The Gravity of the European Situation
Markets continue to gyrate in what seems like wider and wider arcs as volumes gradually decline but the density of news headlines does not. Today, at least one meaningful piece of news that pressured stocks early was that hedge fund (and market-maker) SAC Capital told its investors that it has received a Wells notice from the SEC (indicating that the SEC has determined it may bring legal action against the firm), alleging insider trading. An allegation against the firm, as opposed to individuals within the firm, is a much bigger deal and the concern is that if SAC is impacted or distracted by the charges that liquidity in certain parts of the market may suffer.
This concern didn’t linger very long, though, as stocks were back in the black by lunchtime.
New Home Sales were reported significantly weaker-than-expected, with a downward revision to the prior month’s reported sales. While sales of existing homes have been on a steadily improving pace for a while, New Home Sales have been stuck around 365k since January. Economists had expected a number more like 390k, which sounds aggressive when you look at the chart (source: Bloomberg) below but recall that last month’s figure had been previously announced at 389k and the economists’ estimates don’t seem so outlandish.
This figure doesn’t appreciably change my positive view of the housing market (and more important for me, price change in the housing market) going forward, for two reasons. First is that sales of new homes are dwarfed by sales of existing homes, so that the latter is simply lots more important and the data more statistically useful (e.g., the year-on-year change in the median price follows the same path, but as you can see below in the Bloomberg chart, the new home sales number is dramatically more volatile).
The second reason is that I suspect one reason for the failure of New Home Sales to rise more aggressively is that the gross inventory of new homes has recently been at the lowest level on record (dating to at least 1963). This is a better number to look at, incidentally, than the “months of inventory,” which still shows slower inventory turns than was normal back prior to the bubble. But that’s because of the denominator (monthly sales), not the numerator (houses for sale). And at some level, there are just not enough of the right kind of homes where they are needed. With just 147,000 new homes available for sale, there is only 1 new home for every 2,200 Americans. And they’re mostly bunched together. I suspect this dampens new home sales, and so I am looking much more closely at existing home sales for both activity indications and for price indications.
I had the honor of speaking today at the Euromoney Forex Forum 2012 in New York, on a panel concerning the future of the Euro and how much that future depended on individuals as opposed to bigger historical/economic forces. Readers will be unsurprised to hear that I was fairly firmly on the side of “in the long run, economics wins.”
But as often happens when I am running my mouth, I hit on what I think is an interesting analogy for the Euro and the Euro crisis, and for why “kicking the can” makes at least a certain kind of sense.
The analogy is astronomical in nature, and concerns the process of accretion as it applies to planets. The way that planets are thought to form is by the gradual accretion of small bits of matter – asteroids, rocks, dust into larger and larger bodies until the resulting body is able to sweep its orbit clean of anything which might otherwise accrete. But in the process of that accretion, there are two main determinants of how quickly the accretion occurs (actually, there are probably hundreds, but an analogy is supposed to be a simplification, right?). One is the speed of rotation of the body. A body that is spinning rapidly has a greater tendency to fling stuff outward, while a body that is spinning slowly allows more stuff to clump together. The second is the radius of the body: the larger the body, the greater the angular momentum of the outlying bits for a given rotational speed.
Now, the unification of the Euro was like the creation of a planetoid from seventeen different asteroids, each of which was originally moving with a different vector. As you may recall, the Maastricht Treaty described convergence criteria that required all of the member states to essentially match their inflation rates, their debts, deficits, and interest rates, because the treaty signers wisely realized that if the countries were all moving at different speeds when they joined, there was no chance that they would accrete into a single, unified entity (a planet in my analogy).
But the planet never entirely formed, and some pieces of it on the outer fringe are in danger of being ejected by inertia. The crisis is effectively spinning the planetoid faster and faster, making it harder and harder for the pieces on the outside to avoid flying off into new orbits of their own. In this context, it makes sense to try and slow the rotation, on the theory that if everything just stops spinning long enough, the natural gravity will take over and the pieces will fall back in towards the center and everything will be okay. So policymakers kick the can down the road, assuming that if they can just keep everything together for long enough, it will get easier and easier to do so.
The problem, though, is that this body isn’t acting in isolation. There are tidal forces acting to rip the body apart, in the same way that the comet Shoemaker-Levy 9 was ripped to pieces as it approached Jupiter – the difference in the the pull of Jupiter’s gravity from one side of the comet to the other was so significant that there was no way that the object’s gravity could hold it together .
In the same way, in my view, the many significant differences between the periphery and the core of Europe, combined with the effects of over-indebtedness and a debt market no longer willing to ignore the question of a state’s ability to repay the debt, are tidal forces that are destined to rip the periphery from the core, eventually. I recognize that Europeans will tell me that the gravity of the Euro itself is far greater than I think it is, and if they’re right then the Euro will not splinter and the policymakers are correct to kick the can. But I don’t think they’re right.
 These two forces work against one another, for when the radius of the body decreases because stuff falls towards the center, the speed of rotation accelerates because of the conservation of angular momentum, but that little detail doesn’t enter into the analogy.