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: 14 November 2011: Light at the end of the tunnel

Weekly Commentary on Financial Markets:  

14 November 2011

by Jacob H Schmidt

Light at the end of the tunnel   

News of the week: Positive Developments in Greece, Italy and the ECB; Bank Shares hit by write offs; Apple shares down on pipeline concerns; Credit Hedge Funds negative on Europe and banks

Europe – Euro

While the European politicians continue to be rather low profile, the ECB under its new president Mario Draghi seems to take up the baton and show leadership by buying Italian BTPs. Last Thursday and Friday yields reached levels of 7.5% for the 10 year BTP and the curve even inverted at one point. We know that the ECB would rather have the EFSF do the job of supporting the bonds, but as they have not yet sorted out the funding, the ECB has been pushed into its natural role of lender of last resort. We have been critical of the bond purchases by the ECB because of its potential consequences in the event of default or disintegration of the Euro. However we believe that there is no real alternative and the ECB has firepower, expertise and standing to stabilise the European bond markets. ECB president Draghi seems an excellent choice to head the ECB at this difficult point.

After the appointment of two new prime ministers we see early stages of a positive development in Europe: a new class of leaders, more experts than politicians who understand European politics, have gained substantial experience at major international institutions and demand the respect of the international community as well as the population. The only risk is that the political parties will spoil the party.

Contrary to perma-bearish Nouriel Roubini, who wrote in several FT blog as of last week’s that Greece should default and leave the Euro and Italy’s days in the Eurozone may be numbered, as well and many other economists and market commentators, who all have adopted a very negative view on Europe, we believe that the situation is more complex and fluent: Greece needs a significant debt write off (probably in the range of 75-80% of total, meaning that either the ECB and Paris Club take a hit or the banks take a larger hit). Italy by contrast is a rich country, full of potential, but mismanaged. Italy can live with a huge stock of debt (a la Japan) as long as finances are under control with economic growth and confidence in the country. The high percentage of Italian holders of BTP is also a positive sign. Analysing the situation one must not forget that there is significant political will to preserve the Eurozone: if the Euro goes so does the EU and Brussels. It is possible that individual smaller countries decide to leave the Euro (temporarily), but the Euro as a currency for the main countries Germany, France, Italy and Spain will not disappear. In the long run the Euro might develop into a two zone currency, but will not disintegrate. In addition to the political aspect Germany benefits too much from a weak Euro and a common currency; she does not want to go separate with a strong currency.

We are cautiously optimistic that this is a turn around and leadership developing from the South and at the ECB. While it is still early days and major hurdles to be taken (Greece debt issue, EFSF role, banking recapitalisation, budget deficits et al) we see the light at the end of the tunnel.   

My Grade: B+

Greece

The new Prime Minister Papandreou has a huge job, but his reputation, experience and the realisation by the Greek people that there is no more time to lose can lead to a more positive outcome. In the meantime the next tranches of the bail-out will buy time. Nevertheless the debt restructuring will happen, probably later than expected and at worse terms for the banks. The immediate default risk (2011) is relatively low, but any bond after New Year is at risk.  

My Grade: C-     

US

In the US the main focus is shifting to next year’s presidential elections. On the debt side we are awaiting comments from the Joint Select Committee on Deficit Reduction aka Super Committee set up in August 2011, but expectations are so low that any positive sign be interpreted as an achievement. My Grade: B+

Companies

Bank earnings show the pain of write offs and lower income from investment banking and trading. On the positive side many banks have started looking at the recapitalisation and new capital rules with much higher regulatory capital. Better earnings from corporates. Most major companies have reported and the market will soon focus on 2012. Apple has sold off more than 10% in the last 10 days, on concerns that the pipeline is getting dry and sales in iPads are slowing down. Upside in AAPL limited for the time being. My Grade: B-

Markets

Due to the developments last week markets were very volatile, driven by macro factors. We believe that the extreme volatility will decrease somewhat over the next month as the macro worries move to the background and asset allocation and company specific aspects will affect market prices. My Grade: B

