Playing Chicken on Both Sides of the Pond

Good Evening: U.S. stocks finished mixed today after digesting a series of news stories that could hardly be described as bullish. The economic data released today (CPI, jobless claims, current account deficit, leading indicators, and the Philly Fed survey) were uneventful, but the news flow from Europe and Washington, D.C. was anything but. The non-bailout bailout for Greece is threatening to unravel, while lawmakers in the U.S. House of Representatives are hoping to pass some form of healthcare reform without really voting on it. For his part, Mr. Market seems unruffled by the games of chicken being played by politicians on both sides of the Atlantic. Both the Dow Industrials and Dow Transports hit new, post-crash highs today, thus confirming a “Dow Theory buy signal” for adherents to one of the oldest theories of technical analysis. The real question is whether investors are unwittingly playing chicken themselves with stock and bond prices at current levels.

Stocks traded in a narrow range on light volume all day on Thursday, even with the stories described above hitting the tape at odd intervals. Action in shares of FedEx reflected some of this disconnect after the company reported an earnings beat this morning. FDX swooned some 3% in early trading, only to recover and post a 3% gain by day’s end. The few remaining proponents of the “Efficient Market Theory” were unavailable for comment.

The major averages were somewhat higher mid day when a rumor floated around trading desks that the Fed would again boost the discount rate today. The resulting sell off didn’t last for long and the averages finished mixed. Led by FDX, the Dow Transports (+1%) fared best, while the Russell 2000 (-0.35%) lagged behind. Treasurys were modestly lower, with yields rising between 2 and 4 bps. The dollar eyed the commotion in Europe and rose 0.8%, a rally which tarnished silver a bit but oddly didn’t hurt gold. The yellow metal has been going its own way of late, a fact evident in not only today’s concurrent advance with the greenback but also in Thursday’s 0.25% drop in the CRB index. Perhaps gold is rightly starting to be viewed as a currency in its own right.

“The hard part about playing chicken is knowing when to flinch”. This piece of advice has been available on playgrounds for decades, but it was made memorable by Scott Glenn’s character, Commander Bart Mancuso, in the 1990 movie, “The Hunt for Red October”. As often happens in Hollywood, Commander Mancuso times his move perfectly, a feat some EU leaders have been hoping to pull off with Greece. Standing fully — if only vocally — behind their financially stricken member state, EU leaders no doubt intended to show global investors a resolve similar to that once displayed by 300 Spartans at Thermopylae. These assorted ministers were hoping bond investors would thus be impressed enough to finance Greece back to health without the need for official intervention.

As PIMCO’s Mohamed El-Erian states in the story you’ll see below, however, EU leaders will likely have to flinch and put real money behind their promises. What’s unfortunate about the way things are now turning out is that any aid package might now include the IMF. Having a member state go hat-in-hand to is not only embarrassing for official Europe, it picks the pockets of nations outside the EU and hurts the euro in the process. What the IMF calls its “resources” are comprised mostly of quota contributions from developed nations, with the size of the ding escalating with the size of a nation’s GDP. If you’re starting to wonder whether the U.S.A.’s rank in the IMF pecking order means that, in effect, U.S. taxpayers may help fund any bailout of Greece, please stop wondering. Leave it to the EU to play a game of chicken where both the participants AND the bystanders get hurt.

If U.S. taxpayers get nicked by an IMF bailout for Greece, we may soon be receiving a flesh wound courtesy of our Congress. I don’t wish to debate the pros and cons of any proposed legislation — at least until we find out what it looks like and whether it somehow passes via a parliamentary trick that the House has used before when playing games of chicken with minority opposition in the Senate. And, just in case you’re wondering whether you’re about to be hurt by a healthcare system that is supposed to be a source of healing, please gaze upon the last headline below. Only in America could spending almost a trillion dollars be considered deficit reduction.

Whether either of the political games of chicken described above come home to roost in the capital markets is a matter about which investors seem unconcerned. The major stock indexes are grinding higher; the latest Dow Theory signal is as green as St. Patrick’s day; and the U.S. government can finance itself out to 30 years at rates less than passbook savings accounts earned prior to financial deregulation. Risk premiums in both markets have shriveled as risk appetites have grown. It might be an open question whether investors are playing chicken with forward rates of return or not, but it seems like complacency is becoming more widespread.

The VIX is now at its lowest level since Warren Buffett himself declared the subprime mess largely over during the spring of 2008. What was missing then, as now, was a margin of safety built in to prices for what Met Life likes to call “the IF in life”. And it is indeed possible that investors need not worry about either Greece hitting the wall or healthcare reform hitting their pocketbooks. Similar cries of “wolf” have been issued before about these subjects and nothing has yet happened. I would emphasize the “yet”, especially since volatilities (i.e. the price of purchasing market insurance) are low and securities prices don’t seem to discount what may go wrong in the very near future. I hope I’m wrong, but investors might be playing chicken with Mr. Market and don’t even know it.

— Jack McHugh

El-Erian Says IMF to Aid Greece After ‘Chicken’ Game
Papandreou Seeks EU Aid Deadline, Challenging Merkel
Pelosi Tactic for Health-Care Vote Would Raise Legal Questions
Health-Care Bill to Cost $940 Billion, Reduce Deficit

Print Friendly, PDF & Email

What's been said:

Discussions found on the web:

Read this next.

Posted Under

Uncategorized