Friday, 12 August 2011

Weekly Commentary on Financial Markets

Weekly Commentary on Financial Markets: 8- 12 August 2011
by Jacob H Schmidt
Market dislocations continue, market intervention reach new levels. 
News of the week: Shortselling ban of banking shares in France and some other European stock markets. 
Earlier this week I asked myself: why is it that many market crisis happen or start in the summer? Russia default August 1998, Worldcom July 2002, US subprime crisis July 2007, US banking crisis 2008, 2011 crisis August 2011. While there is no easy answer to this as there were many other crises which occurred in October (1929), Enron (October), LTCM (Sep) et al one explanation is that politicians and decisions makers tend to go on holidays leaving the markets to themselves. If we look at this week’s responses to the crisis there were hardly any comments, and the impression is that so many are away. Speaking to senior people we know that staffing is thin, many CEOs on their break. My grade: C-

Panic selling continued this week, followed by sharp rallies, falls and rallies. Driven by rumours of default exposure (banks), downgrades (France) and stop losses / liquidations liquid equity markets have become volatile and less liquid. Back to 2008 / 2009 price actions. Last night a new ban on short selling was announced. Details for Short selling ban is emerging slowly: no ban in UK, but in France, Spain, Italy and Belgium.  

Are markets dysfunctional or rather governments and regulators? It seems that we are in a déjà vue, after huge swings of 300- 500 points in equity markets regulators revert to draconian measures in the equity markets. The reality is that short selling is only part of the problem, because many participants might sell their LONG positions. You can not forbid selling, can you? A ban on short selling is also a mistake as there are many ways to express a bearish view, other than just shorting a stock: CDS, put options, index arb et al. Short selling ban: big mistake. My grade: D  

After the downgrade of the US by S&P the US government bond markets rallied, CDS tightened, but the USD currency got creamed.  Some unfortunate comments by senior US politicians, but markets switched – as written last week - quickly to the European sovereign situation. It seems that the rating agencies do not understand the dynamics: a downgrade of sovereign debt in its own, convertible FX of a country with huge wealth, resources and a proper taxing system does not make any sense. It is extremely unlikely that a country like the US would default on its debt, but it can devalue its FX. Put the other way around: investors of US govies will always get their USD back, but it might not be worth the same in their own currency. There were many speculations and conspiracy theories why S&P downgraded the US, the reality is it was not the reason for the sell-off in the equity markets.  Fears of a recession, depression and Europe were the reason. The US will continue to be the major market place for years to come. My grade: A-

Europe continues to be a mess, politicians are either on holidays, or silent. What we witness is a real lack of leadership, and lots of uncoordinated actions and comments. The latest announcement of the ECB bond buying program of Italian and Spanish govies lead to a relief of these spreads, at the expense of many other countries. France is now trading at 180 (vs 120 a few weeks ago), Austria 140 (vs 70) and even Germany is up. The following table shows spreads of 5 year CDS (11 Aug prices):

Sovereign Credit-Default Swaps 11/08/2011 change in Spreads  % change in spreads
PORTUGAL 5-YR 893.5 25.1 2.89%
ITALY 5-YR 387.4 12.3 3.28%
IRELAND 5-YR 803.8 26 3.34%
GREECE 5-YR 1775 48.8 2.83%
SPAIN 5-YR 385.7 10.4 2.77%
AUSTRIA 5- YR 143.2 31.4 28.09%
BELGIUM 5-YR 280 22.2 8.61%
DENMARK 5-YR 96.8 7.3 8.16%
FINLAND 5-YR 69.8 4.3 6.56%
FRANCE 5-YR 179.7 11.9 7.09%
GERMANY 5-YR 88.4 4.6 5.49%
HUNGARY 5- YR 405.6 -4.4 -1.07%
NETHERLANDS 5-YR 77.4 5.8 8.10%
SWEDEN 5-YR 58.3 4.3 7.96%
UNITED KINGDOM 5-YR 90.3 5.8 6.86%
UNITED STATES 5-YR 54 -0.4 -0.74%

Source: CMA

Our concern is that after Italy, France might get into serious with the recent widening from 120 – 180. What if French OAT widen to 300? We believe that the ECB program is half baked. In a research note dd. 9 August (Commentary on ECB Bond Buying Program and Policy Recommendations: Why the new bond purchase program is not enough) we suggested that the program should be supplemented y serious buying of such govies by local buyers / pension funds. This would lower the moral hazard. My grade: C- 

FX markets experienced extreme levels when USD/SFR reached 0.71, EURO / SFR 1.05 and Yen dipped as well. Potential intervention by the local banks pushed the USD back to 0.77. Lots of vol, showing the distress and panic in the markets. For borrowers in SFR (most homeowners in European countries, e.g. AUT borrow in SFR to save on the interest rate; public institutions use Swissies to lower their interest payments, e.g. 72% of the City of Vienna’s debt is in foreign currency) very painful. Combining debt with FX speculation is not a good idea, without risk management potentially lethal. My grade: C-

Lots of extreme situations to buy shares this week, but at high volatilities. We believe that mid term these levels in stocks are attractive, but after the short selling ban, and more interventions by central banks and regulators could continue their dislocations. The debt of the European Club Med countries and their restructuring, and now the contagion to France pose serious risks to the markets. As suggested last week: no decoupling of Asia in the event of a bigger European problem.  

Hedge Funds:
Hedge Funds have lost some money, but in general protected well. Some senior people got wacked (Barton Biggs, Paulson). Top Hedge Funds of Funds fulfilling their function as low (lower vol) capital protection plays. My grade: B+

Very unclear where to go from here short term, liquid equity and FX markets will continue volatile, after short selling ban, some markets might dry up. Gold margins increased, and levels of under 1800 all time high, but still attractive for those who don’t trust governments (unless you believe that Gold buying might get banned, see 1980s). Silver relatively cheap here, but very volatile.

Last week I wrote: This might (have been or) be the buying opportunity of the year.  Was it? Yes, if you bought at dips and sold immediately, or held and sold into the second or third bounce. Or sell into the next rally. Don’t panic, but don’t use too much leverage here.
Now: Lots of opportunities, but lots of risks. Too much noise and too many interventions. We recommend caution, buying on dips of blue chips, value for long term, but potentially selling immediately if you are ITM within a few hours or a day or two. Good hedge funds and funds of funds also advisable.

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.

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