Weekly Commentary on Financial Markets: 28 November 2011: Looking into the abyss

Weekly Commentary on Financial Markets:  

28 November 2011

by Jacob H Schmidt

Looking into the abyss     

News of the week: downgrades of European countries; no progress but lots of politics on European front; Bunds become risky assets  

Europe – Euro

Europe and the Euro have moved closer to the abyss: Germany continues with its strategy of showing no commitment to a bold solution, Portugal, Belgium and Hungary got downgrades and another mini-summit between Merkel and Sarkozy (to which Monti was invited, too) ended with no results. No surprise. We have been positive on the appointment of so called technocrats (we prefer the term experts), but underestimated the slow progress in core Europe by the professional politicians.  In addition we see no progress on the EFSF (the leveraging of the Euro 250 b to a Euro 1 t or more fund looks less and less likely, the markets don’t like the idea). It seems again that the politicians underestimate the situation and the markets: it is not the speculators who drive the markets, but the investors, who get really scared of the potential meltdown. As a banker said to me last week in Vienna: we will look into the abyss before we will get a solution. And the abyss is very close. We believe that in the end the politicians will come up with a last minute / last second fix, avoiding a disaster.  Before that we will see more volatility.

My Grade: C-

Greece

Slow progress, risk of deterioration on economic front.  

My Grade: C- 

Italy

Despite the new expert government, ECB support of the bond market and positive signs,   markets are very concerned about the debt burden and the rollover of Italian debt. Next year Italy has to refinance Euro 300 b. At over 7% this will be a serious problem. Over the weekend La Stampa, the Italian newspaper reported of an Euro 600 b IMF loan. The sooner they get the money the better. 

My Grade: B      

US

The US are finding themselves again in a cul-de-sac: the Super Committee has not yet agreed on any reasonable actions, which will lead to general cuts in all areas without consultation. One year before the next elections the US seem to be in full election gear, unable to agree on important measures.  

My Grade: B

Companies

The recent volatility in German Bunds will have an impact on bank earnings: German and other European banks have been thinking about revaluing their Bunds versus the write-offs in Greece and other countries. Austrian banks were hit by the downgrade in Hungary. European banks traded down to depressed levels (RBS below 18, Barclays to 140 p, BNP Paribas to 24 etc.). Due to extreme volatility in commodities mining shares were also weaker.

Recent IPO with fantasy valuation Groupon lost USD 9 in 3 days from USD 25 to USD 16, now trading below IPO price.

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. We see value in selective stock markets.   My Grade: B

Interest Rates

German bunds corrected sharply in the middle of the week, after a failed auction. Yields jumped from 1.9 to 2.30, scaring many investors that the risk-free assets Bunds have become a risky asset. We believe that this is more sign of the general market condition than a deterioration of German credit quality. The extremely low yields and risk aversion have spilled over to Bunds. Many investors are now sitting on heavy losses. Short term German Euro rates are at lowest levels, at some point even negative.  By contrast UST remain “safe haven”. UST at these levels are very expensive. My Grade: C-

Credit

Spreads much wider in Italy, Spain, Portugal and most other European credits. Italy 10 year over 7%, short term rates at 8%. Levels indicate extreme stress and fear. My Grade: C-

Gold, Silver and other commodities very volatile. Gold rallied several times to sell off again, but looking like a safe haven in uncertain times. My Grade: B

Volatility: VIX up again at 35 % from 30% last week.

Hedge Funds

For hedge funds the year is more or less over, the average hedge fund down 2%. Hence the focus will be on next year: how to produce positive returns and protect money. In addition questions such as custody and counterparty risk will be more important than ever. We advise our clients to focus much more on operational risk aspects on top of the investment side. My Grade: A-

Outlook

While volatility is here to stay, the market could rally on any decent news. We believe that equity markets (in Anglo-Saxon countries) offer better value than bonds. We are still slightly positive, but are conscious of the political and macro risks.

Conclusion

In these risky times investment decisions are more difficult than before. Nevertheless there are many investors with big sums at the sidelines waiting for the right moment. In addition companies are active in M&A. We are concerned and believe that politicians are to slow and undecided in their reactions. Nevertheless we do not share the extreme pessimism of many other market participants and analysts.  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: 7 November 2011 Towards more instability – waiting for Roosevelt and a European New Deal

Weekly Commentary on Financial Markets:  

7 November 2011

by Jacob H Schmidt

Towards more instability – waiting for Roosevelt and a European New Deal  

News of the week: Papandreou out – coalition government until elections in Feb 2012; Berlusconi out soon as well; European Q3 earnings season in full swing

Europe – Euro

Another round of meetings, this time the G20 in Cannes as of last week ended with little substance, apart from animosities towards Greece. Focus of the G20 meeting was Greece and Italy – whose PM Berlusconi is increasingly isolated in Europe – no mention of the other basket cases Spain, Portugal and Ireland.  The October 26 bail-out has already lost momentum as the Greeks have not accepted the deal, the EFSF is short of money and concerns over the banks dominate the markets. While the media focuses on the Greek drama – Papandreou to resign, a new PM in the person of respected frontrunners Papandreou or Dimas – the reality is that Greece is in a serious political crisis on top of the economic crisis, but Italy is the real problem: 10 year BTP are trading at 6.6% and 30% north of 7%. With Italy facing political turmoil investors are unlikely to pick up BTP at these supposedly attractive rates as these bonds will get even cheaper very soon. The only buyer in town is the ECB, and they have limited resources. The EFSF will be too small to do the heavy lifting. PM Berlusconi might be out of office soon. Out of the three scenarios or Europe

a. no change – continuous instability;

b. reversal of the European project;

c. further integration with a common bond market and fiscal policy

the likelihood of no change with short term fixes is high (70%), and 15% chance of cases a. and c.

