Leaping to Conclusions

For readers with a single-day time horizon, we have some dreary news: Wednesday marked a particularly dour day historically for markets—meaning history says this is not the day to buy in the morning and sell in the afternoon. The reason for these dour returns? Leap day. The grim outcome, you ask? Well, the S&P 500 has declined on 10 of the last 16 leap days, averaging a decline of -0.6%. (Wednesday made it 11 of 17.) Of course, this small (and highly myopic) a dataset is near useless as a predictive tool. (Don’t believe us? We have a Leap to Conclusions Mat to sell you.)

Daily gyrations and neato leap-day trivia aside, Wednesday brought a decent round of positive economic data, including the following:

• Japanese industrial production rose 2% in January from the previous month, beating expectations.
• German unemployment remained at the lowest in over two decades, holding at 6.8%.
• The Chicago Purchasing Manager Index rose more than forecast from 60.2 in January to 64.0, driven mostly by increased auto sales, business equipment investment and inventory restocking.
• US fourth quarter GDP was revised up from 2.8% to 3.0%—admittedly, not a huge change, but the strength lay in the various revisions. Consumer spending was revised up, businesses cut spending by less than first thought and incomes were revised up. Businesses also restocked inventories more than previously thought.

And rounding out the day’s major news, the ECB conducted its second three-year long-term refinancing operation (LTRO), providing €529.5 billion in cheap liquidity to some 800 lenders. Prior to introducing the LTRO late last year, ECB loans had to be repaid within a year, making them less appealing as a significant source of liquidity. However, the LTRO allows banks to borrow the funds for three years at a very cheap 1% rate, making it a more attractive alternative.

The first round seems largely to have been a success, to the extent it likely boosted banks’ demand for eurozone sovereign bonds (contributing to reducing sovereign debt yields). Some also suggest banks used the cheap money as a means to finance their maturing debts—helping alleviate some funding stresses. It was hoped some of this money would find its way to boosting lending to businesses and individuals. But December’s LTRO was seemingly less successful by this metric.

Some hope this second blast of liquidity will buoy lending more and grease the eurozone economy’s wheels. In our view, this second round’s results remain almost entirely to be seen—though it was likely a positive the demand was strong and European banks are taking advantage of ready, cheap liquidity from the ECB.

Yet some latched onto Wednesday’s results to underpin some pretty broad statements or just took a generally dour view of the news. Some remind us the LTRO isn’t a cure-all for Europe’s ills—countering a claim we’ve yet to find someone make. Others suggest it could create as many problems as it might address. Possible—after all, eurozone politicians could take immediate stress reduction as a driver to relax competitiveness-boosting efforts, while banks may increase their sovereign bond holdings.

But while the LTRO could create problems, discussing them immediately after the auction seems quite premature, in our view. And in fact, this article suggests the LTRO could raise the potential risk in 2015—three years and myriad choices, decisions and plans on the part of banks, investors and policymakers from today. A fact that actually highlights the point of the LTRO: It seems a largely appropriate step on the ECB’s part to buy time by ensuring there’s sufficient liquidity in the European banking system to avoid a credit crunch. That policymakers could bungle decisions over that time isn’t exactly a unique risk, nor one guaranteed to hit home—a near-infinite range of scenarios could develop in that time.

One could similarly assess the decision to try to short-term time a dour leap day. Up or down, one day does not an overall, long-term investment strategy make—or break. Neither does one auction, one data point or one positive GDP revision paint the entire economic picture. But they are all additional points in the complex picture markets do paint. The key is occasionally stepping back to take in the whole scene. In so doing, you just may grasp something many seem to currently overlook—which is at this point, the overall market and economic picture resembles much more a Seurat than it does a Jackson Pollock.