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: 19 December 2011 Banks, Banks, Banks

Weekly Commentary on Financial Markets:  

19 December 2011

by Jacob H Schmidt

Banks, Banks, Banks               

News of the week: Major international banks downgraded again; Belgium downgraded to Aa3 from Aa1; MF Global hearings continue; Concerns on securities lending and multi-hypothecation      

Europe – Euro

Slow progress if any in Europe, the ball is now in the EU members’ parliaments where governments seek support to approve deal. In the core countries Austria, Germany and Netherlands (plus the other stable Nordics) voices of disaccord and doubts on the bail-out and future are emerging. We are concerned about this development. There is still a huge support for the EU and the Euro (“better some instability than war in Europe”). For the markets the politicians’ slow speed is unacceptable, but as written before, the political reality in CEE is different from Anglo-Saxon countries. And most politicians will be on extended holidays until Jan 8, 2012.    

My Grade: C-

Hungary

Political and economic development in Hungary negative. The country is suffering from the big CHF trade, no money left now for any consumption. Changes in laws negative for many existing companies and foreign shareholders. It will get worse before it will get better.

My Grade: C-

Greece

Depressed prices in bonds, no news regarding the PSI.

My Grade: C- 

Italy

Continued volatility in bond prices.      

My Grade: B      

US

Obama cut a new deal on the debt ceiling. MF Global hearing continue, no news where the client money is.  

My Grade: B+

Companies

More news regarding the banking sector: Austrian banks RZB rumoured to raise Euro 2-3 b from the Wallenberg family /or a Nordic bank. Hypo Tyrol, a smaller regional bank needs Euro 230 mm after having been bailed out in 2009 with Euro 52 mm by the State of Tyrol. Another banking scandal (after Bank Burgenland, BAWAG, Hypo Alpen Adria, Hypo Lower Austria) in a small country of 8 million people. In addition the large banks RZB / RBI, Erste and Bank Austria / Unicredit need a lot of fresh capital. 

In the aftermath of last week’s released FSA report on the RBS (where nobody took responsibility, again) the talk is now of a report on the Lloyds bail-out.

Apart from a few top names with sound business models and no exposure to toxic assets and toxic counterparts banks are not investable. Last week we analysed several European banks (Deutsche, Unicredit, BNP Paribas, UBS et al) in detail and concluded that most are too risky to be investable. Major reasons are leverage, size of balance sheets, business model, exposure, cash flow projections.

On Friday latest tech / social media IPO Zynga started trading. Total size USD 1 b. Controversial views as to buy and sell ratings. We have no opinion on the stock.   

My Grade: C-

Markets

Markets dived at the beginning of the week, with the metals leading the sell-off. Some recovery at the end of the week, but still very volatile and risky.  Most people I spoke to last week are negative: on the markets, the economy and the outlook. Metals sell-off a sign for market dislocations.

Critical reports on securities lending and re-hypothecation of assets in Austrian papers and international law journal. Many argue this is the next big shoe to drop.  After Lehman and now MF Global there is certainly a concern about multi-hypothecation of assets. For investors and hedge funds there are important due diligence questions: where are the assets, what is the counterparty, custodian and prime brokerage risk. What happens in the event of a default or market freeze.

My Grade: C-

Interest Rates

Bonds rallied, with US and Euro rates much lower from last week (UST 10 Y at 1.85%, 30Y at 2.85%). German bunds higher, 10 Y yields 1.85%. Big risk off rally. My Grade: C

Credit

Lst week’s Spanish bond auction went very well. Other sovereigns continue to struggle.  My Grade: C+

Commodities

Gold, Silver sold off massively during the week, to come back a bit at the end. We feel that Gold and Silver have switched from being long hedges to being great short hedges for stock and bond exposure. But hugely volatile. My Grade: C

Volatility: VIX at 25%. Surprisingly low given the volatility in other markets.

Hedge Funds

November data confirm our view that hedge fund had another tough month. December unlikely to be better, given the high vol and market illiquidity. 2011 will be marked as a quite bad year in terms of performance, not asset raising however. Total AUM in HF at app. USD 2 t.

Buy and hold is dead, L/S not working, arb tough. What is left: HFT, macro, discretionary trading. What is hot: managers who are nimble, flexible in their approach and with less AUM.  More investors into HF are now very critical as to the benefit derived from their managers. Our view: 85 out of 100 managers are a waste of time and money. 10 are ok, five interesting. Out of the five, one or two perhaps investable.  

 My Grade: B

Outlook

Tough markets, and with only two weeks until year end and less than 10 trading days, many investors are confused what to do here: buying, active trading or waiting for better opportunities. The year-end rally has happened several times over the last 3 weeks, only top last between 3 hours and 2 days. We believe that many participants, in particular the hedgies will choose to wait. Markets dominated by short term trading (HFT, day trading et al).

Conclusion

Major themes continues to be Europe, the banking the sector (most risky) and increasing political risks in Russia, Middle East and USA (elections). Outlook for 2012 is gloomy.    My grade: C 

Happy Holidays and a Successful 2012.     

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.

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.