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A Wall of Worry
New York: February 01, 2010
By John Stephenson

Even blockbuster earnings out of Apple and a slew of other Wall Street darlings wasn't enough to stem the tide, as investors have been hitting the sell button recently. So far, the earnings reports for the companies that have reported fourth quarter earnings have been very solid, yet the market has been weak rather than strong. Recently, the stock market has been trying to climb a wall of worry, as investors have been fretting about developments that could challenge future growth for corporate America .

Resource stocks have been taking it on the chin lately, over the move by China to tighten the country's monetary policy. Investors have reasoned that the move will slow growth and in the process, choke off demand for commodities. But China 's move is aimed at reining in an expansion of credit, rather than stunting growth. Economic growth in China is right on track at 10.7 percent and inflation is modest at 1.9 percent, hardly cause for alarm.

This is not the first attempt by China to contain surging credit. In 2007, the Chinese government also tightened credit yet the demand for commodities continued unabated. The big driver for Chinese commodity consumption is not the overall level of economic activity, but rather, the pace of industrial production. China 's factories managed to set a brisk pace, which exceeded a 15 percent annual growth rate up until the global financial crisis of 2008/2009 slammed industrial production globally into reverse.

Bank bashing has been popular in Washington lately, as President Obama has declared war on greedy bankers and their bonuses. Governments in the United States , France and Britain are cooking up schemes to limit banks' size, to tax bonuses and to curb their trading, so that taxpayers won't ever end up footing the bill when they fail.

Yet in spite of the rhetoric and the popular support that bank bashing has generated, officials will be forced to walk a fine line. Heavy-handed reforms, while popular with the general public, could choke off the very economic recovery that politicians need to ensure for them to stay in office. And while both sides of the American Congress are angry with bankers, the likelihood of getting any kind of aggressive legislation through Congress is pretty small. Talk is cheap and eventually investors will realize that there is an enormous gulf between sound bites and actual regulations with any teeth in them.

Lastly, investors have fretted over the crisis brewing in Greece . The country has become the poster boy for what ails Europe . Last October, a new government took office and revealed that Greece 's debt was more than three times larger than previously acknowledged. The country's Prime Minister, George Papandreou, has cobbled together a plan to shed assets and cap wages for civil servants in an attempt to try and reduce the deficit from 12.7 percent of GDP in 2009 to just 3 percent in 2012—a herculean task.

This debacle has revealed a major flaw in the European Union (EU)—monetary union but not political union. Under the EU's Stability and Growth Pact, member countries are required to limit budget deficits to just 3 percent of GDP. Greece is clearly way above the limit, however, the fact that the rule is not enforced illustrates a major problem with the monetary union. The union has forced countries to give up their national currencies and their independent monetary policy in favor of a common currency. The net result is that the EU is absent the teeth to kick non-compliant countries out of the union is no different than any other fixed exchange rate mechanism.

If Greece had kept its national currency, the drachma, instead of adopting the Euro, the country could have warmed up its printing presses and flooded the system with drachma. With more drachmas in circulation, the currency would decline in value and the country's debts would be inflated away. But with the adoption of the Euro, Greece no longer has that flexibility, making it unable to print money to pay down its debts. The painful choice Greece is confronted with is to default on its obligations or to implement a draconian austerity program that will surely prolong the recession.

The problems of Greece and to a lesser extent, Portugal , Ireland and Spain have highlighted a major flaw in the Euro zone. And the pain is not just limited to countries on the periphery of the European Union; Belgium 's debt to GDP is around 90 percent, in contravention of the Stability and Growth Pact's limitation of 60 percent. As well, both Belgium 's and Austria 's banks have significant exposures to the problem-plagued economies of Eastern Europe.

But in spite of the concerns over Greece , it is still a very small economy within the Euro zone. The country's economy is just one tenth the size of Germany 's and while its problems are massive, they needn't trigger a broader crisis. As well, Greece 's problems would seem to be pretty irrelevant from the perspective of Wall Street earnings and stock prices.

There is no doubt that the market is fretting over many uncertainties that have become apparent lately. But the recent sell off in the markets may have a silver lining for savvy investors. If economic growth from here continues to chug higher; this pause in the markets could be a great opportunity to jump on the equity bandwagon. For my money, this is a great opportunity that should not be missed as most economists are forecasting solid economic growth for at least the first half of 2010.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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