Europe - Euro
Despite rather mixed news out of Europe and a hardening of positions regarding Greece and Hungary, the bond markets of periphery and the Euro rallied over the last week. European politicians have recognised the risks and importance of the crisis and are working full speed, nevertheless national politics and Brussels are at odds. In Germany the discussion continues to what extent to help Greece and the periphery and to what extent to force the German budgetary, fiscal and monetary constraints on the rest of the union and the countries to be bailed out. France is busy with the upcoming elections. And the financial transactions tax opposed by Britain is work in progress and might be introduced in France as early as August of this year and in other countries thereafter. This will widen the gap between the Anglo Saxon and the continental European approach to a new financial system.
My Grade: B-
Greece
Negotiations for a restructuring and the bail-out package of Euro 135 b continue, with an increasing probability that the deal might not happen. The status quo is that private bond holders will take a 50% hit on the principal amount and accept an interest rate of below 4% for new 30 year bonds. As only 60% of the bonds are in private hands (aka banks and other investors) and 40% held by the ECB and other public lenders the debt reduction will not be enough to make a difference in the short run. The proposed deal will reduce debt to GDP from currently 160% to 120% by 2020 only. The deal is necessary to avoid a default on the bond maturing in March. With a severe recession now in its 4th year and 18% unemployment, Greece might be tempted to refuse the bail-out on the grounds that they are not better off with the arrangements, in particular as Germany and the EU want a budget commissioner, effectively a loss in sovereignty. Greek bonds are trading in the low 20s. We believe that any deal will be short lived as Greece really needs a 80% discount on the face amount plus a low coupon. However this will only happen in stage 2. My Grade: C-
Italy
Italian BTP yields are lower again after successful debt auctions of 3 year paper. The yield for 10 year BTP is now below the magic 6% (5.89% on Friday 27 Jan 2012). We had a similar drop in BTP yields in November 2011, but they reversed quickly again. The LTRO is working, for the time being at least, but let's not forget the ECB is holding north of Euro 200b in BTPs and Italy has a total of Euro 300b to refinance this year only. My Grade: B
US
Both macro as well as micro data coming out in line or better. My Grade: B+
Companies
Earnings season has started well with a good number of surprises. Most financials and many other important companies have reported and the focus will now shift to month end trading and the rumoured Facebook IPO, expected to be priced in the USD 100b range. A great company, possibly next to Apple the other great American brand of the 21st century, but at USD 100b somewhat fully priced. My Grade: A-
Markets
Compensation of CEOs and board members is dominating news, with both the RBS chairman and the CEO giving back their bonus for 2011. We believe that this is a healthy debate, long overdue. The markets continue to climb with vol now at 18.5% for the VIX. US stocks up 20% from their November low. In our view stocks are now fully priced for the short term, but mid to long term have still value. Markets will be vulnerable against any bad news such as Greece, Iran or bad economic data.
My Grade: A-
Interest Rates
US rates continue low, after Bernanke's speech last week in which he indicated that rates will stay at low levels until 2014. German bund 10 Y yields also low at 1.87%. My Grade: C
Credit
The Jan 13, 2012 downgrade of French and Austrian government bonds has not had any short term effect. My Grade: C+
Commodities
Gold and Silver rallied together with other commodities. Crude has upside here due to the situation in the Middle East. My Grade: C+
Volatility: VIX now at 18.5%. Looking quite cheap.
Hedge Funds
Talking to many equity hedge funds they have a positive exposure and are quite bullish on the market. David Einhorn's fine by the FSA for insider trading / market abuse shows that the regulators are acting much tougher than in the past. We applaud the FSA for being more active than in the past. However it is questionable whether in this case David Einhorn really committed an offense and deserves the fine. In general a very good start for the industry with strong numbers in all strategies except for short bias and managed futures. We prefer relative value and hedge strategies over directional ones. With USD 2 t in assets, low interest rates, a lot of uncertainty and good HF performance we will see more inflows. My Grade: A
Outlook
While macro and micro data are getting better in the US, there are many risks which could derail the recovery in the US and the positive mood in the stock markets. Greece and Hungary are the immediate risks, followed by Iran and later the elections in France, the US and many other countries.
Conclusion
For investors the objectives of positive returns and capital protection are key. Hence any exposure should be taken under deep value / long term aspects and / or on a hedge basis only. My grade: B+
Grading: A, A-, B+, B, B-, C+, C- D (adapted from American University Grading / Marking System), higher marks for visibility, clear outlook, little risk, lower marks for little visibility, unclear outlook, high risk.
Jacob H Schmidt,international financial markets expert, HF expert, Webster Finance Professor. Expert Witness. Anglo- Austrian, multi-lingual,-cultural, critical thinker. CEO of Schmidt Research Partners Ltd, an investment advisory firm and MD of SFP-International Ltd, a consulting and training company. Available for high quality investment advisory, due diligence and consulting projects.
Schmidt Research Partners are expert providers of advisory services, due diligence, research, consulting and training in financial markets.
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.
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