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.
