Weekly Commentary on Financial Markets: 25- 29 July 2011
by Jacob H Schmidt
This week: only bad news.
This week can be described as a series of bad news: bad news from US politics, from the economy and companies.
The US debt ceiling deadline dominated the news and markets for most of the week. The markets went risk-on /risk-off (RO-RO) several times during the week. Confusing and stressful for investors. Congress playing ”Great Brinkmanship Game”. As we are approaching the deadline of August 2/3 for the debt ceiling increase, two plans (Boehner-Rep; Reid- Dem) are on the table but no political will for compromise. Hence the reputation of the USA has suffered a severe blow: rating agencies might downgrade the debt, Chinese state-run media outlets say “debate over raising the debt ceiling has "kidnapped" the worldwide economy”. "Such political brinkmanship in Washington is dangerously irresponsible," Xinhua wrote in a commentary published on Thursday. Senior officials from international organisations (World Bank) and fund managers (Bill Gross) criticize the US administration and law makers. What has happened to the US to sink to such lows? One point is clear: the US is a superpower in decline. History teaches us that big empires end when they can no longer run their affairs properly (see Roman empire, Soviet Union). America’s debt is not the main problem, but its increasing inability to solve issues. Since 2008 the country has been on life support with ST fixes. My Grade: F
Second main focus was the earnings season: European banks reported lower earnings, due to tough conditions in Q2 and write-offs for a Greece restructuring. Firms in other sectors made cautious remarks regarding the outlook. US earnings mixed – some reported strong numbers (Chevron, Starbucks, Dupont), others disappointed. Real question is: how will companies fair under the threat of a default and a slow-down in the economy. While many US companies are first class, a debt default could bring many of them down. My Grade: B+
Data (macro-economic) reported during the week all point towards weaker national economies: UK, US and Europe. In China higher inflation and lower growth (still in the high teens however) also pose a threat. US data reported on Thursday (employment) and Friday (GDP, consumer confidence) were disappointing. After an initial sharp correction, the equity markets bounced back later in the morning. Traders with no fear of a toxic US debt ceiling jumped in to push markets higher again.
My Grade: B
The European sovereign debt problem continues to be a concern, as no further details of the Greece bail-out were revealed. Spanish and Italian bond issuance led to higher yields in these bond markets (5.9% for Italian 10 year BTP, 6.1% for Spanish 10year bonos). Italian long term BTPs are down more than 5 points for the week (from 105 – 99.8). We valued the Greece restructuring in our research note dated 24 July 2011 and found value at current levels, but also pointed to the risks: slow progress – restructurings take more than a few weeks – as well as the high level of debt. If Greece restructures the bonds as announced, current prices are somewhat attractive. Without restructuring they are a big gamble, in the event of a default they could sink much lower (we could see them in the 20s). Italy and Spain are the two real risk factors. While no further details regarding the bail-out and restructuring were disclosed, European politicians confuse markets with conflicting statements.
My Grade: C-
Real issues for the next few months: US debt (not debt ceiling), potential downgrade of US and many other European countries, Club Med restructuring and the impact on corporate earnings. Asia will not be able to decouple from these developments, and if the US get close to a default, the impact could be massive.
More numbers from Hedge Funds for June and YTD: on both sides of the 0% line, some funds being positive (mainly RV and ARB), many negative (L/S, Macro). We see a lot of deleveraging in HF, scared of a repeat of a 2008 Lehman. If the debt ceiling is passed and some reason returns to markets HF will have to be quick to put on exposure, in order to participate in the potential rally. The great HF managers report that they find the current markets most challenging. In a world where the USA are no longer AAA and a default possible, HF / HFoF become the alternative. Hence even low returns become attractive, as long as the money is not tied up in US banks or vaults. Swiss and German PBs become attractive alternatives. We prefer small to medium sized HF who can capture the opportunities. Large HF are currently at a disadvantage . Hedge Funds have a role to play here. My Grade: B+
Equity markets are down for the week, on low volume, volatility and metals up. Many pros recommend to stay on the sidelines, however any potential deal could trigger a big – short term – rally, to be followed by another sell-off. This is market for the best traders only as well as real value-oriented long term investors.
Conclusion: like last week’s recommendation markets will continue volatile; hence opportunities for S-T traders; precious metals (gold and silver) as an insurance; credit (sovereign US and Club Med) negative. Selected HF doing well. Favourite trade: avoid / short US, Spain and Italy; opportunistic longs in Greece, Portugal. VIX at 24.5% (up from 17% last week) in middle of range, Gold probably the better hedge. In equities buy blue chips on panic. HF and HFoF in RV / ARB, but manager selection key.
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.