Weekly Commentary on Financial Markets: 1- 5 August 2011
by Jacob H Schmidt
Last week: only bad news. This week: worse. Next week: better.
Sorry to sound so negative, but this week was probably one of the worst in the last three years. The sell off – panic yesterday is still a puzzle to many, how did the markets decide to sell off after 2:30 EST? Nobody has any real explanation. Program trading, summer, panic and bad news. Nevertheless, let’s be positive and constructive and analyse, where we can go from here.
After US Congress’s”Great Brinkmanship Game” on the US debt ceiling, they compromised and voted it through. No surprise to anybody, but the episode certainly destroyed the USA’s reputation further. The humiliations of the USA continue, after rating downgrade threats over the last weeks, Chinese state media calling the debate a "kidnapping of the worldwide economy”, Putin went one step further and accused the United States Monday of “living beyond its means like a parasite on the global economy”. Whatever we think about the USA’s total debt, its debt ceiling debate and the US economic policy, Putin’s comment sounds like Nazi propaganda. However, the US did it, they increased debt ceiling, with some positive developments in terms of cutting expenditure and raising revenues. In our view this is not the end of the US: it is unlikely that we will see a default by the US (one market observer, David Murrin of Emergent called for the US to default to solve its high level of debt). Japan has double the level (dent to GDP) with even lower rates. The US have one secret weapon: the American dream, allowing for everybody to participate, a capitalist system with values (their covenant derived by the Founding Fathers from the Bible). While I believe that the USA’s role as the only superpower is in decline, I would not write off the USA’s capabilities and values to succeed. My grade: A-
After the US debt ceiling the market switched back to Europe, and as written last week, with a focus on Italy and Spain. Greece seems to be out of focus (after the big announcement a few weeks ago), no further details regarding the re-profiling / restructuring have been published, we only know that the exchange shall at the end of August. My experience with restructurings over the last 20 years tells me that it takes much longer, it is never clear cut and the devil is in the detail. Italy’s internal political problems and the lack of progress on the economic front led to focus of the market on Italy and Spain. Credit spreads widened significantly, stocks in Milan and Madrid down sharply over the week. Last but not least the ECB committed to buy further bonds (BTPs and other Club Meds) after a 4 months pause and will provide ample liquid to European banks. The tight liquidity situation in the interbank market and the ECB is again the lender of last resort. Europe’s lack of action and re-active policy is the main reason why the markets are so paranoid and panicky. My grade: C-
Data (macro-economic) reported during the week continue to point towards weaker national economies: UK, US and Europe. ADP on Wednesday was mixed, Thursday’s jobless claims slightly better, and Friday’s employment situation awaited with much anticipation. In the US the talk is now of a double dip recession and QE3. My Grade: B
We continue to believe that the markets will focus again and again on the real issues of the US debt, the debt of the European Club Med countries and their restructuring, but also at corporate earnings. No decoupling of Asia in the event of a bigger European problem.
Hedge Funds returns in the last few days: with some exceptions rather bloody, Dow Jones Credit Suisse Core Hedge Fund Index is down 0.45% for the week (and MTD). Macro and L/S disappoint. CTAs and Fixed Income Arb / RV positive. As HF have delivered rather meagre performance, many HF managers will be tempted to add positions here. Market for talented traders and top HF only. My Grade: B+
Equity markets reacted as predicted last week: rallied on the rumour of a US debt ceiling deal, triggered a short term rally, and sold off over the next days to climax this morning. Equity markets are now down for the year, and down almost 10% for the month. Gold and Silver rallied until a sharp sell off last night. US rates are too. Credit spreads in Club Media at all time highs. There are no many macro dislocations: USD / SFR at 0.765; USD / Yen at 78; Gold at 1670; US 10 year at 2.45%; US 5 year CDS at 55 bp; Germany 5 year CDS at 70 bp; France at 140 bp; Italy 370 bp and Spain 407 bp. Not to speak about some great companies being greatly undervalued. We believe that central banks will continue to intervene on some of the very distorted crosses (e.g. USD / SFR).
Markets are confused what led to the very sharp sell off yesterday. Very high volume in the last few days in the first week of August. Is this computer trading or fund managers? We believe that the markets panicked in the last few days, were driven by programs and the almost daily risk on – risk off on scares many real investors. Valuations in many markets look very attractive and we believe that investors should be constructive.
Friday’s employment data (non farm payroll and unemployment rate) was much better than expected, and will support markets here. Shorts will think twice about their exposure here.
Constructive on equities (US and Europe); precious metals positive, even though Gold getting pricey, buy on dips; most credit (sovereign US and Club Med) still negative, but some great opportunities. Selected HF doing well. Favourite trade: VIX at 29% (up from 24% last week) pricey. For those who bought / are buying buy blue chips on panic enjoy the bounce. USD / SFR on oversold level and intervention potential.
This might (have been or) be the buying opportunity of the year.
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.