Weekly Commentary on Financial Markets: 4- 8 July 2011
by Jacob H Schmidt
After a nice rally during the week markets end weaker giving back much of the gains. Still up for the month.
After the several weeks of focus on Greece, the rating agencies, markets and central banks switched to Portugal. Its downgrade by Moody’s to “junk” increased its debt service by several percentage points. I estimate that the new downgrade costs Portugal EURO 10 b. 5 and 10 year government bonds are now in double digit territory, or in price terms in their 50s. While Italy and Spain have also suffered their bonds are still trading in their high 90s. We believe that they are utterly mispriced.
The string of positive US data ended on Friday with a very weak job report, a slow-down in the economy. All equity markets sold off, partly due to the data, partly due to the overbought levels.
As German banks have indicated their interest in participating the French proposal for a voluntary reprofiling foresees now a 3.5% coupon instead of 5.5% for 30 year bonds. The implied haircut is significant here, nevertheless will not be enough to alleviate the pain for Greece.
Very interesting comments from the ECB: change in the collateral rules for Portugal, trying to sound tough, but the market knows their cards. Interest rate hike by ECB not helpful for Ireland and other PIIGS. What will the ECB do with all the PIIGS paper? As we know that a quick solution is unlikely the ECB has to relax the rules and hope that none of the countries panic aka default.
Hedge fund returns reported for June and YTD range from modest to disappointing:
While the smaller, medium sized and specialists eked out positive numbers for June (1% levels) and the year (2-4%), the larger funds are doing badly: Paulson, Tudor, Moore, Greenlight et al are all down for the year, some big time (double digit). Hedge Funds of Funds in low single digits, some of which with innovative angles (e.g. FX exposure / hedges) to add value.
Further summer rally from here less likely, we think that it will be volatile with sharp reversals. Next few weeks full of risks: Greek maturities and package; US debt ceiling; Arab spring / summer movements to continue; China soft landing and further political unrest. Spreads in Italy and Spain expected to blow out further.
Conclusion: investors should tread carefully throughout the summer, using extreme levels to add to positions and unload after sharp rallies. We like undervalued stocks, potentially hedged with indices. We also take a liking of these hedge funds of funds which re-invent themselves, e.g. via new macro hedges or portfolio construction. Arb and RV funds are preferable over long – short and global macro funds. A lot of opportunities in the PIIGS debt markets, both on the ST end (2011/12) and long end (trading in their 50s). Favourite trade: long 10 Y Portugal, short 10Y Spain or Italy. Positive carry and convexity. VIX at 16.5% cheap.