Stock markets

As stocks continue their volatile uptrend, the major indices will test important resistance in the coming week. If they can break through – which is unclear - we might see a much larger rally until New Year. My Grade: B+

Interest Rates

US rates pretty much unchanged from last week: 2.07% vs 2.06% for 10 year notes (vs last week); also in German bunds (1.89 vs 1.84%). My Grade: C+

Credit

Spreads in Italian BTP exploded, now at 6.45% for 10 year bonds (Wednesday 7.5%, last week 6.6%). Greece 10 year at 28.4% (high 20s price level). Austria 10 year 3.37%, France OAT 10 year at 3.39%.  My Grade: C-

In the commodity space base and precious metals continue their volatile moves. Silver at 34.7, Gold at 1780. My Grade: B+

Volatility: VIX stable at 30 % from last week.

Hedge Funds

Last week we spent a lot of time with credit hedge funds. Credit hedge funds take positions in fixed income instruments, anything from sovereign debt to corporate and structured debt (ABS, RMBS, CMBS et al). The majority of these managers focus on idiosyncratic risk and hedge their positions. A small number takes outright long or short positions. We identified a number of interesting commonalities: hardly any fund has produced big numbers, most are plus / minus zero YTD. US RMBS offer good opportunities for specialists in these markets. They preserve capital, with lower volatility, but fail to produce positive returns. Secondly many use the same instruments for hedging: liquid equity markets, namely the S&P500, but also other liquid equity indices. The hedging with S&P futures explains part of the volatility in equities, but also seems suboptimal as these managers are exposed to significant basis risk. Thirdly most hedge funds agree on their extremely negative view on European banks and the PIIGS. The investable Dow Jones Credit Suisse Core Hedge Fund Index is -0.6% to November 9, 2011, YTD -6.24%. CB Arb and Managed Futures are up MTD, but also down for the year. Teh broader non-investable index has much better numbers: Fixed Income and Global Macro 3.6% and 5.8% YTD, Short Bias up 13%. In conclusion a tough year for hedge funds, but security selection (picking great manager) adds significant alpha. My Grade: A-

Outlook

We are turning positive as some of the political and macro risk decreases and rates remain at lowest levels. The Christmas rally in equities will continue, as hedge funds and other investors are underinvested, but equity indices will have to break through the major resistance levels (S&P500 at 1275, FTSE at 5700). Investors will have to pick excellent hedge fund managers or securities that give enough beta and alpha to benefit from the rally.

Conclusion

We feel that some progress has been made in Europe and the mood has turned positive now. The fixes are still short term and many challenges ahead, but short term into the new year we see a more positive market environment. Hopefully politicians will use this window of opportunity and come up with the bazooka. My grade: A-

    

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: 24 October 2011: No Bazooka weapon – rather Bazooka chewing gum

Weekly Commentary on Financial Markets:  24 October 2011

by Jacob H Schmidt

No Bazooka weapon – rather Bazooka chewing gum     

News of the week: little progress on European bail-out plan; questions over Chinese slow-down; US earnings season going well

Europe – Euro

We are still waiting for the “bazooka”, but it becomes clear that the package will be much smaller than initially hoped for. Last week’s false news in the Guardian that the European package would be worth north of E 2 t led to more market volatility. Due to much disagreement around the details the deadline for the announcement of the details of the package has been moved to October 26, 2011 when the European ministers will meet again (after this weekend’s meeting). We hear again that other parties such as the BRIC countries should be brought in, but the main idea remains some sort of leverage of the EFSF. We believe that we will see a smaller plan, enough to prevent a market collapse in order to get us to another summit in the next few weeks. In conclusion we seem to get Bazooka chewing gum – remember the funny comic strips and the bad taste the gum leaves in your mouth.  My Grade: C+

