Weekly Commentary on Financial Markets: 16 January 2012 Europe at Risk

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-

Greece

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- 

Italy

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      

US

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+

Companies

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

Markets

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+

Interest Rates

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-

Credit

Downgrade of French and Austrian government bonds probably priced in.  My Grade: C+

Commodities

More range trading in Gold and Silver. Oil very volatile. My Grade: C+

Volatility: VIX still at 20%. Looking quite cheap.  

Hedge Funds

We saw some positive numbers for the first 10 days of trading. Good start of the year. My Grade: B-

Outlook

The downgrade of the 9 European countries was expected, but nevertheless could push sentiment towards negative again.

Conclusion

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-

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.

Weekly Commentary on Financial Markets: 9 January 2012 / Markets in Honeymoon Mood

Weekly Commentary on Financial Markets:  

9 January 2012

by Jacob H Schmidt

Markets in Honeymoon Mood                    

News of the week: major equity markets up in first week of trading; European banks under pressure; US economy in recovery         

Europe – Euro

The European saga continues: higher yields of both the periphery and the core countries (Austria, France) due to downgrading and refinancing fears. In addition the message from politicians is mixed. On the one hand no one really questions the Euro and the EU, on the other hand the commitments are slow and weak. More summits can be expected. The markets are impatient and many observers seem to lack a proper understanding of continental European decision making. We believe that the horror scenarios of a breakup of the Euro are exaggerated, but progress will be slow (the European way) and minor changes in the Euro currency possible. It is obvious that the ECB will have a bigger role, as the EFSF has not been able to raise sufficient funds and might suffer itself from a downgrade of France. The result will be slow growth and continuous instability, but no break up. Most Europeans are willing to pay a higher economic price rather than risking political instability or war.   

My Grade: C-

Hungary

Downgraded to junk after a new act which could threaten the central bank’s independence was passed by parliament. Hungary which needs another bail-out package, likely to come from the IMF, is on a more nationalistic course and at odds with the EU and international community. 

My Grade: C-

Greece

No news, but rumours that the write-off will be in the 70-80% range.  At the current price levels of around 20 for Greek GGB these bonds are fully valued, but such a heavy discount would help Greece out of the crisis.

My Grade: C- 

Italy

BTPs oscillating around the magic 7%. The refinancing of Euro 300 b is the main point here, and at 7% this is expensive, but better than a shameful IMF package. We believe that there is enough wealth in Italy and the country cannot be compared to Greece or the other smaller PIIGS.

My Grade: B      

US

It seems as if the US are in a recovery mode: better pay roll numbers, a lower unemployment rate  and in general better macro data point towards a small growth. The other main issue are the elections, and with zero interest rates we could indeed see a recovery. Question is whether the US can decouple from Europe and China, which is the other big question mark. 

My Grade: B+

Companies

Banks continue to be the main focus, with Italian and French banks under pressure. European banks do not trust each other and prefer to lend to the ECB. Other financials will also continue to suffer, while consumer and electronics depend on the US growth.  We continue to be critical of the social media IPO frenzy. In general better numbers from US companies, mixed results in Europe. US stocks preferred over European.    

 My Grade: B-

Markets

Positive start of the year. The equity markets are in honeymoon mood, but question is for how long. US equities could continue to drive the other markets up, or even decouple. Question is whether hedge funds will continue to use S&P futures for the hedging of illiquid positions and other markets.

My Grade: B+

Interest Rates

US Notes and Bonds’ prices off, with higher yields (UST 10 Y at 1.96%, 30Y at 3.02%). German bunds unchanged, 10 Y yields at 1.85%. A recovery in the US could push rates much higher. My Grade: C-

Credit

French and Austrian government bonds under pressure. Risk of an immediate  downgrade from AAA.  My Grade: C+

Commodities

Gold, Silver sold off at the end of the year, to rally again and sell off at the end of last week. Gold and Silver seem to trade without direction, in a wide trading range. My Grade: C

Volatility: VIX at 20%. Looking relatively cheap.  

Hedge Funds

2011 was a bad year for the industry, with an average performance of -4%, but also a lot of dispersion. We reviewed all major European hedge funds of funds and are preparing a report on the different providers and funds. To be released in the next few days.

 My Grade: B-

Outlook

Positive vibes from the US, negative vibes from Europe. BRICs mixed. The major themes to watch in 2012:

1.      China – soft or hard landing

2.      US recovery

3.      US elections

4.      Russian elections

5.      Geopolitical instability in MENA

6.      European banks

7.      European debt crisis

8.      Valuations of social media stocks

9.      Commodity prices as an independent source of risk

10.  Greece restructuring as a benchmark for future European cases

The markets will focus on these issues, switching from topic to topic as news break. No easy market for investor.

