Weekly Commentary on Financial Markets: 13 Feb 2012

Weekly Commentary on Financial Markets: 13 Feb 2012   Issue: 5/2012     13 Feb 2012   More Money News of the week: Greek parliament approves austerity measures; now awaiting next tranche; Apple shares hitting USD 500 mark; more liquidity by ECB and BoE      Europe - Euro European finance ministers will meet again this week, to discuss the latest austerity measures, but the news is that Brussels / Berlin wants a written commitment that the parties will also stick to the plan and actions after the next elections. In addition they switched from the proposal of an EU budget commissioner to the idea of an escrow account for the servicing of the debt. While conceptually interesting we do not believe that this will fly with the Greeks: they feel that the rest of the EU do not trust them and lack to treat them as equals. The very tough measures combined with other conditions will - in our opinion - lead to a very dangerous socio-political development in Greece. Comparisons to the Weimar Republic and the rise of the far right in the 1920 and 1930 come to mind. We are very concerned. My Grade: C The Euro The ECB will provide more liquidity via the LTRO (another tranche at the end of Feb) and the BoE via a GBP 50 b program announced last week. This liquidity injection is key to keep markets running, but we ask what the central banks will and can do if the situation gets worse, Greece and other peripherals default and banks get into trouble. The answer is even larger balance sheets. The Euro looks overvalued at these levels. My Grade: C Greece Greece took the first hurdle on Sunday when they approved the austerity measures. Now the next step is with the EU which will discuss the plan on Wednesday and should release the funds for the next tranche. Thereafter the restructuring is on the agenda. If all goes well we will not see a default in March and Greece can concentrate on bringing down its debt to GDP level from 160% to 120% by 2020 and go to elections in April. For the local population the outlook is very sad and tough as they will face harshest economic conditions for the foreseeable future. From a macroeconomic POV the austerity plan and the restructuring do not make any sense. Greece cannot service the debt load without growing which they can't under this program. As written above we are concerned that the socio-political situation might turn for the worse, a weakening of the mainstream parties, more poverty and unemployment and civil unrest. We believe that given the tough stance of the EU on austerity, written commitments and escrow account, Greece will be forced to leave the Euro and the EU as they will not be able or allowed to renegotiate. But this might happen only in 2013, as a default and more Euro volatility is not helpful for the upcoming elections in France and Germany does not want a Euro problem either. Greece might choose leaving the Euro sooner than that: very unlikely to be before the elections, but anytime thereafter. My Grade: C- Italy President Obama praised premier Monti's efforts and results at his Washington trip last week. 10 Y BTP yields continue at the sub 6% level, short dated at the 3% level. Root problem of high level of debt is unchanged. My Grade: B Japan Bad news out of Japan, where the Q4 GDP dropped by an annualised 2.3%. A warning sign for Europe and the US. My Grade: B-         US Obama unveiled his budget, a balancing act of cuts and stimulus, to be voted on today. Sentiment in the US continues to be good. My Grade: B+ Companies Swiss banks reported earnings last week, depicting the tough conditions in the markets: investment banking activity is down in all three banks (CS, Julius Baer, UBS), focus on getting more private clients, more on shore and less offshore and of course the higher capital requirements. Barclay's earnings were also lower and showed a similar picture. In light of the facebook IPO other internet and tech companies get the investors' attention. Groupon's results were weak, but they fiddle around with the website and services. Linkedin had good numbers. And Apple, certainly not an internet company but a also trading at a high price and multiples, has hit the magic USD 500. Rumours of dividends could make the stock eligible for income investors. We would not be surprised to see a stock split to make the shares look cheaper. On the M& A front Vodafone is considering a bid for Cable and Wireless. My Grade: A- Markets Overbought conditions continue in the equity markets. Traders and investors took Sunday's vote in Greece as a good sign, despite the worsening situation in the country and many other risks in the markets. We believe that the overbought condition will change when the market realises that no new money will be added at these levels and bad news will hit the wire. While many hedge funds are net long, many long only investors have cut their positions and many traders are net short. My Grade: A- Interest Rates US and German rates at low rates, unchanged, due to QE, operation twist and the increasing fear factor.   My Grade: C Credit Spreads continue at the tighter end. Corporate credit and EM preferred by investors.   My Grade: B- Commodities Gold and Silver range trading. My Grade: C+ Volatility   The VIX has gone up from last week's low of 17.3% to the 19.5% levels. Still looking cheap given the risks in the markets. My Grade: A Hedge Funds Good times for L/S stock picking, relative value and event hedge funds as volatility is high enough to move markets, allowing managers to exploit dislocations without getting whacked by crazy markets. Our preferred strategies for 2012 are event, L/S and credit / distress. My Grade: A Outlook We believe that the markets are dancing on very thin ice, as the Greek situation is getting worse, banks are directly and indirectly exposed to the sovereign risks and geopolitical risks in the Middle East are on the rise. The overbought equity markets might hover at these high levels for some time, and suddenly sell off as e.g. in the summer. Conclusion Caution in the markets is recommended. 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. Watch Jacob H Schmidt latest interview on Bloomberg TV: Feb. 6 (Bloomberg) -- Jacob Schmidt, founder and chief executive officer of Schmidt Research Partners Ltd., discusses Julius Baer Group Ltd., Credit Suisse Group AG and UBS AG. He speaks with Andrea Catherwood on Bloomberg Television's "Last Word." (Source: Bloomberg)