The only progress in the Greece PSI is in the much higher haircuts discussed: instead of 21% implied the levels are in the 50-60% range, in line with market levels for Greek debt. Time is running out for Greece and the creditors, but it seems that a default will be avoided at any cost at the moment. Most market participants agree now that Greece has to default and it might be better for Greece to do so sooner rather than later. If they take the pain now, go through one or two years of contraction and restructurings, devalue the currency and regain competiveness, Greece could emerge from the crisis within short period of time – see Mexico 1994, Russia 1998 et al. But it is more likely that the short term fixes continue as politicians believe that the ECB and the European banks would suffer from a default and its contagion.  My Grade: D      

US

US earnings relatively positive so far, better than the revised low estimates. My Grade: B+

Markets

Equity markets continue volatile due to the uncertainty in Europe, but at relatively high levels. US markets are at levels not seen since June, but Europe lagging behind. Company specific news again more relevant. Interesting developments in the miners (Xstrata, Glencore, BHP Billiton), banks (US versus European) and IT (Apple, HP et al). My Grade: B+

Interest Rates

US rates again higher on the long end (2.22% at 10 and 3.27% at 30 year). Market seems to test Fed’s willingness to buy bonds for operation twist and a potential QE3. Bonds still looking pricey here, but if inflation is to drop, Fed intervenes and markets scared due to Europe, they could rally again. Market also knows that PIMCO went long long-dated bonds in massive operation twist speculation. Rates also much higher now in German bunds (2.11%).  My Grade: C-

Commodities continue sideways with high volatility.  My Grade: C+

Hedge Funds

With only three months to go in 2011 and performance across the industry rather weak some hedge funds find themselves in a difficult position: should they add risk here with the potential to turn around for the year (a la PIMCO who has underperformed in long only bonds and has put on his massive long duration tarde), or rather preserve capital. The answer seems to be rather the capital preservation strategy as this is what institutions want and need. We see three developments: a. pension funds and institutions are still interested in hedge funds of funds, but also look at single HF and other structures; b. focus is on low risk, little correlation and capital preservation; c. institutions care for the content, not the wrapper. My Grade: A-

Outlook

The Christmas rally in equities likely to continue for one or two more weeks, selling on the news of a bail-out possible, in particular if high expectations of markets are not met. Investors are confused (term sued by Woody Brocks at Asset Allocation conference last week). Popular view among academics is now that inflation to drop from here (UK headline 5.2%), Greece to default and fiscal policy needed rather than more monetary interventions. At an asset allocation conference I attended last week Nouriel Roubini painted a very dark picture regarding the debt problem in Europe and the US – in line with his reputation as Dr Doom. Other leading economists who grosso modo agreed with him included Woody Brocks – who gave an excellent presentation – as well as the IMF economist for Europe. Investors – both institutional and HNW – have become more tactical in their asset allocation and use many new instruments, tools and techniques, but avoid some products they deem expensive or less useful (e.g. new vol ETF et al).  

Conclusion

Markets have started discounting good news and assume now that the politicians will release a substantial package. The solution will be a short term fix, but good enough to take the fear away for several months, before getting into trouble again. 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.

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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: 10 October 2011

by Jacob H Schmidt

Bank Bail-out Season, Earnings Season and Year-end Rally      

News of the week: Merkel – Sarkozy meeting ended with promise to recapitalise banks, but without details; Apple Founder Steve Jobs dies age 56; Dexia bailed out again; downgrades of Italy and Spain and banks. 

