Weekly Commentary on Financial Markets:
7 November 2011
by Jacob H Schmidt
Towards more instability – waiting for Roosevelt and a European New Deal
News of the week: Papandreou out – coalition government until elections in Feb 2012; Berlusconi out soon as well; European Q3 earnings season in full swing
Europe – Euro
Another round of meetings, this time the G20 in Cannes as of last week ended with little substance, apart from animosities towards Greece. Focus of the G20 meeting was Greece and Italy – whose PM Berlusconi is increasingly isolated in Europe – no mention of the other basket cases Spain, Portugal and Ireland. The October 26 bail-out has already lost momentum as the Greeks have not accepted the deal, the EFSF is short of money and concerns over the banks dominate the markets. While the media focuses on the Greek drama – Papandreou to resign, a new PM in the person of respected frontrunners Papandreou or Dimas – the reality is that Greece is in a serious political crisis on top of the economic crisis, but Italy is the real problem: 10 year BTP are trading at 6.6% and 30% north of 7%. With Italy facing political turmoil investors are unlikely to pick up BTP at these supposedly attractive rates as these bonds will get even cheaper very soon. The only buyer in town is the ECB, and they have limited resources. The EFSF will be too small to do the heavy lifting. PM Berlusconi might be out of office soon. Out of the three scenarios or Europe
a. no change – continuous instability;
b. reversal of the European project;
c. further integration with a common bond market and fiscal policy
the likelihood of no change with short term fixes is high (70%), and 15% chance of cases a. and c.
My Grade: C-
In Greece the drama continues, as Papandreou has agreed to resign and the search is for a new prime minister. Both frontrunners have good credentials, but will they be in a position to change anything in Greece? We believe that the interims government will satisfy the formal requirement for the next tranche and buy time. It is not in Europe’s interest that Greece collapses, but the outlook is very grim for Greece. The stability will be very short term. The risk that the new Greek government could go for a default and Euro exit has increased. The immediate default risk (2011) relatively low (2011 bonds trading at prices of 88-90), but any bond after New Year is at risk. My Grade: D
The WSJ reported last week that 15% of all US citizens rely on food stamps. This is the real tragedy of the recession and the 2008 crisis: official unemployment rate of 9%, unofficial rate of 16%, structurally many are long term out of job and poverty in one of the richest countries of the world. While the US debt is a problem, the increasing poverty in the US is the real failure of the administration. Most European countries do a much better job. The US debt problem will become the focus soon again, when the Joint Select Committee on Deficit Reduction aka Super Committee set up in August 2011 will have to issue a recommendation by November 23, 2011. Nevertheless US debt looks safe versus the less stable European debt markets. US rates to stay at 0% until 2013 at least according to last week’s FOMC. My Grade: B+
European companies report Q3 earnings, most doing ok, except for the banks, who show heavy write offs due to exposure to Latin Europe and difficult equity markets. BNP Paribas reported a Euro 2.2 b write down on Greek debt (a 60% write off), more French banks to follow this week: Soc Gen, Natixis and Credit Agricole. The focus will be the write off of sovereign debt, the revenues from the business segments and redundancies. The higher capital cost due to Basel III and additional buffers will make banks less profitable. We see more use CoCos (conditional convertibles) to achieve the higher ratios.
In the US Groupon went public with a 30% increase on day 1 (from 20 to 26). While many investors are very critical of the business model and the numbers, the IPO was a first day success due to the controlled size (5%) and probably the role of the syndicate. We believe that Groupon used a small window of opportunity to go public which might close again soon. Linkedin trading at 300 times next year earnings, Groupon at ??. Groupon et al stocks are really for day traders and hedge funds flipping on the first. No serious investor would buy a company with a P/E of 300 or even negative P/E. A lot of OPM buyers. My Grade: C+
Continuous high vol in equity markets, FX and bonds which are overshadowed by macro events. Sovereign risk appraisal is en vogue again. My Grade: C+
In the world of economic uncertainty and sovereign risk stocks have been doing reasonably well: Dow is up 3% YTD, SP500 flat, FTSE down 6%, but European and EM stocks down more than 10%. Good, stable companies in liquid markets looking attractive, and the constant sell offs allow investors to pick up great stocks at cheap levels. For traders this creates additional opportunities. My Grade: B+
US rates volatile from week to week: 2.04% vs 2.31% for 10 year notes (vs last week); Rates also lower now in German bunds (1.84 vs 2.19%). Too much volatility for large government bond markets. My Grade: C-
Wide spreads in Italian BTP, now at 6.6% for 10 year bonds. Greece at default levels. Spain at 5.6%. Irrespective of Berlusconi or a new government, Italy needs to roll over Euro 300 b next year. My Grade: C-
In the commodity space base and precious metals also volatile. Silver at 34.5, Gold at 1760. My Grade: B+
Volatility: VIX up to 30 % from 24% last week.
A tough year for hedge funds, as Dow Jones Credit Suisse Core Hedge Fund Index was up 1.85% in October but down 6.1%. YTD. HFoF doing better, showing that fund selection is key. My Grade: A-
Continued political uncertainty, default risk and the fear of a double dip recession guarantee high volatility. For investors the choice is tough as HF and PE flattish at best, most equity markets down and rates low. The Christmas rally in equities has limited upside, investors tempted to take profits where possible.
While European and world leaders disappoint and the naive hope that China would save Europe got dashed, the risks of instability are increasing. According to our analysis there are many parallels to the developments after 1929 when leaders missed the opportunity to reform the process. It took four years until 1933 when President Roosevelt got elected and started the New Deal. Europe is waiting for its Roosevelt (or Roosevelts) and New Deal. My grade: B-
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