Weekly Commentary on Financial Markets: 24 October 2011
by Jacob H Schmidt
No Bazooka weapon – rather Bazooka chewing gum
News of the week: little progress on European bail-out plan; questions over Chinese slow-down; US earnings season going well
Europe – Euro
We are still waiting for the “bazooka”, but it becomes clear that the package will be much smaller than initially hoped for. Last week’s false news in the Guardian that the European package would be worth north of E 2 t led to more market volatility. Due to much disagreement around the details the deadline for the announcement of the details of the package has been moved to October 26, 2011 when the European ministers will meet again (after this weekend’s meeting). We hear again that other parties such as the BRIC countries should be brought in, but the main idea remains some sort of leverage of the EFSF. We believe that we will see a smaller plan, enough to prevent a market collapse in order to get us to another summit in the next few weeks. In conclusion we seem to get Bazooka chewing gum – remember the funny comic strips and the bad taste the gum leaves in your mouth. My Grade: C+
The only progress in the Greece PSI is in the much higher haircuts discussed: instead of 21% implied the levels are in the 50-60% range, in line with market levels for Greek debt. Time is running out for Greece and the creditors, but it seems that a default will be avoided at any cost at the moment. Most market participants agree now that Greece has to default and it might be better for Greece to do so sooner rather than later. If they take the pain now, go through one or two years of contraction and restructurings, devalue the currency and regain competiveness, Greece could emerge from the crisis within short period of time – see Mexico 1994, Russia 1998 et al. But it is more likely that the short term fixes continue as politicians believe that the ECB and the European banks would suffer from a default and its contagion. My Grade: D
US earnings relatively positive so far, better than the revised low estimates. My Grade: B+
Equity markets continue volatile due to the uncertainty in Europe, but at relatively high levels. US markets are at levels not seen since June, but Europe lagging behind. Company specific news again more relevant. Interesting developments in the miners (Xstrata, Glencore, BHP Billiton), banks (US versus European) and IT (Apple, HP et al). My Grade: B+
US rates again higher on the long end (2.22% at 10 and 3.27% at 30 year). Market seems to test Fed’s willingness to buy bonds for operation twist and a potential QE3. Bonds still looking pricey here, but if inflation is to drop, Fed intervenes and markets scared due to Europe, they could rally again. Market also knows that PIMCO went long long-dated bonds in massive operation twist speculation. Rates also much higher now in German bunds (2.11%). My Grade: C-
Commodities continue sideways with high volatility. My Grade: C+
With only three months to go in 2011 and performance across the industry rather weak some hedge funds find themselves in a difficult position: should they add risk here with the potential to turn around for the year (a la PIMCO who has underperformed in long only bonds and has put on his massive long duration tarde), or rather preserve capital. The answer seems to be rather the capital preservation strategy as this is what institutions want and need. We see three developments: a. pension funds and institutions are still interested in hedge funds of funds, but also look at single HF and other structures; b. focus is on low risk, little correlation and capital preservation; c. institutions care for the content, not the wrapper. My Grade: A-
The Christmas rally in equities likely to continue for one or two more weeks, selling on the news of a bail-out possible, in particular if high expectations of markets are not met. Investors are confused (term sued by Woody Brocks at Asset Allocation conference last week). Popular view among academics is now that inflation to drop from here (UK headline 5.2%), Greece to default and fiscal policy needed rather than more monetary interventions. At an asset allocation conference I attended last week Nouriel Roubini painted a very dark picture regarding the debt problem in Europe and the US – in line with his reputation as Dr Doom. Other leading economists who grosso modo agreed with him included Woody Brocks – who gave an excellent presentation – as well as the IMF economist for Europe. Investors – both institutional and HNW – have become more tactical in their asset allocation and use many new instruments, tools and techniques, but avoid some products they deem expensive or less useful (e.g. new vol ETF et al).
Markets have started discounting good news and assume now that the politicians will release a substantial package. The solution will be a short term fix, but good enough to take the fear away for several months, before getting into trouble again. My grade: C-
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