Weekly Commentary on Financial Markets: 15- 19 August 2011
by Jacob H Schmidt
More panic in global equity markets after disappointing Merkel – Sarkozy summit, Europe under more stress.
News of the week: Swiss National Bank considering EURO peg.
After the much anticipated and discussed Merkel-Sarkozy summit which was deemed to clarify the European debt problem the outcome was another headline event with little substance: news of a European economic government and more coordination, and a no to Eurobonds (bonds issued by the EU, in EURO, as a joint commitment). The market had expected some sort of news on Eurobonds and sold off in the absence of any news. We believe that Eurobonds are either to come shortly (within 6-12 months) or the EURO and Euroland to suffer more stress. Another sign of European leaders rather listening to their voters. Big embarrassment for Barrosso and the commission. My grade: C-
In the middle of the week more rumours of the health of European and US banks’ balance sheets pushed global stock markets down, with extreme panic selling on Thursday and more panic on Friday. It seems that a combination of risk on – risk off, forced selling by hedge funds and many people on holidays led to extreme swings in equities. European markets rallied Friday midday to recover from the lows of the week before European close, but US markets closed down again. The short selling ban as introduced last week on financial stocks of four European markets did not achieve anything: while short sellers had to cover their shorts, more long investors sold their positions. Others dumped index futures. A Deja vu of 2008. Equity markets as the catalyst for FX and European sovereign debt problems. My grade: C-
The European debt problem remains unsolved, no news of a European resolve, but more bond purchases by Trichet. The program has pushed yields from over 6% in Italian BTPs and Spanish bonds to below 5%. Next week Belgium and Slovakia will issue new bonds for the first time since the recent market crisis. Good to know that the ECB is the buyer of last resort. In addition banks buying them can refinance them with the ECB. While the bond purchase program has worked so far, the moral hazard has been increased, and it is unclear what the ECB would do with the portfolio in the event of a default. Anyway the program has bought policy makers some time, but the clock is ticking. My grade: B+
There is a lot of confusion regarding a “Eurobond” issue program, meant to lower the refinancing cost of the problem countries. We do not believe that Eurobonds are the right solution, rather, as suggested last week, investors such as Italian and Spanish pension funds should participate and buy their governments’ bonds. It would show commitment and lower the moral hazard. My grade: C
Tomorrow the first Greek GGB (EURO 5.9 b; 3.9% GGB 20 Aug 2011) has its maturity date. Friday’s quote of 99.5-100 indicates that the bond will be repaid. We are not so convinced of the fate of the next maturities (May, March and Aug 2012; app. EURO 30 b). Greece cannot afford paying them back, and a default or the suggested reprofiling is overdue. Despite the announcement of the deal in July we have not seen further details. The exchange was supposed to occur at the end of August 2011. More likely the exchange will take place 2012. My grade: C-
In the FX markets the CHF vs USD and EURO weakened from its highs at the end of last week / beginning of this week. USD / CHF rallied from 0.71 to 0.80 within 2 days on the rumour of SNB interventions and a EURO peg, but sold off immediately after reaching the 0.8 mark. Some late CHF bulls were stopped out of positions, but CHF remains relatively strong, at the pain of the Swiss. We do not believe that the Swiss people really like a EURO peg, and the bazooka might not work long term. Desperate attempts by the SNB, which might end in more FX reserve losses. We expect CHF to continue at these levels for the near future, as long as Euroland and USA are a mess. My grade: C-
News that Barton Biggs cut positions while Warren Buffet bought (both when markets were at the lows) give some indication of the hedge fund industry. Actually we believe that Buffet is a HF manager in disguise, while former giants like Barton Biggs, Paulson and other find it very tough to manage money at these extreme levels of volatility. Some true talent make good money, though (in the high single and double digit range YTD). We believe that 2011 is an excellent test for all managers, and we are adjusting our short list of managers. From a due diligence point of view many managers fail our stress test. HF indices show modest returns, but no disaster either. My grade: B+
We believe that due to the high volatility the thousands of ETFs which rely on their market makers could be at risk: long term (hold) investors might end up with illiquid instruments. Most ETF are really short term in nature, serving as alternatives to futures contracts for participants who cannot / do not want to use futures. Not all ETFs are bad, but every instrument has to be due diligence checked before invested into. My grade: B-
Macro data: bad Philly data, German GDP low, risk of recession. My grade: C
Equity markets’ high vol versus lower vol and lower yields/spreads in Club Med showing the dislocations created by the interventions left and right (short selling ban, Gold margins, SNB, ECB et al).
No change from last week’s view. Crazy market actions to continue until UK bank holiday (Aug 29) or even US Labor Day (Sep 5). Gold looking very expensive here short term (up 25% since July), but more upside possible mid term if turmoil continues. Silver cheap in comparison.
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.
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