For the third time in the past two years, the world is obsessed with the idea that a breakup of the Euro is going to bring down the global economy. The chart above uses the ratio of the Vix index (which rises as fear increases) to the 10-yr Treasury yield (which falls as the world despairs over the prospects of economic growth) to gauge the amount of destruction that the market is worried about. It was worse in the prior two episodes, but it's pretty bad right now, as market chatter essentially assumes the imminent exit of Greece from the Eurozone, followed by a significant devaluation of the Greek currency, and the subsequent impoverishment of all Greek citizens.
But to judge from this chart of U.S. retail sales, the revolving Eurozone crises have had no discernible impact on the U.S. economy. By just about any measure (ex-autos, ex-building materials, and/or ex-gas stations) U.S. retail sales are rising at a healthy 6% annual pace, with no signs of any slowdown. Moreover, sales have significantly exceeded their pre-recession highs, even though there are 5 million fewer people working today than at the end of 2007. Indeed, the Eurozone crisis probably has helped boost the U.S. economy, since capital has fled Europe for the relative safety of the U.S. banking system. Things could be a lot better here, but they are improving, albeit slowly.
In other news today, the May home builders' market index rose to a new post-recession high, providing yet more evidence that we have seen the bottom in the housing market. Furthermore, as Mark Perry notes, "there are now at least 25 metro markets that have reported double-digit gains in either the number of homes sold, or median home prices, or in some cases, both."
So what's not to like? Well, of course there are still many problems lurking in the wings, and the list is long, beginning with the "fiscal cliff" of sharply higher tax rates that is approaching come January 1st, followed by the risk that a re-elected Obama might be able to boost tax rates even more, and the possibility that Europe might return to the financial dark ages as governments refuse to tighten their belts and the Eurozone banking system implodes. But meanwhile, life goes on for the vast majority of the globe's population, markets are slowly but surely enforcing some badly-needed discipline on politicians of every stripe, and the internet—via outlets such as this blog—is providing more information and perspective on what's going on than has ever been available before.
Markets work best when they have plenty of information; big problems happen only when something unexpected comes out of the blue. We've known about the Eurozone debt and banking problem for over two years, and we've known about the U.S. fiscal problem for over three years. The U.S. housing market has been under tremendous pressure for over 5 years; there can't be a single sentient, potential homebuyer in the U.S. that isn't aware of the problem of an overhang of foreclosed properties. It's my belief that most or all of the problems have been priced in by now: 10-yr Treasury yields are as low as they've ever been, reflecting a market that holds little or no hope for the future; despite record-setting corporate profits, the PE ratio of the S&P 500 is only marginally higher today than it was at the end of 2008, when the global financial system threatened to collapse; and although swap spreads are off their highs, they are still quite elevated in Europe.
The sum of the fears that still plague the market can also be found in the intense demand for safe-haven liquidity. Fortunately, both the Fed and the ECB have taken extraordinary measures to accommodate this demand for liquidity by expanding their balance sheets to a truly unprecedented degree. I'm not saying that the fears are overblown. I'm simply pointing out that markets have had plenty of time and help in evaluating and accommodating these fears, and that therefore the consequences are not likely to be as bad as the market seems to be expecting.
This has been my thesis ever since the end of 2008, and it continues to be: markets are priced to horrible expectations, but the reality is likely to be less awful than expected.
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