Weekly Commentary on Financial Markets: 3 October 2011
by Jacob H Schmidt
Difficult times for investors
News of the week: EFSF backed by German Bundestag – with constraints; Greek’s next tranche at risk; Buffet in buy back of Berkshire Heathway shares
Europe – Euro
The main concerns of the markets – Euro, EFSF, ECB and the debt problem continue to dominate the markets. Germany’s vote on the EFSF was greeted as a success – only short term though- and is deemed to put pressure on the smaller outstanding countries to conform. The different ideas regarding the EFSF – extending the EFSF from Euro 400 to Euro 2 t; leveraging it by 5 times; using the money to capitalise the banks – floated by politicians, market participants and academics, remind us of 2008 when US Secretary of the Treasury Hank Paulson fought for the TARP in order to support the ABS markets and buy bonds, but changed his mind and saved the banks. Too many ideas, lack of strategy. We believe that an increase in funds for the EFSF is highly unlikely (too difficult to get national support) and the leverage by a factor of 5 risky (its effects not guaranteed). The EFSF will probably take over from the ECB and continue the stabilisation of the Italian, Spanish and other weak government bond markets, until they reach the ceiling and will ask for an increase (and will get a small increase, as part of the muddling through strategy). There is a small chance that the EFSF will become a European TARP, capitalising the banks. The funds would be sufficient and the mission welcomed by most in the markets. Some countries might not like such a development as they would lose the grip on their banks. My Grade: B-
The European Commission’s Barroso gave a big speech on Wednesday to ask for more powers claiming that Brussels (Brussels- Strasbourg) would be better positioned to run fiscal and economic policies than the member nation states. It is not certain that this is really the case, but looking at recent surveys in Germany where 44% in favour of a return of the DM and 75% against more money for a euro rescue fund it seems that the commission is not in sync with the population. My Grade: B-
Greece fighting on all fronts to avoid a default: the PSI (aka reprofiling of the debt) pending, the second tranche – key to avoid a default as Greece will run out of money in the next few days – at risk as the statistical data to be provided by Greece might not be finished and delivered to the TROIKA on time (deadline this Friday). We hear of more demonstrations and real desperation of the Greek population, a dangerous development. It is possible that politicians might consider a default the smaller evil, in the very near future. This is obviously in contrast to the major European states who need to avoid a default to save their banks. We believe that with the second week of October the risk of default is extremely high. While plans are out to tackle this scenario, the reality will be ugly for markets and dislocations dominate for some time. My Grade: C-
While US president Obama suffers from low approval rates due to the bad economic data and risk of a double dip recession, the USA are considered the safe haven in the current global risk environment. China’s slowdown and potential end of the property boom, no decoupling of Asia from a global recession and European debt problem and signs of stress in LATAM make US bonds and equities make look relatively attractive. The political stability and the creativity of the US population are positive factors, but the enormous debt problem, high unemployment and low growth are serious risks which the markets will remember and refocus soon again. We are concerned that in the event of a double dip recession (triggered by a Greece default, the bursting of the China property bubble, or other) the FED will have no tools left: interest rates are already ultra low, the yield curve manipulated via operation twist and QE. My Grade: B
Equity markets closed down for the week and month. On the one hand have been reporting good earnings and are sounder than in 2008, there are several risks out: earnings disappointments (a la UBS, Man et al), contagion in the event of Greece (banks), risk of a global recession (all stocks), China slowdown – hard landing (miners, China and EM stocks, luxury goods). Man shares sold off 25% in 2 days after reports of big outflows from their hedge fund business. Another rather curious development is Warren Buffet’s announcement that he will now buy back Berkshire Heathway shares (A and B), probably in the range of USD 20 b. This is a strange development as Buffet has been against share buy backs. We believe that he has deviated from his investment approach and engages in transactions which no longer fit his deep value philosophy. The size of the company is definitely too big. The share buy back is a mistake. In general we believe that the next month will be crucial and could be very dangerous, after that some kind of Christmas rally can be expected, even though short lived. My Grade: B
Interests and bond markets look very dear with US 10 Y at 1.9% and German Bunds at 1.6%. In the credit markets we would wait for cheaper levels in Greece (20s/30s rather than current 40s), Italy and Spain expensive. My Grade: C
Commodities suffered one of the worst weeks: all were down, some more than 20% in 2 days, with high volatility. We see commodities in the hands of traders, short term speculators and ETF investors who have very different views that the traditional commercial participants. This trend is likely to continue for the foreseeable future. My Grade: C
It is obviously too early to get a proper picture of this month’s performance of the entire industry, but it seems that managed futures and EM were positive while most other strategies were flat to slightly down according to Dow Jones Credit Suisse Core Hedge Fund Index. In any event Q3 and YTD the performance of the indices is negative (YTD -7.3% for the index) which is disappointing. However we see significant divergence in all strategies and also on the HFoF level. In the current markets flexibility, experience and liquidity are key for the success of a manager; manager selection being more important than strategy selection. In addition size is also a factor: smaller AUM easier to manage. Funds on our shortlist are 0-10% up for the year, depending on risk, style and size. My Grade: A-
Difficult markets for investors due to political, economic and market uncertainty. While equity markets look more attractive due to the dividend yield / bond yield differential and we see some great bargains, stocks could suffer in a Greece default scenario. We recommend to keep the powder dry and use the high levels of volatility (via options, trading approaches et al). If and when the issues of Greece et al will be addressed markets will react very fast. Investors have to be positioned for this outcome.
The next two weeks might be decisive for Greece, Europe, the Euro and the global economy. My grade: C-
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