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: 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.

Weekly Commentary on Financial Markets: 31 October 2011 Eurozone Rescue Plan: Big Headline – Little Details

Weekly Commentary on Financial Markets:  

31 October 2011

by Jacob H Schmidt

Eurozone Rescue Plan: Big Headline – Little Details     

News of the week: European bail-out plan released with little details and many question marks; account error of Euro 55 b at German HRE bank; markets rally  

Europe – Euro

The Eurozone rescue plan as announced last week consisted of a big number, but very little details. The main components of the plan: USD 1.4 trillion via EFSF; bank recapitalisations; Greece PSI with 50% haircut.

Many questions remain: no details were released. The deal via the EFSF is effectively a huge CDO structure with leverage. We see three main problems: the number is not big enough; the funds are not provided yet; the hair cut and CDS implications.

A major issue is the “voluntary hair cut of 50%” for Greece debt by banks. It is the politicians’ plan that the PSI will not trigger a CDS pay out. We believe that some banks and most hedge funds are likely to opt out of the PSI. The USD 1.4 trillion announced by Sarkozy will be provided in part by China but at what cost? Over the weekend Luxembourg’s Junker said no concessions for aid. It is highly unlikely that China will invest into the EFSF without conditions.

France is unhappy about deal because of the China component; Germany is unhappy because of the banks – the FTD compared Merkel’s dealing with the banks with scenes from a “Mafia movie”; in Austria 64% of the population is against bail-out.

Conclusion: as predicted last week, this plan is leaving us with a bad taste (Bazooka chewing gum style) and has significant deal risk.  

My Grade: C+

The Greece restructuring (PSI) has no details and should be done within 2-3 months, January 2012 is mentioned as a deadline; the experience from past shows that takes much longer. In Greece anti-German feelings are growing and the suggested write-off is not enough to help Greece and to entice the population to support the plan. The risk that the PSI will not happen and Greece will default and leave the Euro in next 3-6 months is high. We estimate the probability of such a scenario at 50%.

My Grade: D     

Germany

Due to an accounting error at FMS Wertmanagement, the bad bank set up after Hypo Real Estate’s nationalisation and bailout in 2009, which forgot to book the liability side associated with the assets they took over, Germany is now Euro 55 b (!!) richer, on paper only. Nevertheless the result is an improvement of Germany’s debt to gross domestic product ratio: from 83.7 to 81.1 percent (2.6% points). The number in question is massive (even for Germany) and the subject (transferring of assets and liabilities) relatively straight forward. What is the accounting knowledge of the FMS, of the auditors (PWC) and what about the risk management function of the supervisory bodies and regulators? A fail for any first-year student in finance or economics. If this can happen in Germany, how many black holes are there out there at banks and federal agencies? My Grade: D

US

We believe that the markets will focus now for a few weeks on the US debt issue. US earnings relatively positive so far, better than the revised low estimates. My Grade: B+

Other geopolitical risks include Syria (tensions rising, over 3000 killed so far, Assad threatening “Afghanistan” like scenario if West gets involved); Egypt (instability after Arab spring, elections soon); US election next year; elections in Italy next year; OWS protests in US and Europe spreading; risks of far right emerging in European / EU countries as a result of many factors: bail-out, decisions taken in Brussels / Strasbourg versus local / national sentiments, bank recap requirement, local factors. My Grade: C+

Markets

Earnings in US and Europe relatively positive, but many releases also dressed up (see last week’s banks, e.g. UBS which showed a profit of SFR 1 b despite write off of 2.3b). The earnings release of UBS (using an accounting loophole, FAS 157, marking-to-markets of liabilities) were in particular negative because it seems that the bank showed a profit to be able to pay high boni and compensation, despite the huge trading loss; we believe that the accounting profit was used to justify the payments. According to the Rescue Plan banks will need only Euro 100 b, much less than the IMF number of Euro 200-400 b; and even of Euro 100 b  only Euro 20 b in capital increases, the rest in retained earnings and balance sheet reductions. My Grade: B+

Italian spreads widened again after a less successful auction of Italian BTP, where Italy placed only part of the paper. Without the ECB buyers seem rare. The yields are above the symbolic 6% mark (6.05%). German yields also rose (10 y at). Italy needs to roll over Euro 300 b next year.  My Grade: C+

Stock markets

Equity markets continued the rally in all sectors, banks benefitted from lower recap number.   S&P 500 and other major stock markets are now in positive territory for the year. US Brokerage firm MF Global (the former brokerage arm of Man Group, spin off from Man in 2007) dropped due to 1.20, down 85% in last 12 months. does not pose systematic risk to financial system, most likely to be sold in next few days with shareholders being wiped out.  Groupon road show for upcoming IPO started last week, many now critical of business model. We do no like the business model of Groupon and financials. We believe that the IPO might either be pulled or be disaster for investors and lead manager.  My Grade: B+

Interest Rates

US rates again higher on the long end (2.31% vs. 2.22% at 10 year last week; 3.35% vs. 3.27% at 30 year last week). Rates also much higher now in German bunds (2.19% vs. 2.11%). A lot of pain in the portfolios of investors who went long in the last few weeks.  My Grade: C-

Credit

Greek bond prices rallied several points after the announcement of the bail out. Italian BTPs fell and other periphery held up. My Grade: C-

In the commodity space base and precious metals also rallied. Silver at 35, Gold at 1740. My Grade: B+

Volatility: VIX down to 24% from 33% last week.

Hedge Funds

HF performance looking better this month across the board except for CTAs who suffered from the sharp trend reversals. Dow Jones Credit Suisse Core Hedge Fund Index is up 1.55% MTD. Managed Futures / CTA down 3.6% MTD. My Grade: A-

Outlook

The Christmas rally in equities is likely to run out of steam in the next few weeks as markets want to see details of the bail-out, progress in Greece and implementation of the economic programs in Italy. Because valuations are reasonable, but political and macro risks are hovering over the markets, stock markets will continue with higher than normal volatility. As long as the bailout stands the downside risk is limited. However as we believe that there is a significant deal risk corrections with sharp reversals are highly likely until year end.

Conclusion

With only two months until year end, investors and traders will have to look into 2012 to identify opportunities. Due to the risks ahead of us we believe that sovereign credit will continue to be the focus, equity volatility will prevail and the danger of inflation will be over the rates markets. In our investment strategy we recommend quality companies and quality hedge funds, in our asset allocation we focus on tactical strategy in order to exploit high levels of volatility and to adapt asset allocations as the macro environment changes. Unfortunately we are still in the unfolding of the excesses of the bubble and the market crisis of 2008.  

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: 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.

.

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.