In January we wrote:

Events we expect for 2015

• Commodity prices stabilize near current levels, start rising again.
• The US dollar rises another 15-20% against world currencies, then resumes a long term slide.
• The Eurozone fractures, with basket case countries such as Greece leaving the Euro to achieve the devaluation that makes their economy competitive again.  Even Spain and Italy are candidates for abandoning the Euro.  If this happens, Germany will plunge into recession as her primary export markets dry up.
• The 70 month bull market in US stocks finally runs out of steam.  US large cap stocks which did so well in 2013 and 2014 may return nothing in 2015.  Earnings at small and mid-sized corporations continue to expand, enabling the small and mid-cap indexes to outperform large caps
• 2015 ends up like 2011 where the S&P 500 gained only 2.1%.

At mid year we note:

• The Commodities Research Bureau Index ended 2015 at 230.0, bottomed at 208.8 in March, last at 224.4.  Oil (WTI) bottomed at $44 in February and March, most recently at $58.34.
• The US dollar rallied another 7.2% against world currencies through March, since then has been flat to lower.
• Greece is on the verge of exiting the Euro.
• US stocks traded since January in an extremely tight trading range of up 1%-up 4%, up 1.3% though June 30th.
• Stocks SHOULD have sold off 5-10% sometime during the first half of the year as the employment situation and corporate earnings failed to impress.  With both poised for improvement in the second half of the year, we now lift our expectations of S&P 500 gains to 6% for 2015

Click here for major US and world economic indices.

Greece in detail

Last week, Greece defaulted on an IMF loan repayment and closed its banks to block capital flight.  On Sunday, Greeks will vote in a referendum, on whether to accept the final bailout offer from European creditors, or reject the offer, which would lead to "Grexit" within days. 

To recap history, the Eurozone encompassed most countries in Western Europe on January 1st, 1999, with Greece joining New Year's Day two years later.  Since then, 7 Eastern European countries have adopted the Euro.  The advantage of joining is the elimination of currency translation costs when dealing with other Eurozone countries.  Among other benefits, peripheral countries are able to borrow at substantially lower rates than previously in local currency.

The disadvantage is that a country loses its ability to manipulate interest rates; for example, to lower rates to stimulate an economy in recession.  A country may borrow more money than is prudent given new, lower borrowing costs.  Most importantly, without ability to devalue its currency, a country may lose its comparative advantage in local exports.  Italy, for example, was a powerhouse manufacturer of luxury goods under the Lira.  Under the Euro, Italy lost competitiveness in manufacturing to China, which continues a policy holding down the Renminbi.

25% of the German economy is tied to exports.  Germany was eager to lend money to Greece so that Greeks would buy German engineering to build highways, German cars to drive on those highways, German refrigerators and air conditioners for every home.  Unfortunately, once a country (or company or family) has debt exceeding 100% of GDP (or company revenues or family income,) it's nearly impossible to keep up with interest on the loans, let alone repay principle. 

By 2000, Greece already had debts exceeding 100%, touched 113% in 2008, then soared recently to 175% (as of 2013.).  How did the ratio go so badly so quickly?  Creditors continued to lend ("good money after bad") even as the Greek economy cratered 29.2% from 2008 through 2014.  Demands of creditors that Greece practice "austerity" have actually made matters worse.  Less government spending lowers demand, which reduces income, which reduces taxes, which makes debt service even harder.  Without a "haircut" of at least 50% in the value of outstanding debt, is it impossible for Greece to EVER get ahead of debt service.

What happens if Greece defaults completely on its debt and exits the Euro?  For sure, short term chaos.  Deposits in euros held be Greek citizens would be converted to Drachmas mostly likely at a discount of 50%.  On the bright side, Greek exports of farm goods and fish would instantly become more competitive, and the tourism industry would surge.  The Greek unemployment rate, currently 25%, 50% among young men, would drop dramatically.  If the Greek government could simultaneously reform tax collection, there actually would be cash flow to service future debt.

The big loser would be Germany, the primary holder (about 25%) of $271 billion owed by Greeks.  Germany would also lose an export market, potentially other markets if countries like Portugal follow Greece.  Germans generally feel that the Greeks have a moral obligation to repay debts, but don't forget - there are two parties to every loan.  The Greeks should not have borrowed so much, and the Germans should have not lent so much.