 Conclusion

Gloom in Europe and hope of a recovery in the US will offer great opportunities. Substantial risk of dislocations will arise again similar to the ones in 2011.   My grade: C

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.

Weekly Commentary on Financial Markets: 21 November 2011: Back to Rating Concerns

Weekly Commentary on Financial Markets:  

21 November 2011

by Jacob H Schmidt

Back to Rating Concerns    

News of the week: markets impatient with lack of progress and extremely volatile; signs of serious disagreements between Berlin and Paris; Austria’s AAA rating at risk  

Europe – Euro

The Euro crisis continues, with elections on Sunday in Spain leading to a change in government to the Popular Party. In Italy and Greece the new governments lead by experts – unfortunately sometimes called technocrats by the media – what a pejorative label for people who run for office out of duty and due to their expertise – will need time to implement policies. But the markets are impatient. And it seems the fellow EU members and international organisations as well. The debt auctions of last week in Spain, Italy and France were a disaster – placed little paper at high levels. Italian yields rocketed back to above 7%.  

Austria’s AAA rating at risk (and many others’ as well) as budget deficit and debt burden rising. Talk in Austria of cutting some Euro 40 b in 3 years, agreement in principal to reduce debt – dubbed debt break or “Schuldenbremse” – but not sure how to do: cut expenses such as transfer payments, stream line admin or increase taxes. Rating review due before year end.

EFSF without progress, as funding is a serious problem. Talk is still of leveraging a base amount, but they cannot even raise the base amount. In the meantime the ECB has to do the job, risking to be in breach of their mandate. We also noticed a change in Germany’s way to communicate its conservative approach to ECB policy and the debt problem in general. Exclusion from the Euro, sanctions and German standards are the new vocabulary. There is also deterioration in the Paris – Berlin relationship.

My Grade: B

Greece

Slow progress but protests – we will need some kind of Marshall plan.  

My Grade: C-     

US

Results from the Joint Select Committee on Deficit Reduction aka Super Committee still focus, recent news from the progress rather disappointing: political brinkmanship part 2 (part 1 was in the summer).  

My Grade: B

Companies

Focus on the banks which will need to raise a lot of capital to satisfy higher capitalisation requirements – capital adequacy according to Basel 2.5 and Basel III. Banks also need to write off more bad debt. So far all most banks have stressed that they will try to avoid public funds. We also noticed that many banks (e.g. UBS, Soc Gen et al) use the fair value accounting provision (mark to market) for the revaluation of outstanding their debt as an extra-ordinary revenue to show profits when in reality they lost money. While this is permissible under IFRS (157) we are critical of the repercussions.

My Grade: B-

Markets

No change in our assessment of markets: stocks, bonds, FX and commodities continue very volatile, driven by fear, sentiment and little liquidity.   My Grade: B

Interest Rates

US rates lower from last week: 1.98% on risk aversion from 2.07% for 10 year notes (vs last week); also in German bunds (1.97 vs 1.89%). My Grade: C+

Credit

Spreads wider again

Spreads in Italian BTP wider again, were at > 7% last week after rally to 6.45% for 10 year bonds. Greece 10 year at 28.19% (high 20s price level). Austria 10 year 3.39% (high was 3.6%), France OAT 10 year at 3.46% (high was 3.7% last week).  My Grade: C-

Gold, Silver and other commodities sold off, Gold now seen by some as a risky assets. Hedge fund manager Paulsen sold USD 2 b in Gold ETF. My Grade: B

Volatility: VIX stable at 30 % from last week.

Hedge Funds

Despite difficult year in performance terms assets have swelled to almost USD 2 t. Hedge funds use lower leverage, due to more risk aversion (most funds bearish on markets) and prime brokerages reduction in lines. My Grade: A-

Outlook

We are still slightly positive, but are conscious of the political and macro risks. Good markets for skilled traders and short term hedge funds as well as very long term investors.

Conclusion

We were – perhaps prematurely – optimistic of the developments in Europe, hoping that the expert – or technocrat – governments and new leadership of the ECB would lead to swift change and hence turn sentiment. We still believe that there is light at the end of the tunnel, but as Dr Woody Brock, a famous American economist and game theorist said in a meeting with me last week: “perhaps the light at the tunnel is an oncoming train”. Possible, it all depends on policy and implementation, there is no time to lose and little space for error. Decisions have to be made pretty quickly, mainly in terms of banks and the debt problem. We believe that the ECB and the EFSF have to act quickly, the EFSF to be used as a TARP for banks and the ECB to stabilise the bond markets. 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.

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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.