Weekly Commentary on Financial Markets: 30 January 2012 Issue: 3                                      30 Jan 2012 Hedge Funds are back      News of the week: World Economic Forum in Davos; Greek restructuring making little progress; RBS boss gives up bonus       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. . SFP School of Finance   We are running the following training courses in Feb 2012:    1. ANALYSIS OF HEDGE FUND STYLES AND STRATEGIES (WITH PERTRAC), 2-3 FEBRUARY, CENTRAL LONDON 2. HEDGE FUND PERFORMANCE ANALYSIS (WITH PERTRAC), 6-7 FEBRUARY, CENTRAL LONDON 3. PRIME BROKERAGE, 13-14 FEBRUARY, CENTRAL LONDON 4. EXOTIC DERIVATIVES, 20-21 FEBRUARY, CENTRAL LONDON 5. THE FUTURE OF RISK MANAGEMENT IN HF (WITH PERTRAC)   23-24 Feb 2012, CENTRAL LONDON         To book your place or for questions about the courses please call us on +44-20-7723 8060   or email us at susi.schmidt@sfp-international.com  Europe - Euro - Italy - Greece - Markets - US - Stocks - Interest Rates - Credit - Commodities -  Hedge Funds

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: 12 December 2011 Slow Progress and Enfant Terrible

Weekly Commentary on Financial Markets:  

12 December 2011

by Jacob H Schmidt

Slow Progress and Enfant Terrible             

News of the week: ECB cuts rates by 25 bp to 1%; UK vetoes EU deal and gets isolated; European banks need Euro 115 b in capital; FSA publishes RBS report     

Europe – Euro

Another eventful week, some progress on the European front, but not enough to calm the markets. European politicians seem to have gotten the message as they tried to hammer out a comprehensive solution, not perfect, but certainly in the right direction. Fiscal compacts (i.e. greater fiscal cooperation and coordination), additional 200 b in funds but no bazooka. Because the UK prime minster David Cameron vetoed the deal leading to an isolation of the UK as no other country followed him, the deal is not fully agreed. We believe that Cameron’s move was a serious error of judgement and based on bad advice: the UK cannot afford playing l’enfant terrible as it has important trade relationships with the continent, has London as a global centre of finance and wants to be a leader rather than a niche player like Switzerland. Cameron is in the hands of Tory backbenchers who are working on an EU referendum. This has already put a lot of strain on the coalition government and will upset many global companies who have their headquarters in the UK. Germany and France seem 100% committed to make this work, with or without the UK, but the pace is European style. Many analysts do not understand the continental European way of decision making and negotiations. We believe that the last summit has shown that there is a clear political will to save Europe, the Euro and to move on. However there will be more summits, slow progress and confusing messages out of Europe. But let’s not forget Europe is heterogeneous and still work in progress. Any comparison with the USA is mistaken.   

The Euro was very volatile due to the political developments, the ECB rate cut and the press conference by ECB president Draghi on Thursday. Draghi was very clear in his message on policy, the outlook for the economy and the role of the ECB. However we believe that one needs to read his message clearly: when he says that the ECB can’t and won’t take up a bigger role, it means that he will do so when markets get ugly. And it is clear that markets are unsatisfied with the outcome of the summit and the slow pace. Hence they stay volatile, with significant temporary downside risk. The ECB will have to do more to support the periphery markets. As written last week, the solution will be in a two-class Euro, allowing the weaker countries to stay within the Euro, but becoming more competitive. UK papers wrote about preparations at the UK Treasury (finance ministry) as to a potential break-up of the Euro. These news are little helpful, as they are incorrect: of course the Treasury has to foresee any potential outcome, but the likelihood of a Euro breakup is far-fetched. Nevertheless tough times ahead.