The Eurozone is forecast to grow modesty in 2015, a little better in 2016.  Interestingly, the German stock market is up 11.6% YTD, France up 14.9% YTD (each gained 2.6% in 2014.)  Investors are betting that Grexit will NOT push the Eurozone back into recession.

The primary driver of the US stock market this year is news on the Greece situation - up on good news, down on bad news.  The fear is that the default of Greece would parallel the default of Lehman Brothers in 2008.  Unlike Lehman Brothers (in business on Friday, bankrupt on Sunday), investors have had three years to prepare for Greece's default.  Most private holders of Greek debt sold out with losses some time ago.  The Germany government can simply expand the money supply to cover defaulted Greek bonds, much as the US Federal Reserve create the TARP reserve ($700 billion) to buy junk debt securities during the 2008-9 financial crisis.

Our take: rip the bandage off!  The situation for Greek citizens is so dire that defaulting might actually buy breathing room to make things better (short term pain, long term gain.)  Capital markets might suffer for a few weeks until investors realize that Grexit is not the end of the world.

Sunday night update: Greeks citizens rejected the latest bailout offer 61-39.  Back to the bargaining table though without Greek finance minister Vanis Varoufakis, who resigned Sunday night.

An old saying goes, "Never discuss politics, sex, or religion at a polite dinner."  Wealth advisors are recommended to be similarly tactful to avoid "offending" clients.  We believe that ANY topic with economic impact must be reported and analyzed.  Warning: the next several sections could offend.

Recent US Supreme Court Rulings

The Supreme Court ruled 6-3 in "King v. Burwell" that a mistyped phrase in the drafting of the 906 page "Patient Protection and Affordable Care Act" did NOT invalidate the provision of a federal insurance exchange in those parts of the country which did not have state provided insurance exchanges.  Had the Supreme Court ruled the other way, 6 million US citizens would have lost access to health insurance, possibly creating a death spiral where the whole system collapsed.

Is "Obamacare" an ideal health program?  No!  Is it far better than the alternative, in which average Americans face bankruptcy and foreclosure due to unplanned medical expenses?  Yes!  20 million Americans are now insured through Obamacare.  11.9% of Americans, or 35 million remain uninsured.  Costs generally have been lower, savings have been higher, than originally forecast.  Despite this good news, the Republican controlled Congress submitted legislation 60 times in the last 5 years to overturn Obamacare. Contenders for the Republican nomination for President have sworn to repeal Obamacare on Day 1 of their presidency.  They better have a good replacement on Day 2.

The Supreme Court ruled 5-4 in Obergefell v. Hodges that the Constitution guarantees a right to same-sex marriage.  Consider the evolution of the societal opinion on this topic.  20 years ago: "Gay marriage?  That's preposterous!"  In 2015: "Gay marriage?  Why is this still an issue?"  Massachusetts was the first state to legalize gay marriage in 2004.  The 1996 Defense of Marriage Act (1996) defined marriage at the Federal level as the "union of one man and one woman," but that law was struck down as unconstitutional in 2013.  US v. Windsor cleared the way for recognition of gay marriage at the Federal level including the filing of joint tax returns and  sharing of Social Security benefits and pensions (but only in states that recognized same sex marriage.)  Obergefell v. Hodges swept away all such distinctions between straight and gay marriage.

Why do we care about these rulings more than others?  Settling these two issues removes economic uncertainty for ten of millions of Americans.  Anything that REDUCES economic uncertainty INCREASES economic output!

Update on the 2016 US Presidential Election

Disclaimer: all political forecasts are not what we want, but what we expect.  David Edwards, author of this commentary, is a progressive libertarian independent who shifts registration between Democratic and Republican parties depending on which primary he wants to vote in.

In April 2014, we wrote facetiously, "With 0.0% of precincts reporting, CNN declares Hillary Clinton CNN the next president of the United States."  15 months later, our comment seems freakishly prescient.

On the Republican side - comedy and chaos.  Jeb Bush maintains a slight edge at the top of the GOP polls (with 15%.).  Trump (the candidate du jour) is at 12%.  We wrote in March "the Republican primary process will operate like a circular firing squad."  That situation is worsening by the day.  Where is the candidate with the stature of Reagan, Eisenhower, or even Nixon?

