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.

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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.

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.