Wednesday, 8 February 2012

Weekly Commentary on Financial Markets: 6 Feb 2012

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Weekly Commentary on Financial Markets: 6 Feb 2012
Issue: 4                                                                            6 Feb 2012

Crunch Time for Greece and Europe     
 News of the week: Greece bail-out and restructuring still unsolved; facebook IPO prospectus out; Swiss banks reporting 2011 earnings  

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Europe - Euro
News and markets continue to be dominated by the debt story: how to save Greece, the banks and ring fence the other countries from a contagion. Lots of rumours but no real progress. More below. As banks report earnings, the issue of compensation and bonus comes up again. In the UK RBS was in the headline for the boni of the current chairman and CEO of the bank, who were supposed to be paid a bonus despite significant redundancies and no profits. In addition her majesty's government took the opportunity to strip the former CEO Sir Fred Goodwin of his knighthood, demoting him to a commoner. A very rare occasion, but many asked the question where is the action on all the other culprits. In the US the bonus of Goldman Sachs CEO Blankfein and others is top news.
Apart from Greece, Hungary is the other - less reported - debt problem in Europe. The situation is very tense there, as companies cannot service their debt. Malev, the national carrier declared bankruptcy on Friday after 66 years of service, as the European Commission ordered the airline to repay state-aid it received from 2007-2010. Not very helpful in times when Hungary feels misunderstood and isolated in Europe.
My Grade: B-

Rumours over the last few days have been that there is a deal, only to be retracted and postponed. While the media reported that the main reason is the coupon on the restructured debt, we believe that the Greek come more and more to the conclusion - as written before - that the bail-out cum restructuring of debt will not help them at all. As the next bond, the Euro 14 b maturing in March, is coming up, the risk of default has increased. We believe that there is a 50% chance that there is no deal. This means that even if a deal is announced it might be rejected later in Greece or not consumed. Of course, even if there is a deal, the debt load is unsustainable. To put it simply: Greece needs a 80% hair cut plus low coupons, and Germany has to pay for it, like it or not.
My Grade: C-

Yields are lower again, with 10 Y BTP now at 5.76%. Question is what is the ECB's total holding. Given the LTRO, which offers a great carry trade to banks, Italian BTP are interesting, but vulnerable to any shock, such as a Greece default.
My Grade: B    

The better than expected job data propelled the markets on Friday. The cynic view is that the data is manufactured, as less people register for work, the weather was good and it is an election year. Nevertheless the US are definitely doing better than Europe. My Grade: B+

On the corporate front we are seeing three major themes: banks, IPOs and M&A.
For the Swiss banks it is earnings week. This morning, Julius Baer, the Swiss private bank reported a 27% drop in earnings (10% adjusted for a German tax settlement). While a highly capitalised bank (22% Basel 2.5) we see a range of issues: scissor effect of fee income and expenses (and FX effect on top), tax issues with the US and the reliance on good performance. Compared to the other two big Swiss banks, Baer is relatively small and needs to grow. They lost out on Banque Sarasin, another smaller Swiss private bank last year, which was acquired by Safra. UBS is in repair mode after last year's Delta One losses, but has made some good progress. They also nominated two younger, highly respected women to the advisory board, namely Beatrice Weder di Mauro, an ex-IMF and World Bank economist, professor of economics and advisor to the German government as well as Isabelle Romy, an international litigation expert, lawyer and associate professor. In our view a very exciting nomination and development at UBS. Credit Suisse, which will report on Wednesday, has the same headwinds as the other banks, higher capital requirements and tough trading environment, but an excellent risk management and top position in prime brokerage. Barclay's will report earnings on Thursday.    
The facebook IPO has put a spell on the market: currently the (when and if) market cap for facebook is USD 115 b. After a review of the prospectus / OM we come to the conclusion that despite all the many risks the IPO will be a success as it is manufactured and designed to be one. Whether the company will be worth USD 100 b in 5 years is another matter. We also noticed several hacking incidents in facebook accounts.
The third major topic is the rise in M&A, of which the Glencore / Xstrata is the most exciting one. It will create a mining superpower, managed by a team of very skilled executives.
My Grade: A-

Equity and debt markets continue their rally despite mixed news (many negative earnings surprises) and the European debt problem. It is a combination of low interest rates, liquidity provision via the LTRO (ECB funding) and the IPO / M&A fever.
My Grade: A-

Interest Rates
US rates still low, but on the way up as the macro data are getting better. German bund 10 Y yields almost unchanged at a low of 1.89%. My Grade: C

On the back of the LTRO and the positive mood Italy and Spain are trading at lower yields and spreads to German bunds than last week. Italian 10Y BTP at 5.75%, Spain at 4.99%. The bigger risk is with Portuguese and Irish bonds. My Grade: B-

Gold and Silver rallied to 6 week highs, before selling off again. Crude weaker despite the situation in the Middle East. My Grade: C+
Volatility: no surprise that VIX is lower at 17.3%. Looking even cheaper than last week.

Hedge Funds
Most hedge funds have reported excellent numbers for January 2012, ranging from up 3 to up 7%, depending on strategy and leverage. The traders seem rather wrong footed with short positions in equity indices and other risky assets. The Dow Jones CS Core Hedge Fund Index was up 2.2% in January. Funds of Funds also up between 0.5% and 2.5%. However the good news of positive performance comes with the bad news of more correlation to other markets as observed over the last few years. We still believe that hedge funds can add value to a portfolio in many respects, but investors need to work harder to find the best managers, to monitor them and if necessary change the allocations. And managers need to work harder to generate returns, be transparent and have a clear marketing strategy.
Our preferred strategies for 2012 are event, L/S and credit / distress.
My Grade: A

As equity markets have risen between 5-10% in January alone, it is unclear how much longer the rally can continue. Volume is quite thin in many markets. Most investors are still at the sidelines, and we doubt that they will get in at these higher levels. On the other hand we see and know of many short positions which are very painful and  
provide some support.

Our concern is with the unresolved debt problems of Europe, Greece, Hungary and the other periphery countries. Political risk in the MENA must not be underestimated. But markets are still in a bull mode. 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.

SFP School of Finance  
We are running the following training courses in Feb 2012:   

 23-24 Feb 2012, CENTRAL LONDON   

 To book your place or for questions about the courses please call us on +44-20-7723 8060  

Europe - Euro - Italy - Greece - Markets - US - Stocks - Interest Rates - Credit - Commodities - 
Hedge Funds

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