Weekly Commentary on Financial Markets:
5 December 2011
by Jacob H Schmidt
Waiting for the next key date: 9 December
News of the week: central banks provide emergency USD funding for banks; UK debt threaten to get out of control; markets had best week in short covering and Christmas rally
Europe – Euro
As expected more sweet words, lots of political positioning in France, Germany and UK, but no solution in sight. As we wrote last week, we will look into the abyss and the rumour has it that last week one (or more) banks were in trouble. The Fed decided to do the right thing and show leadership by providing emergency funding via USD swap lines with the major other central banks. That is the good news. The bad news it is not enough, and by no means a solution. After so many summit, deadlines and announcements of bail-out packages the market and investors have lost faith in the politicians’ will and ability to sort Europe out. It becomes clear that long term goals and short term political mandates are difficult to square. We continue to believe that a break-up or collapse of the Euro is unlikely, but changes in the membership possible. We foresee two possible scenarios: a. a temporary exit from the Euro, e.g. via a wider trading band, to allow a specific country to regain competitiveness or b. a split of the Euro into two sub Euros, a Northern, stronger Euro and a Southern, softer Euro. The PIIGS could all be part of the softer Euro, but still be part of the overall Euro currency and idea. How to implement this? Look at the letters on the Greek, Italian et al banknotes (Y = Greece, S= Italy, M = Portugal et al). Banks and sovereigns are trading at wide CDS spreads to Germany and other hard currency Euro countries. The change in rhetoric by Madame Merkel as noted in her speeches over the last year points towards a change in her view of the Euro, but not a complete dissolution as prescribed by many economists outside the Euro and Europe. We believe that many experts outside continental Europe lack the deeper understanding of European decision making and in particular central European politics. Last but not least, the ECB will be part of the solution, directly or indirectly via the IMF.My Grade: C-
No progress on restructuring, hopes that Greece does not default too soon. Greylock Capital, a New York based hedge funds with extensive experience in restructurings in Latam and other EM – and whom we have known for over 20 years – has been invited to join the steering committee for a Greek restructuring. The inclusion of a specialist like Greylock is positive as they can bring valuable experience to the table.
My Grade: C-
No news regarding a much needed support loan or bail-out package. On the positive side Italian savers and pension funds seem to like the 7 and 8% handle and buy Italian bonds. A strong local market could make all the difference.
My Grade: B
Better economic data in the US (unemployment now at 8.6% after Friday’s job number), but low growth of 2-3% max, if any. Herman Cain, one of potential Republican contenders for the US presidency withdrew over the weekend. US markets stronger on more confidence in the US economy and US leadership.
My Grade: B+
Better earnings, oversold levels in shares and a feeling that stocks – in particular multi-national companies – are better risk than most sovereigns. Recent IPOs have not done well, see Groupon, Glencore et al. The announcement that Facebook might offer shares valuing the company at USD 100 b means indicates a peak. But I am convinced there are plenty of investors who can’t wait to buy at the top. Similarly ETF Securities is looking for a buyer, probably a trade sale. Same scenario, fully valued.
My Grade: B
The emergency swap lines lifted markets, just in time for a month end rally. High correlation in all asset classes, equities, commodities and other risky assets. Markets are likely to stay volatile, but with less than 20 trading days left in 2011 hedge fund and long only buyers who all underperformed this year should come in and buy on dips. My Grade: B+
UST 10 Y at 2.06%, 30Y at 3.06%, many investors (e.g. hedge funds and PIMCO) having positioned themselves in long dated bonds to sell to the Fed for the twist operation. No luck so far, Pimco at the bottom this year. German bonds rallied a bit, 10 Y yields down from 2.30 to 2.13%. My Grade: C-
Spreads volatile over the week, Italian bonds have rallied from the 8% (2Y) and >7% for 5-10 year BTP to below 7%. Greek bonds are trading at 22 bid, price, not yield! At these levels Greek bonds start looking attractive. My Grade: C+
Gold, Silver and other commodities very strong. Gold rallied after South Korea increased their reserves. Gold and Silver now risky assets, could extend their rally into new year. My Grade: B+
Volatility: VIX down to 2% from 35 % last week.
We saw several more hedge funds over the last week, most of whom have defensive portfolios, flat to negative returns for the year and find it difficult to run bigger exposure. The high volatility is a serious problem for any fund with more than USD 300 m. In addition credit funds using equity markets as hedges introduce more volatility to the already less liquid stock markets. Global Macro should also do fine, alas many hedge funds – among them many blue chip names such as Moore, Paulson, Caxton - have disappointed. In our view smaller hedge funds run by experienced managers and hedge funds funds of funds allocating into smaller managers with a focus on trading and volatility will continue to be the better choices. My Grade: A-
Markets moving in steps, any good news leading to short covering rallies, any slightly negative news to sell-offs. Due to the chronic under-investments of hedge funds and many other investors, corporate activities and short covering from cross hedges we remain slightly positive until year end.
Markets awaiting the December 9 deadline, to see whether Europe will sort itself out. We believe in mini fixes, avoidance of disasters, but no proper solutions. While the outlook is uncertain and staring into the abyss becomes more common, companies continue to operate and make money. Hence the extreme pessimism and horror scenarios painted by Dr Doom & company have to be taken with a pinch of salt! My grade: B+
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