Weekly Commentary on Financial Markets: 18- 22 July 2011
by Jacob H Schmidt
Another eventful week: Banks Stress tests, Greek package, US debt ceiling deadline and earnings season. For investors, traders and market watchers quite stressful, given that we are in the middle of summer and many people away or about to go on holidays. No respite this year, I am afraid.
The long awaited results from the 2011 European bank stress came out last week, but it took the market several days to digest and understand the results. Conclusion: tougher than last year, but not tough enough. The test did not even take a Greek default (now a reality!) into consideration. Hence the objective of calming the market was missed. My grade: C-.
Secondly the European sovereign debt problem was addressed by the Eurocrats and national politicians, with a grand second bailout cum restructuring announced last night. The deal is impressive, with a Euro 109 b bail-out, PSI (private sector involvement), extension of maturities, 3.5% coupon and a buy-back program via the EFSF to become the European Monetary Fund. Political unity on TV, with strong messages. However short of details, and lengthy in its implementation, and the suspicion that the smaller countries were not included in the talks. Markets rallied on the news of the deal (equities, Euro, Bonds) while Gold and Silver fell sharply. We believe that the Merkel – Sarkozy put has very short maturity, to expire early next week when participants realize that the devil is in the detail (and the details are not clear yet), the bail-out is not sufficient and the European citizens won’t like the bail-out and bigger plan, once they understand the implications.
Where do we see the real issues: the bail-out is big in size, but not comprehensive. Greece’s total debt amounts to more than Euro 350 b, its debt burden being too big for a small country with no growth (and no significant growth potential), a huge public sector and a bad history as a debtor. The package’s debt forgiveness is reported in the 20% range, which is not enough to relieve the country of its debt service burden. The PSI will neither be voluntary not work as some institutions and funds / hedge funds will request a higher / full repayment. We hear that the banks will be allocated their share in the PSI. The hedge funds that bought bonds will request full repayment like the ECB. The 3.5% interest rate sounds like a bargain, but will still be too high for Greece and probably the other countries too. It is not clear that the contagion to Spain and Italy is prevented. This sounds pessimistic, but I am afraid to say that it will become much worse, with a looming further default in 2-3 years and a proper hard, Brady style restructuring: we believe that Greece needs at least 50% haircut, ultra-low rates and 15-30 years maturities. In order to get new money (which could / should be part of the restructuring) Greece will have to offer market rates and / or sweetener like GDP recovery / participation vouchers or similar. Latin America did it in the 1990s and it helped them recovering. Poland and Bulgaria did it, and they got out of the mess. Greece and some of the other countries will have to face reality, too. Europe has delayed the real decision. We are just not ready yet. My grade: C-
Apple’s earnings were amazing, beating guidance and consensus by a large margin. They did it again, sold as many iPADs and iPhones as they could, for the stock to rally sharply. My grade: A
The Murdoch testimony dominated news on Tuesday, threatening David Cameron’s future for a few days only. The impression of the public is that the hearings were not tough enough, and the Murdochs and News Corp emerged as the winners. As I wrote on twitter: a lesson in chutzpah. Most members of the panel were pussy footing. In the UK we seem to have moved on already. My grade: D
Hedge fund returns reported for June and YTD range from disappointing to interesting:
Soros is reported to be 75% in cash due to a lack of opportunities, Paulson down 12% in his flagship due to mistakes ranging from investment in Sino Forest and aggressive bets. Other funds have also disappointed with negative returns. On the other hand we see a fair number of hedge funds that are positive (high single to double digits) due to their strategy (niche) or their skills (trading, analysis, implementation). Hugh Hendry’s Eclectica is one of them. Hedge Funds of Funds have also produced low vol numbers and we believe that this might be the come-back for the fund of funds industry. My grade: B+
After Greece the markets can focus now on the US debt ceiling problem which is being dragged on. For US treasuries investors the US debt ceiling has a positive aspect (ironic) as a delay in the approval of a higher ceiling means less bonds will be available, and the problem is not one of solvency but a political / legal action to raise it. Incomprehensible how politicians mess around with US’s rating. My grade: C-
Limited upside in equities from here, with substantial downside if and when the market realizes that the Greece bail-out is full of hot air. In a low interest rate environment full of political risk safety is key (return of capital rather than return on capital).
Conclusion: investors who had the guts to pick up cheap stocks earlier in the week, unload after the sharp rally. We like precious metals (gold and silver) as well other commodities. On the HF side we prefer Arb and RV funds versus long – short and global macro funds, but emphasize the talent side. It is not so much the strategy, but the manager which makes the difference. These are tough markets, and only the best can make money here. Favourite trade: none. VIX at 17% (down from 22% earlier in the week) with the Dow at 12,700 quite cheap.
Jacob H Schmidt, international financial markets expert, HF expert, Webster Finance Professor. Anglo- Austrian, multi-lingual,-cultural, critical thinker. CEO of Schmidt Research Partners Ltd, an investment advisory firm and MD of SFP-International Ltd, a consulting and training company. Available for high quality investment advisory, due diligence and consulting projects.
This commentary is for information only. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be solely relied on in making an investment or other decision. It is not an invitation to buy, sell or subscribe and is by way of information only.