Weekly Commentary on Financial Markets:
16 January 2012
by Jacob H Schmidt
Europe at Risk
News of the week: S&P downgrades 9 European countries Friday night; ECB leaves rates unchanged; earnings season has started
Europe – Euro
The awaited downgrade of AAA rated European countries occurred Friday evening, shortly before market close. While Austria and France lost their important AAA rating, Italy and other EU countries were also downgraded. In Austria the downgrade generated much fear and discussion; however in France the government and public seem more relaxed and blame the rating agency of ill timing. Germany which was rumoured to lose its AAA as well was left unchanged. Whatever opinion one might have of the downgrades and the timing, they are not good for the financial markets and the real economy. Politicians have very little time to act now. Last week the ECB left Euro rates unchanged and provides ample liquidity to the banks. The next issue will be the Greek GGB maturing in 2 months time. It is hard to believe that the rating agencies still have all the power and influence, after all their plunders and mistakes, and the bad opinion politicians and policy makers have of them. An overhaul of the oligopoly of the rating agencies is overdue. My Grade: C-
Worrying developments in Greece: no progress on the debt problem as some hedge funds want lower discounts (as they are long having bought bonds in the 20-40 price range), but Greece needs a larger discount for the restructuring to make a difference to the current huge burden. Others who are long CDS are waiting for the default to benefit from a potential maximum pay out. Two German politicians mentioned a possible exit of Greece from the Euro (politicians close to Angela Merkel, which might mean that they are preparing the floor for her) without repercussions for the Euro and the markets. We believe that with the current developments an exit becomes very likely, and hopefully later rather than sooner as the disruptions could be massive. We are very concerned about the consequences. A Greek departure might trigger the departure of two or three more countries to follow. It is possible to find a solution within the Euro (a two tiered Euro). My Grade: C-
Italian BTP yields lower (6.64% for 10 y BTP) after more successful bond auctions of short and mid term debt. However the situation remains very tense, and the demand for bonds stems from the LTRO (3 year ECB program) and the ECB bond purchasing program. There are also some Italian and high yield buyers in the market. My Grade: B
Fragile recovery in the US: jobless claims were slightly worse than expected, consumer confidence is better. Most market participants agree that the US is in a better shape than Europe. But the trend is still weak and a change in sentiment could derail the positive development over the last few months. My Grade: B+
Earnings season started last week. Much awaited JP Morgan reported earnings in line with estimates (0.9 cents for Q4), which the market did not like and sold off (-2%). We thought that JP Morgan would surprise again like in the previous 8 quarters. Nevertheless the reported earning and the numbers are decent enough and better than many other banks. The interesting part in our view is the loss of app. USD 500 mm (before tax) due to the DVA (debt valuation adjustments). As discussed regarding other banks who mark their liabilities, banks can show profits when their debt prices fall in the secondary market, but must also mark up the debt when prices recover. This can be quite costly. This week, many financials, including Wells Fargo, Citi and Goldman Sachs will report earnings. My Grade: B
Market were a bit more volatile, but had still a positive spin. We believe that the downgrades will push markets lower, and with much uncertainty regarding Greece and other PIIGS we could see much lower equity prices. Volumes in the major markets have been very low until middle of last week; they increased in the last 3 days to normal levels.My Grade: B+
Lower yields again on US Notes and Bonds (UST 10 Y at 1.85%, 30Y at 2.91%). German bund 10 Y yields at 1.77%. Yields much too low, but could go lower on flight to safety trades. My Grade: C-
Downgrade of French and Austrian government bonds probably priced in. My Grade: C+
More range trading in Gold and Silver. Oil very volatile. My Grade: C+
Volatility: VIX still at 20%. Looking quite cheap.
We saw some positive numbers for the first 10 days of trading. Good start of the year. My Grade: B-
The downgrade of the 9 European countries was expected, but nevertheless could push sentiment towards negative again.
Due to the massive macro risks we recommend defensive strategies with wealth / capital protection as the foremost objective. 2012 could be a nasty year. My grade: C-
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