Europe – Euro

No progress on European front, banks faced downgrades and sovereigns as well. The banking sector is in bad shape, the stress test of 3 months ago not worth the paper written on it. Dexia, one of the largest European banks, was bailed out on Sunday night by Belgium and France (4 b in cash by Belgium, 90 b in guarantees by France and Belgium / Lux, against Euro 700 b in credit exposure), but the other European banks are under immense pressure. This is very bad news for France and Belgium whose public finance is already in bad shape. J-C Trichet is to retire next month and European politicians are working on plans how to save the Euro and Europe, no longer Greece. The problem is: too slow. We believe that it highly likely that the individual nation states will capitalise their banks, as the EFSF might continue to be used to support the Italian and Spanish bond markets. From a European perspective it would be preferable to turn the EFSF into a TARP, i.e. to capitalise all European banks via one source, but as said before, the EFSF is not big enough. No real news from the Merkel – Sarkozy summit on Sunday: they promise to apply common criteria for the capitalisation of the banks, but no further details. This sounds like so many previous meetings: no real progress; no real plan because “the devil is in the details”.  My Grade: C-

Regarding Greece the former taboo – a default by Greece – seems to have become a fact, just waiting to happen. In Germany former chancellor Schroeder presented a plan regarding Europe, including a 50% debt reduction for Greece. Merkel has also shifted her position somewhat, but seems still to target 2013 for a default. Watching events in Greece we believe that they might decide for a default sooner that later. By the way, Greece is running out of money in the next few days....  My Grade: D     

US

Many US data of the last few weeks pointed towards a double dip recession, but last Friday’s better job data has suddenly changed the mood and all eyes are now on the earnings season to start on Tuesday with Alcoa (Dow 30 component). Due to the lower analysts’ forecasts surprises are possible. This could give stocks a boost, and kick off a Christmas rally. Economic situation confusing, Fed still in markets with operation twist, and earnings. My Grade: B+

Markets

Stocks specific news (alpha) as well as market swings (beta) have pushed prices of large companies to the tune of 5-15% per day! As an example Xstrata, a FTSE 100 company with a market cap of GBP 27 b can move + 10% and – 10% (or vice versa) within a day. The early death of Steve Jobs is very sad, as he was one of the great leaders of our times, but for AAPL it is bad news in the mid-term, as we believe that the company will no longer benefit from the genius of its founder. No doubt, the company has a deep infrastructure, a reserve of new ideas and we will continue to buy our Ipods, Iphones and Ipads, but AAPL has seen its best days in terms of stock price and looks fully valued. Bank stocks can be toxic here: any bail-out – recapitalisation due to a Greece default can wipe out current shareholders, see Dexia. UBS fired the two managers in charge of the equity trading business, but apart from UBS CEO Gruebel, no other major reshuffle / changes so far. We believe that UBS will only recover after a proper change in culture and management. On the other hand the next earnings season to start on Tuesday could turn US stock market to “BULL”. The VIX at 36% and interest rates at close to all time low could pull investors in, and the marginal buyers such as hedge funds are currently underinvested. We prefer US and UK stocks over EM and European stocks which are riskier.  My Grade: B+

US interests rates now higher with US 10 Y at 2.08% (vs. 1.9% last week) and German Bunds at 1.94% (vs. 1.6% last week). In the credit markets Greece is trading in the 30s (price wise) with 174% (1Y), 67% (2 Y) and 26% (5Y) and 23.5% (10Y). Italy (5.4% for 10Y) and Spain (5% for 10Y) bearing in mind the ECB purchases. We still believe that Greece is too early and too high to be bought, Italy too expensive and US and Germany yields to low. My Grade: C-

Commodities continue volatile. Gold currently no hedge, but might recover from here after phase of consolidation.  My Grade: C+

Hedge Funds

Many articles report that hedge funds had their worst quarter since 2008, but we also see many funds which have performed well or at least protected capital. Conclusion: first manager, then strategy. Expertise is key, edge essential and small size beautiful. We also see a come-back of hedge funds of funds.   My Grade: A-

Outlook

No change in our outlook from previous weeks. Key data in the next two weeks will be any action by Greece (potential default or similar announcement), bank bail-out in Europe and the earnings season in the US. Investors will also consider positioning for a (or the) Christmas rally.   

Conclusion

Markets driven by more sentiment and robots (high frequency trading, holding positions for seconds only), not by analysis. The next two weeks might be decisive for Greece, Europe, the Euro and the global economy. 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.

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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.