Risk controls are Mandatory: EWQ, EWG, EWP, SPY

May 08, 2012, 15:28 pm ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

The truth about Austerity is it hurts.  The process of becoming fiscally responsible is not unlike the recovery process of a drug addict who finally decides he is going to go straight.  The hope is, of course, that the ‘addict’ does not become a repeat offender like Lindsay Lohan, but instead accepts the responsibilities that go hand in hand with recovery.  The temptation and the risk are surely there, but they say the first step is admitting that you have a problem.   Everything afterwards is the torturous side effects of the process.

Today we are witness to the struggles that are occurring in Europe as Greece (GREK) , France (EWQ), and other countries begin to feel the real pressures of the German(EWG)  – lead fiscal responsibility mandates.  For some countries it is easier than others, but for those countries deepest into debt, Spain too (EWP), the burdens are high.  Recent headlines make me think of Trading Places, when Jamie Lee Curtis rushes Dan Aykroyd on the steps of the Police Station asking for another fix.  She want ‘just one more fix baby!’ 

European nations are finding it extremely difficult to deal with the no-growth side effects of fiscal austerity.  Higher taxes and lower government spending make it almost impossible to grow because monies are siphoned from the economy to bring the Government into balance. 

However, this process merely offsets the debt-influenced growth that brought those economies to where they are today, so if the process is considered as a complete package the growth of many years past is simply being offset by prudent fiscal conditions which may stifle growth for a while, maybe many years, and create an ongoing high risk environment in the process.

Ultimately economies balance out, because debt levels cannot increase forever, and the EU has drawn the line.  Unfortunately the United States has not even taken step one in the recovery process and that is the biggest concern of them all.  We have not yet admitted that we have a problem, but soon, just like we saw in Europe, we will not have a choice.  That is where it gets tough. 

The United States has been accustomed to living off of the needle of the Government since President Clinton was in office.  He was the last President to run a surplus and pay down debt, and since then the debt levels have ballooned.  The natural state of economic weakness expressed by The Investment Rate is going to happen as sure as death and taxes, but now we are faced with something much more serious.

As we transition from ‘the needle’ to austerity, which will probably take place after the November elections, taxes will increase and government spending will be further cut, both in an effort to get closer to a balanced budget.  This will further curtail the already slow economic growth that exists today, and exponentialize the influence of The Investment Rate. 

We won’t want to admit it, but our hands will be forced by the market instead of by our sound judgment.   Then, at that very moment, we will recognize that the Social Security and Medicare systems are starting to take money out of the economy as well.  Officially in 2012 the unfunded liabilities of the US Government start to act as a sieve too.  When those liabilities are factored in, and the blatant neglect of those systems are considered alongside our stated national debt, anyone can see that we are far worse off than any of our Government Leaders want us to believe. 

Even if we decide to stop paying Social Security and Medicare it will have a devastating impact on our economy, so there is no way out of this other than to print money out of thin air, and that is not a recipe for growth.  In the 1970s, for example, they considered fabricated inflationary growth, which might be similar to fabricated growth derived from the printing press, to be not worth the risk, so they sold the market and brought P/E multiples down to single digits in the S&P 500 (SPY).

If you thought it has been bad recently, you haven’t seen anything yet.  Just like in the movie Trading Places, there is nothing worse than turning a rich man into a poor man, and therefore, in light of the circumstances, controlling risk in this environment is mandatory.

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