Weekly Commentary on Financial Markets: 22-26 August 2011
by Jacob H Schmidt
Dislocation, Dislocation, Dislocation
News of the week: Swiss Frank 3 month rates negative, Buffet getting another special deal, Brevan Howard up 10% in August.
The EU continues to show disunity: Germany’s chancellor Merkel “Nein” to Eurobonds, Finland and other countries asking for more collateral on the Greece deal and a general absence of Eurocrats due to the summer holidays give a good indication of the status quo of the European project. No word from Barrosso and the commission. Merkel getting into more difficulty at home, being criticised both for being too lenient with the demands of Europe as well as showing no leadership and giving up on Europe. We believe that Merkel is a very skilled politician who understands the dynamics of national versus European, but she might not be so safe any longer. From a European perspective really bad. France and Italy are busy cutting their deficits avoiding further stress and a potential downgrade. Thursday’s rumour of downgrade of Germany (from their AAA) was nonsense of course, but enough to drive the DAX down, at one point more than 4% in 30 minutes. Germany suffering for periphery sins. It shows the nervousness of the markets and that stock markets can be used to express bearish sovereign / credit views. My grade: C-
Stocks continued with huge swings, rallies followed by sell offs. Sector and asset rotations on a daily basis. The mood is still that of “risk on” / “risk off”, in a macro fashion. The short selling ban introduced two weeks ago by Italy, France, Belgium and Spain will be extended until September 30. The short selling ban has not done much to the banks, after an initial rally in bank stocks, they sold off again and are currently trading at around the levels of the time before the ban. As written before, you can ban short selling, but you cannot prevent selling by long only investors. In addition the markets always find alternatives in such cases. European and US stock markets are in a really bad shape, looking oversold, but from a fundamental point of view too hot to be touched. Politics, interventions and resulting dislocations make it very tough for real investors to get involved here. My grade: C-
The European debt problem continues to be unsolved: Greece’s reprofiling is at serious risk here, with the Finns and other Europeans asking for more collateral, the low rate of participation by the banks (rumours have it that only 50% - 60% will participate), have pushed Greek yields on the GGB 2013 to 45%, the GGB 2012 55%. In the meantime Italian BTP and Spanish binds trading at around 5%, down from their much higher levels 2 weeks ago, as the ECB is constantly in the markets supporting these bond markets. Not sustainable. Trichet really wants the EFSF to take over, but it becomes increasingly unlikely that the EFSF will get in soon as German and other legislators are deadly against this, including the German president. The risks are multiple: Greece potentially defaulting with no plan, the ECB getting into trouble due to Greece, chain reaction affecting Italy, Spain and France. We are not out of troubles yet. My grade: C-
Commodity markets (Gold and Silver) reacted strongly on the general worries earlier in the week, with Gold rallying to a all time high of 1910 and Silver reaching 44 (high of 49 was reached in April / May). The all time high, news of the Gold ETF GLD having surpassed the SP500 ETF SPDR as the largest ETF led to a 10% correction of both metals within 24 hours. In contrast to Silver which in May collapsed from 49 to 33 within three days, Gold has not sold off more, staying in the 1700 – 1790 range. Volatility continues to be very high, and many investors having again burnt their fingers. My grade: C
In the US stock markets the news of the week was yesterday’s announcement of Buffet’s investment in Bank of America shares. Buffet will buy USD 5 b in pref shares with a 6% coupon and get warrants with a 7.15 strike. Great deal for Buffet, but not necessarily for BofA investors. In 2008 when Buffet who bought into Goldman they called him. This time, he called BofA. There are several important questions: what kind of due diligence has Buffet done, that he can put a substantial amount into BofA? Why did CEO Moynihan accept such a deal (6% being quite expensive with FED funds at 0%)? Is this investment a trade, a punt or real conviction? Is Buffet moving the markets in his favour (GS warrants moved into the money after BofA deal)? Why did he not buy common shares? Why was nobody else offered such a deal. I suspect that Sovereign Wealth Funds, Pension Funds and other larger investors might want to copy this aggressive strategy of approaching firms and getting a “special deal”. However it will not be helpful for the wider markets and the confidence of the general investor. Are such deals fair? My grade: C-
In the FX markets the CHF continues to be in the headlines: The SNB intervened twice with massive liquidity injections (on Aug 3 increasing money supply from 30 b to 80 b, on Aug 17 from 80 to 200 b), pushing short term rates for the first time in the history of a major country to negative. CHF Libor Futures traded as high as 100.72 but have eased off to 100.10 since then. The massive move which came as a surprise to most market participants took some speculators out of their aggressive long CHF FX and short rate futures positions, but rates continue to be negative. The message is very clear: don’t mess with a central bank. Nevertheless we believe that in due courses investors will take again a look at the CHF. A Euro peg is very unlikely. Rather more interventions as seen recently. Big dislocation. My grade: C-
The other focus today and over the weekend is the famous yearly Jackson Hole conference of the central bankers. So far he has not said anything substantial yet, only that he is “prepared to employ its tools as appropriate to promote a stronger recovery”. Bernanke’s statements will be analysed, but we believe that it will be full of Rhetoric and no real action. Bernanke stated repeatedly that rates will stay low (i.e at 0) until at least 2013. Very unlikely that he will have reasons to move from that position. This also means that the dislocations will continue. My grade: B
Extreme volatility will show its toll at the end of the month, with some funds being down 3-5% MTD. As said before this is the test for the talent, and some managers have indeed performed extremely well. Brevan Howard Global Macro Fund is up 10% MTD, the firm made USD 1.5b in August. Other global macro managers are also up, however at lower levels of 2% (Moore) or 3% (Tudor). By comparison the Dow Jones Credit Suisse Core Hedge Fund Index shows negative numbers for all strategies in August (-6% for Event to -3% for Global Macro), except Managed Futures which are up 2% MTD. Hedge Fund investments should be in talent, not indices. My grade: A
Macro data: US GDP growth at a low 1%, Initial Job Less claims slighklt higher at 417,000 (and above the 400k magic level). UK GDP grew by 0.2% in Q2, German GDP dropped 0.1% in Q2. Looking very soft. My grade: C
Extreme volatility in equity, FX and commodity markets over the last four weeks drove many investors away, and even professionals lost serious money. Bond prices too low, but can go even lower (see CHF). Gold sold off as predicted, Silver corrected in sympathy.
Be ready for more surprises, both positive and negative. Buffet style investments and corporate deals very likely (as many companies are cash rich, see Apple). Some risk assets now good value, for the long term investor. Gold and Silver might shine again, this time in sympathy with the equity markets. Beware of more negative news from European periphery. Italy, Spain and France less attractive, Greece might default without a deal. Markets to calm down somewhat, next focus is Labour Day in the US and Obama’s speech.
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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