June 12, 2015

Stocks staged a moderate gain after Wednesday’s sharp increase. Solid gains in May retail sales was the initial catalyst. Markets bounced back and forth through the session as hopes of a solution to Greece’s financial crisis ebbed and flowed.   If there is going to be a solution, it won’t happen until the very last moment, or even a day or two after, for that matter. Bonds continued to stage massive moves. Until a few weeks ago, normal behavior was a daily move in interest rates on 10-year sovereign debt of 1-5 basis points. Now 10-basis point daily moves are commonplace.

As central banks sop up more and more long term bonds outstanding, and traders view the bond market increasing as the place where they can get the most trading leverage, volatility in the bond markets have spiked. There is no economic reason to explain these daily moves. None.   No “investor” is waking up one morning and deciding they want to lock up an income stream of five basis points or, for that matter, 1% for 10-years. These markets have been taken hostage by traders working with high leverage, making bets on daily moves in rates based more on market internals than changes in such market fundamentals as changes in inflation expectations. Obviously, all markets are linked. Changes in interest rates over time are reflected in other markets including stocks. But stocks were never priced against a long term expectation of rates anywhere near 1%, let alone five basis points. If one had to look at a bond yield that was most tied to stock P/E ratios, it would probably be the yield on BB or B rated junk bonds, a security class with risk characteristics similar to equities. While those yields have risen a bit in recent weeks, the percentage change in rates has been much more moderate than for government debt yielding near 1%. Moreover, the junk market is simply too thin and too diverse for traders to play the way they play the government bond market. The bottom line is that bond market volatility will have an echo impact on stocks, but unless these markets get completely out of control, the impact should be moderate as it has been in recent weeks.

As for Greece, I really have no opinion on the outcome. This certainly isn’t my area of expertise. But I will offer a few thoughts. First, very few political solutions of this magnitude get achieved before the last minute. The situation is aggravated here by two facts. First, Greece has a new government that has no political experience and campaigned on extreme promises that it has very little chance of getting the rest of Europe to accept. Second, Greece’s political and economic institutions have eroded in recent years making any possible agreement very difficult to implement. Does that mean some agreement will be reached anyway?   Will everyone decide to somehow kick the can down the road? Will a stalemate lead to default? No one wants the last alternative and thus the consensus is that somehow all sides will find a way to keep Greece afloat for a while longer without solving the longer term problems. While some still opine that a Greek default would be the next Lehman Brothers like-event, that sounds quite illogical. Greece simply isn’t very big, and everyone owning Greek debt or other obligations has had years to prepare for any such eventuality. It would seem to me that a Greek default might be more similar to the collapse in Argentina a bit over a decade ago, impactful to some but not needle moving.

Late yesterday, Twitter announced that CEO Dick Costolo was stepping down and would be replaced on an interim basis by co-founder Jack Dorsey. Twitter is one of the highest profile young social networking companies that has never lived up to its hype economically. While its user base has been growing rapidly. the company is still struggling to figure out how to monetize comments limited by definition to 140 characters. Twitter’s stock rose as the news broke after hours. Analysts have made Mr. Costolo the whipping boy for Twitter’s relatively sluggish growth. Will his successor bring greatness to Twitter? Obviously, we can’t answer that question until we see who he is and what his game plan might be. But I will note the following.   Pick any great tech company of the last 50 years and in almost every case, you can attach that greatness to the spirit and abilities of its founder. Think Amazon and you think of Jeff Bezos. Netflix and Reed Hastings. Tesla and Elon Musk. Microsoft# and Bill Gates. Oracle and Larry Ellison. And, of course, Facebook# and Mark Zuckerberg. Steve Jobs hit a few speed bumps before returning to Apple#, but clearly the company’s glory days were connected to him. Tim Cook has been an admirable successor, but he followed and icon, a far different situation than Mr. Costolo’s successor will find for himself. I am not writing Twitter’s obituary, but I would suggest that making Twitter a money-making machine isn’t simply a matter of finding a solid CEO in a job search. None of the icons I just named found their jobs via a headhunter. Twitter is a great tool for certain people and certain industries. It is a forum for celebrities to speak. It lets politicians opine publically. It is a window to worlds of upheaval and disaster. But Twitter isn’t at the core of social networking the way Facebook has become. True iconic brands aren’t born every day and some visionary products ultimately fail miserably. There are no Bricklin cars anymore. Madman Muntz doesn’t make TVs. Richard Branson still hasn’t put anyone into space (but he still might!). But all the successes I noted above shared one common vision. What they saw had no limits. What they built was the best at the time they built it and stayed the best for years and years. Twitter never was the best, and I doubt it will ever be the best. It’s a great product with a niche and for that it should be rewarded. It is destined to be more than an asterisk in history, but it will be a tall order for Costolo’s replacement to make it truly iconic and “must have.”

Futures point lower this morning.

Today, Jim Nabors is 85. Former President George H.W. Bush is 91.

James M. Meyer, CFA 610-260-2220

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# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.

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