My Grade: C+

Greece

No real news on Greece, secondary market prices for GGB are now 20 bid for most maturities. Very tough for holders of debt who have it marked at 50 or higher.  At 20 Greek GGB start looking interesting: the carry is massive. The risk is that Greek debt will get a 70% discount and long restructuring. In this case the bonds could trade down to the low teens.   

My Grade: C- 

Italy

Austerity program in progress which is good news. While Italian BTP are very volatile (trading between 6% and north of 7%) Italy seems to have secured the refinancing of the Euro 300 b due next year. At 7%+ BTP look attractive, and locals are buying. With the new ECB 2 y loans these bonds are very attractive for banks.    

My Grade: B      

US

Again better economic data in the US, but overshadowed by Europe.

My Grade: B+

Companies

Company news dominated by news on banking capital: European banks will need to raise Euro 115 b in the next year. For some banks, such as Commerzbank, this might mean a nationalisation and quasi-wipe out for existing shareholders. French banks have massive exposure to Italy and Spain. They will have to address this soon. Their derivatives and other capital intense activities will also have to be cut in view of the higher regulatory capital requirements.

In the UK the long-awaited FSA report on the RBS bail-out was published Monday morning (12 Dec 2011). The FSA explains the failure as a combination of six factors (capital position, ST funding, asset quality, credit trading, ABN Amro acquisition, systematic risk plus number seven RBS management). The FSA claim that under Basle III the ABN Amro acquisition could not happen. Furthermore they say that the FSA was “too focused on conduct regulation at the time” and they ”failed adequately to challenge the judgement and risk assessments of the management of RBS”. They also write that they were understaffed. We do not agree that the ‘light touch’ regulatory regime was the reason for the black out. It is rather the cosy relationship between the agents at the expense of the principal, a classic agency problem. The one answer that remains is why out of several thousand FSA employees nobody realised that RBS ran a massive balance sheet of several trillion on a small equity base, the leverage was massive (between 50 and 70 times at the peak). The information was out there, and many market participants had voiced their negative view. The FSA could have listened to independent market analysts, spoken to hedge funds. It is astonishing that there was no “whistle blower” at the FSA. The language of the report is critical, but unfortunately too general, in the end nobody takes responsibility. Nobody is punished.  

The FSA suggests a renewed public discussion on remuneration and more regulation. We believe that in 2008/9 the governments missed a great opportunity to reign in banking activities and corporate behaviour at banks when they saved them from collective collapse.  Let’s see what can be done now. We are not against regulation, but doubt very much that more regulation is the solution. What is required is “smart supervision”, where common sense rules, not more regulation. Our conclusion is that the report contributes very little to the burning question of “who”, not “why”.

My Grade: C-

Markets

Key dates: Tuesday FOMC meeting announcement. Friday is the important quadruple witching (expiry of stock index futures, stock index options, stock options and single stock futures). PPI Thursday, CPI Friday. Only 15 business days left in US (13 in UK, 14 in Europe) to adjust portfolios.

Markets will continue to be volatile, short term and in a constant risk-on / risk-off mode until next year.  My Grade: B+

Interest Rates

Rates pretty much unchanged from last week (UST 10 Y at 2.06%, 30Y at 3.11%). German bunds higher, 10 Y yields up 2 bp to 2.15%. We are unimpressed by these levels. My Grade: C-

Credit

Spreads continue to be very volatile over the week, Italian and Spanish bonds up and down within hours. Driven by politics and news. Greek bonds are trading now at 20 bid  price. My Grade: C+

Gold, Silver and other commodities also very volatile. My Grade: B+

Volatility: VIX at 26%.

Hedge Funds

Dispersion of performance in all hedge fund styles and also on fund of funds level. The average HF performance of -4% is disappointing and will lead to many reallocations. Only funds and firms with a long track record (positive) and a convincing story will be survivors after 2011. We still see interest for hedge funds exposure from pension funds, but little appetite from leveraged accounts and private clients.

 My Grade: A-

Outlook

Continuous focus on Europe macro development and US data. As per last week for the next 2-3 weeks we remain slightly positive on the stock markets as any good news leads to immediate short covering and investors are under-invested in stocks.

Conclusion

The further developments in Europe will be slow and serious risks remain, but we believe that the political will to save Europe and the Euro is too big to be negative.   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.

Weekly Commentary on Financial Markets: 5 December 2011 Waiting for the next key date: 9 December

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-

Greece

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- 

Italy

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      

US

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+

Companies

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

Markets

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+

Interest Rates

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-

Credit

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.

Hedge Funds

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-

Outlook

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.

Conclusion

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+

    

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.