by Jacob H Schmidt
Bank Bail-out Season, Earnings Season and Year-end Rally
News of the week: Merkel – Sarkozy meeting ended with promise to recapitalise banks, but without details; Apple Founder Steve Jobs dies age 56; Dexia bailed out again; downgrades of Italy and Spain and banks.
Europe – Euro
No progress on European front, banks faced downgrades and sovereigns as well. The banking sector is in bad shape, the stress test of 3 months ago not worth the paper written on it. Dexia, one of the largest European banks, was bailed out on Sunday night by Belgium and France (4 b in cash by Belgium, 90 b in guarantees by France and Belgium / Lux, against Euro 700 b in credit exposure), but the other European banks are under immense pressure. This is very bad news for France and Belgium whose public finance is already in bad shape. J-C Trichet is to retire next month and European politicians are working on plans how to save the Euro and Europe, no longer Greece. The problem is: too slow. We believe that it highly likely that the individual nation states will capitalise their banks, as the EFSF might continue to be used to support the Italian and Spanish bond markets. From a European perspective it would be preferable to turn the EFSF into a TARP, i.e. to capitalise all European banks via one source, but as said before, the EFSF is not big enough. No real news from the Merkel – Sarkozy summit on Sunday: they promise to apply common criteria for the capitalisation of the banks, but no further details. This sounds like so many previous meetings: no real progress; no real plan because “the devil is in the details”. My Grade: C-
Regarding Greece the former taboo – a default by Greece – seems to have become a fact, just waiting to happen. In Germany former chancellor Schroeder presented a plan regarding Europe, including a 50% debt reduction for Greece. Merkel has also shifted her position somewhat, but seems still to target 2013 for a default. Watching events in Greece we believe that they might decide for a default sooner that later. By the way, Greece is running out of money in the next few days.... My Grade: D
Many US data of the last few weeks pointed towards a double dip recession, but last Friday’s better job data has suddenly changed the mood and all eyes are now on the earnings season to start on Tuesday with Alcoa (Dow 30 component). Due to the lower analysts’ forecasts surprises are possible. This could give stocks a boost, and kick off a Christmas rally. Economic situation confusing, Fed still in markets with operation twist, and earnings. My Grade: B+
Stocks specific news (alpha) as well as market swings (beta) have pushed prices of large companies to the tune of 5-15% per day! As an example Xstrata, a FTSE 100 company with a market cap of GBP 27 b can move + 10% and – 10% (or vice versa) within a day. The early death of Steve Jobs is very sad, as he was one of the great leaders of our times, but for AAPL it is bad news in the mid-term, as we believe that the company will no longer benefit from the genius of its founder. No doubt, the company has a deep infrastructure, a reserve of new ideas and we will continue to buy our Ipods, Iphones and Ipads, but AAPL has seen its best days in terms of stock price and looks fully valued. Bank stocks can be toxic here: any bail-out – recapitalisation due to a Greece default can wipe out current shareholders, see Dexia. UBS fired the two managers in charge of the equity trading business, but apart from UBS CEO Gruebel, no other major reshuffle / changes so far. We believe that UBS will only recover after a proper change in culture and management. On the other hand the next earnings season to start on Tuesday could turn US stock market to “BULL”. The VIX at 36% and interest rates at close to all time low could pull investors in, and the marginal buyers such as hedge funds are currently underinvested. We prefer US and UK stocks over EM and European stocks which are riskier. My Grade: B+
US interests rates now higher with US 10 Y at 2.08% (vs. 1.9% last week) and German Bunds at 1.94% (vs. 1.6% last week). In the credit markets Greece is trading in the 30s (price wise) with 174% (1Y), 67% (2 Y) and 26% (5Y) and 23.5% (10Y). Italy (5.4% for 10Y) and Spain (5% for 10Y) bearing in mind the ECB purchases. We still believe that Greece is too early and too high to be bought, Italy too expensive and US and Germany yields to low. My Grade: C-
Commodities continue volatile. Gold currently no hedge, but might recover from here after phase of consolidation. My Grade: C+
Many articles report that hedge funds had their worst quarter since 2008, but we also see many funds which have performed well or at least protected capital. Conclusion: first manager, then strategy. Expertise is key, edge essential and small size beautiful. We also see a come-back of hedge funds of funds. My Grade: A-
No change in our outlook from previous weeks. Key data in the next two weeks will be any action by Greece (potential default or similar announcement), bank bail-out in Europe and the earnings season in the US. Investors will also consider positioning for a (or the) Christmas rally.
Markets driven by more sentiment and robots (high frequency trading, holding positions for seconds only), not by analysis. The next two weeks might be decisive for Greece, Europe, the Euro and the global economy. My grade: C-
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.