous U.S. quantitative easing plans and shows how the effects were short-lived. The article and accompanying charts did a great job of telling the real story; unfortunately, I can’t link to them here, but it’s worth picking up the paper (or searching online) to take a look. Although I enjoy a market rally as much as anyone, the equity market reaction seems overdone.

All the more so, when we see the very weak U.S. employment figures released today. The employment gain of 96,000 was well below the expected 130,000, and previous figures were revised downward. The unemployment rate fell, but that was because of a large drop-off in the labor force. Hard to put any nice spin on this news, which is in direct contrast to the positive market action yesterday. More reason for caution. We will discuss this more tomorrow, but as noted in the article above, it is not good news for President Obama’s reelection campaign.

One more story I just have to mention, from page A8 of the NYT. “Singaporean Tells China US Is Not in Decline” talks about how the prime minister of Singapore, the son of Lee Kuan Yew, Singapore’s legendary leader, “warned China . . . that it should view the United States not as a declining power, but as a nation with the ability innovate and bounce back.” I could not agree more, and it is really nice to hear that from an independent, respected source with no U.S. bias. Times are tough, but this is still one of the best countries in the world.

There are some other follow-ups on issues we have discussed before, but this is already running long. I am off to Maine again this afternoon, so I hope everyone is set for a great weekend. I know summer is over, but I intend to remain in summer mode as long as I possibly can.

Have a great weekend!

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