February 17, 2015

The Emotions that Drive the Economy

Animal spirits were improving last week, according to Barron's.

The idea of animal spirits was introduced to the dismal science (a.k.a. economics) in the late 1930s, courtesy of John Maynard Keynes. In The General Theory of Employment, Interest and Money (a dreary title that surely could have benefitted from an injection of animal spirits), he wrote:

"...a large portion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities."

In modern times, Keynes' idea blossomed into the field of behavioral economics, the study of human psychology on economic decision-making. One of the animal spirits that influence decision-making is confidence (another is overconfidence) which can drive stock markets higher.

Last week, easing measures by the European Central Bank (ECB), a cease-fire agreement in Ukraine, optimism about negotiations over Greek debt, and better than expected earnings for many companies, helped improve investment sentiment in Europe for the fourth straight month, according to Reuters. Many European markets moved higher.

In the United States, strong fourth quarter earnings, improving oil prices, and good news from Europe helped push markets higher as well. Reuters reported the CBOE Volatility Index (VIX), Wall Street's fear gauge, hit its lowest level for the year on Friday.

Data as of 2/13/15	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	2.0%	1.85%	14.6%	15.8%	13.9%	5.7%
10-year Treasury Note (Yield Only)	2.0	NA	2.7	2.0	3.7	4.1
Gold (per ounce)	-0.7	2.8	-4.9	-10.5	2.3	11.3
Bloomberg Commodity Index	1.8	0.1	-19.7	-10.4	-4.9	-3.4
DJ Equity All REIT Total Return Index	0.0	4.7	26.4	15.0	18.5	9.2

A Comedy of Euros: Grexit Part II

More Greek drama. You know things are getting contentious in the Eurozone when the newly-elected Greek Prime Minister, Alexis Tsipras suggests Germany may owe Greece war reparations.

Talk of reparations is a distraction from the real issue which, according to Financial Times, is the possibility that Greece will need a third bailout when the current one expires. Yet, the new prime minister has promised to end austerity measures. Members of his government have described those measures, which were implemented before Eurozone leaders would agree to the first Greek bailout, as "fiscal waterboarding."

You may recall the euro crisis. Back in 2009, the European Union (EU) insisted France, Spain, Ireland, and Greece reduce their budget deficits (the difference between what a government spends and what it receives in taxes). The Eurozone set a limit for debt (the accumulated value of deficits) at 60 percent of gross domestic product (GDP) which is the value of goods and services produced by a country.

In December 2009, Greek debt was $442 billion or about 113 percent of GDP, according to the BBC. After the discovery of irregularities in Greek accounting and a flurry of concern Greece would have to leave the euro, the country implemented an austerity program to reduce the deficit which included severe cuts to public spending. The program was well received by the EU, and EU leaders agreed to a major bailout for Greece which included writing off about 50 percent of the country's debt.

In recent days, the Greek people have been cheering as their new government reverses the reforms implemented by the previous government and talks tough with Greek creditors. The Greek government is seeking additional financial assistance from other Eurozone countries but insists it will not adhere to the reforms previously in place. Eurozone leaders have expressed willingness to extend the current bailout as long as Greek fiscal reforms remain intact. Negotiations have begun to bridge the gap.

Greek market performance shows not everyone is impressed with the new government's stance. The yield on three-year Greek bonds had risen to 17 percent at the end of January, and bank shares had lost significant value. The Economist reported:

"So back to the markets and the game of chicken being played between Greece and the EU. A Grexit [Greek exit from the euro] might cause problems for the EU in the form of losses for the ECB and others on bad debts... But, as we have seen, Greek financial markets are tanking. So investors clearly feel the EU has a stronger hand to play."

It seems to be a good time to reflect on an old saying: Beware what you wish for; you just might get it.

Weekly Focus - Think About It

"You don't develop courage by being happy in your relationships everyday. You develop it by surviving difficult times and challenging adversity.

— Epicurus, Greek philosopher

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

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