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: 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.

.

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.