On the Democratic side, Hillary Clinton's (62.8%) lead over other candidates slid from +60% a month ago to just +48.5% (Bernie Sanders clocks in at 14.3%.)  Sanders attracts Democrats disaffected by Clinton's centrist bent and Wall Street connections and could win a couple of primaries.  We doubt his campaign will mount a serious threat to Clinton.  Joe Biden may yet step into the ring, but too little, too late.

How the sausage is made:

1. About 220 million Americans are eligible to vote (the other 93 million are either too young, disqualified by a criminal record, or disenfranchised by lack of identity credentials (certain states.)
2. The turnout rate varies between 50-60%.  We project turnout on the low side in 2016 (let's say 55%), so 120 million voters.
3. 48% of voters will vote Democratic reflexively, 45% will vote Republican, so the voters that are in play only amount to 7% or 15 million.
4. These voters are "independent" or "undecided" or simply too distracted to think about the election until the final weeks.
5. In many states, the opinions of the undecided voters don't matter - New York will vote Democratic; Texas will vote Republican.
6. These states: Colorado, Florida, Nevada, Ohio, Virginia, Iowa, New Hampshire, and to a lesser degree North Carolina and Wisconsin will be swing states in 2016.
7. 270 out of 538 electoral votes are required to win the presidency (a tie at 269 throws the elections to Congress, with the House voting for president and the Senate voting for vice-president.  Given current composition of Congress, a tie would ensure a Republican White House.
8. At present, the Democrats will likely start election day with 247 votes already in the bag versus 206 for Republicans.
9. As Mitt Romney saw in 2012 (losing in a landslide to Barrack Obama 206-332,) the Republican candidate MUST win virtually every large state, while the Democratic candidate ONLY needs to pick up one (Florida) or two (Virginia and Ohio) large states to win the presidency in 2016.  Demographic trends in Florida and Virginia favor Democrats.
10. Both parties are expected to spend a combined $5 billion on this election cycle.  Hillary Clinton and Jeb Bush are well ahead of their peers in what we call the "air war," locking down multi-million dollar commitments from major donors (campaign finance laws are no longer meaningful.)
11. This $5 billion will be spent primarily in the swing states.  The campaign ads will be directed primarily at the 7% undecided votes in those states, so 1.4 million in Florida, 800K in Ohio, 580K in Virginia, 2 million in the other states, for a total of 4.8 million voters or about $1100/voter. Those voters will see the nastiest, vilest commercials yet aired as both parties seek to sway the undecided (or not - many will be focused on the end of the baseball season or the start of the football season.)

Our forecast as of July 2016:

• Jeb Bush is the Republican nominee
• Hillary Clinton is the Democratic nominee
• Personality will matter more than issues
• Clinton is the eventual winner
• Both House and Senate remain in Republican hands in 2016
• The political gridlock we've seen since November 2012 prevails through at least 2018.

Religion and the Founding Fathers

This 4^th of July weekend, let's go "big picture" on one of the most divisive topics in our country - religion.

Senator Ted Cruz described the affirmation of Obama Care and gay marriage as the "some of the darkest 24 hours in our nation's history."  Really?  Darker than the 9/11 attacks, the Pearl Harbor attack, the outbreak of the American Civil War, the burning of Washington DC by British invaders during the War of 1812?  Darker than the assassinations of Kennedy, Lincoln, McKinley, Garfield and King?

Justice Anthony Scalia wrote, ""I write separately to call attention to this Court's threat to American democracy...Today's decree says that my Ruler, and the Ruler of 320 million Americans coast-to-coast, is a majority of the nine lawyers on the Supreme Court."

To the infinite amusement of Canadians and Europeans, Americans invoke God and the Bible to justify any number of moral, ethical and legal positions.  To get a sense of how ludicrous this can become, substitute "imaginary friend" whenever a politician invokes God (Ruler, Almighty, etc.)  To get a sense of how dangerous this can become, consider the ongoing slaughter of Muslims divided between Sunni and Shia sects, or the historical slaughter of Christians divided between Catholic and Protestant sects.

Americans generally believe that the US was founded on religious principles. For example, "In God We Trust" is printed on our currency.  Americans generally don't know that the motto "In God We Trust" was adopted only in 1956 (as a means of distinguishing "God-fearing" United States from the "godless" Soviets.  The motto "E Pluribus Unum - from many, one" was adopted by the Continental Congress in 1782.