My Grade: C-

Greece

In Greece the drama continues, as Papandreou has agreed to resign and the search is for a new prime minister. Both frontrunners have good credentials, but will they be in a position to change anything in Greece? We believe that the interims government will satisfy the formal requirement for the next tranche and buy time. It is not in Europe’s interest that Greece collapses, but the outlook is very grim for Greece. The stability will be very short term. The risk that the new Greek government could go for a default and Euro exit has increased. The immediate default risk (2011) relatively low (2011 bonds trading at prices of 88-90), but any bond after New Year is at risk.  My Grade: D     

US

The WSJ reported last week that 15% of all US citizens rely on food stamps. This is the real tragedy of the recession and the 2008 crisis: official unemployment rate of 9%, unofficial rate of 16%, structurally many are long term out of job and poverty in one of the richest countries of the world. While the US debt is a problem, the increasing poverty in the US is the real failure of the administration. Most European countries do a much better job. The US debt problem will become the focus soon again, when the Joint Select Committee on Deficit Reduction aka Super Committee set up in August 2011 will have to issue a recommendation by November 23, 2011. Nevertheless US debt looks safe versus the less stable European debt markets. US rates to stay at 0% until 2013 at least according to last week’s FOMC. My Grade: B+

Companies

European companies report Q3 earnings, most doing ok, except for the banks, who show heavy write offs due to exposure to Latin Europe and difficult equity markets. BNP Paribas reported a Euro 2.2 b write down on Greek debt (a 60% write off), more French banks to follow this week: Soc Gen, Natixis and Credit Agricole. The focus will be the write off of sovereign debt, the revenues from the business segments and redundancies. The higher capital cost due to Basel III and additional buffers will make banks less profitable. We see more use CoCos (conditional convertibles) to achieve the higher ratios.

In the US Groupon went public with a 30% increase on day 1 (from 20 to 26). While many investors are very critical of the business model and the numbers, the IPO was a first day success due to the controlled size (5%) and probably the role of the syndicate. We believe that Groupon used a small window of opportunity to go public which might close again soon. Linkedin trading at 300 times next year earnings, Groupon at ??. Groupon et al stocks are really for day traders and hedge funds flipping on the first. No serious investor would buy a company with a P/E of 300 or even negative P/E. A lot of OPM buyers.  My Grade: C+

Markets

Continuous high vol in equity markets, FX and bonds which are overshadowed by macro events. Sovereign risk appraisal is en vogue again. My Grade: C+

Stock markets

In the world of economic uncertainty and sovereign risk stocks have been doing reasonably well: Dow is up 3% YTD, SP500 flat, FTSE down 6%, but European and EM stocks down more than 10%. Good, stable companies in liquid markets looking attractive, and the constant sell offs allow investors to pick up great stocks at cheap levels. For traders this creates additional opportunities.  My Grade: B+

Interest Rates

US rates volatile from week to week: 2.04% vs 2.31% for 10 year notes (vs last week); Rates also lower now in German bunds (1.84 vs 2.19%). Too much volatility for large government bond markets.  My Grade: C-

Credit

Wide spreads in Italian BTP, now at 6.6% for 10 year bonds. Greece at default levels. Spain at 5.6%. Irrespective of Berlusconi or a new government, Italy needs to roll over Euro 300 b next year.  My Grade: C-

In the commodity space base and precious metals also volatile. Silver at 34.5, Gold at 1760. My Grade: B+

Volatility: VIX up to 30 % from 24% last week.

Hedge Funds

A tough year for hedge funds, as Dow Jones Credit Suisse Core Hedge Fund Index was up 1.85% in October but down 6.1%. YTD. HFoF doing better, showing that fund selection is key. My Grade: A-

Outlook

Continued political uncertainty, default risk and the fear of a double dip recession guarantee high volatility. For investors the choice is tough as HF and PE flattish at best, most equity markets down and rates low. The Christmas rally in equities has limited upside, investors tempted to take profits where possible.

Conclusion

While European and world leaders disappoint and the naive hope that China would save Europe got dashed, the risks of instability are increasing. According to our analysis there are many parallels to the developments after 1929 when leaders missed the opportunity to reform the process. It took four years until 1933 when President Roosevelt got elected and started the New Deal. Europe is waiting for its Roosevelt (or Roosevelts) and New Deal. 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.