March 11, 2014

Russian Actions Unsettle Markets

Okay, so Russia sending troops into Ukraine's Crimean Peninsula did unsettle world markets. At least it did last Monday.

Like a diver plummeting off a cliff, markets in various parts of the world lost value last Monday as investors responded to the possibility of war between Ukraine and Russia. The New York Times said it like this:

"The escalating crisis in Ukraine created turmoil in global markets on Monday, hitting stocks from Wall Street to Ukraine and causing a spike in oil and natural gas prices that could reach into consumers' wallets. But despite fears that the conflict between Russia and the West over Ukraine could shift into a military confrontation, analysts said there was little risk of global financial contagion or of major blowback to Western economies."

Perhaps that was the reason markets generally did so well during the rest of the week. That and the fact Russian President Vladimir Putin seemed to pause for a breath and, possibly, a reconsideration of strategy after the Russian stock market lost about $58 billion on Monday. (That's more than the cost of the Sochi winter games.) There were other economic consequences, too. A rapid decline in the value of the ruble led to a sharp rise in short-term Russian interest rates, and the Russian central bank was compelled to spend about $12 billion defending the country's currency.

Meanwhile, back in the United States, the bull market celebrated its fifth birthday. During the last five years, the value of investors' holdings in U.S. stocks has increased by about $16 trillion, according to Wilshire Associates as reported in Barron's. As if that weren't remarkable enough, last week the Federal Reserve reported the net worth of U.S. households rose by nearly $3 trillion during the last quarter of 2013. It's enough to make you wonder whether the cost of quantitative easing, which expanded the Federal Reserve's by more than $3 trillion, was worth it.

Data as of 3/7/14	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	1.0%	1.6%	21.1%	12.8%	22.7%	5.1%
10-year Treasury Note (Yield Only)	2.8	NA	2.0	3.5	2.9	3.8
Gold (per ounce)	0.7	11.1	-15.5	-2.4	7.7	12.8
DJ-UBS Commodity Index	1.6	8.3	-0.5	-6.9	5.4	-0.6
DJ Equity All REIT TR Index	-0.4	7.9	4.2	11.0	31.6	8.4

The Cypriot Economy

Where are they now? Remember that island in the Mediterranean that was in turmoil about a year ago and turned to the European Union (EU) for a bailout? The situation in Cyprus was a bit confounding because the country was growing relatively robustly and had a small budget deficit. The issue was the country's banks which were bigger than its domestic economy. Cyprus had about 8 trillion euros in deposits and only 4.5 trillion euros of annual government revenues, according to BCA Research cited in The Economist. Since bank deposit guarantees are only as good as the country providing them, Cyprus needed some help.

Eurozone leaders responded to the Cypriot bailout request with demands for austerity and reforms - pretty much the same thing they'd been requesting from other bailout recipients - but a 'bail-in' also was part of the package. What is a bail-in? The EU required debt holders and uninsured depositors help absorb bank losses and fork up new capital. Although the idea was initially rejected by the Cypriot parliament, the government capitulated relatively quickly. The Economist described it like this:

"At first, a raid on insured [bank] deposits was envisaged, though ultimately they were spared and the main victims were uninsured depositors - a decision made easier by the fact that many of them were Russians. But getting creditors both to absorb losses and to recapitalize the country's biggest bank (which also had to absorb the second-biggest and even more comprehensively bust bank) is not proving to be a great success."

How unsuccessful has it been? The Cypriot economy contracted by about 5 percent in 2013 and is expected to continue to wither this year. Unemployment in the country is at 17 percent.

There are several lessons that can be learned from events in Cyprus, according to The Economist: 1) It's important to have a state-backed 'bad' bank where bad loans can be held and dealt with over the long term; 2) Forcing uninsured depositors to take a hit helped protect taxpayers, but it also damaged public confidence in banks; and 3) Fiscal policy makers need pragmatic and flexible solutions because every banking crisis is different.

Weekly Focus - Think About It

"If your actions inspire others to dream more, learn more, do more, and become more, you are a leader.

—John Quincy Adams, Sixth President of the United States

Best regards,
Sean M. Dowling, CFP, EA
President, The Dowling Group Wealth Management

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