21 December 2010

Winners & Losers in 2010

Bloomberg via Saxo Bank

15 December 2010

Detailed exposure of banks to PIGS countries

he BIS latest publication provides interesting details which are usually kept away from public eyes; I talked to the BIS which confirms that they were able to publish these detailed data following an authorization from Central Banks in Europe. I guess this disclosure had only one objective: to show that Spanish banks gross commitment to banks and public sector in Portugal, Greece and Ireland is minimal at USD 19.2 billion vs a total exposure of USD 98.3 billion, i.e. 20%.
These statistics also confirm my previous analysis of a very low exposure of Italian banks to PIGS countries at USD 76.3 billion, 5.4 X less than France and 6.7X less than Germany. This number is even lower if exposure to banks and public sector only is considered (7X less than France and 9X less than Germany). France and Germany have a total exposure to PIGS of USD 410 billion and USD 512 billion respectively, nice numbers which explains a lot about the Greek and Irish rescues...
The bar charts show that banks have substantially reduced their exposure to the PIGS countries during Q2 2010, even if unevenly (Germany for example cut 25% of its exposure to the non-bank private sector in Ireland whilst increasing it by 5% to banks). I have no doubt that this has continued since, with all the sovereign debt reduction flowing to the ECB balance sheet.

Bank for International Settlement: Highlights of international banking and financial market activity

08 December 2010

Tracking the Global Economy: United States

The latest release by the FED of St Louis confirms that the economic situation of the US continues to (slowly) improve.

Federal Reserve Bank of St Louis: Economic Research

07 December 2010

What did the financial crisis did teach us about the Eurozone?

© Markets & Beyond

In any crisis, one can become depressed and see the glass always half empty and not learn lessons, continuing the same mistakes or inventing new ones, even worse. One can also learn from past mistakes and improve.
The financial crisis taught us a few things which were hidden deep within its foundation due to a flush of liquidity, low interest rates, deflation imported thanks to industrial delocalization and the absence of control:
  • The Euro is a political currency, not an economic one and will fail if the latter does not dominate the former; please understand me, I do not wish the fall of the Euro, I am just explaining the inevitable if politicians in Europe continue to act blindfolded for the sake of the Eurozone and EU enlargement for themselves.
  • Behind the smokescreen of European solidarity, European countries are participating in rescue plans to save first  their banks, second the countries which are bankrupt, not the other way around (why do you think the UK is participating in the bailout of Ireland and not the one of Greece?). Without banks at risk in France and Germany, I doubt we would have witnessed such bailout, in particular Ireland that most European politician abhor (too low taxes to their taste and a former economic success, not like Greece – Europe prefers cheaters).
  • The root of the crisis is not addressed with the past and yet to come rescue packages: the one-fits-all does not work without the loss of sovereignty on fiscal and social policies, i.e. the end of sovereign states in Europe – if you don’t control your fiscal policy, you are no longer independent.
  • Without a mechanism of automatic sanctions, strong enough to discourage Government not to abide by the convergence criteria (60% debt/GDP, 3% budget deficit), there is no way the Eurozone can work; past experience has demonstrated the lack of courage of politicians in front of voters.
  • The all idea of economic convergence behind the Euro has in fact witnessed the contrary with a competitiveness gap increasing between the North and the South of Europe. The rescue packages extended to Greece and Ireland are not solving anything, just adding debt to already overly indebted countries and plunging them into a deflationary spiral making these debts even more difficult to service despite artificially low interest rates. Oh! Yes, we are gaining a few years, as if it were be enough. 
There are two different ways to address over-indebtedness. Whilst Iceland and Ireland had both too much private-sector debt and a banking system massively overleveraged, their response to the crisis has been rather different. As BCA Research analyses it: 
“Iceland and Ireland experienced similar economic illnesses prior to their respective crises: Both economies had too much private-sector debt and the banking system was massively overleveraged. Iceland’s total external debt reached close to 1000% of its GDP in 2008. By the end of the year, Iceland’s entire banking system was crushed and the stock market dropped by more than 95% from its 2007 highs. Since then, Iceland has followed the classic adjustment path of a debt crisis-stricken economy: The krona was devalued by more than 60% against the euro and the government was forced to implement draconian austerity programs. In Ireland, the boom in real estate prices triggered a massive borrowing binge, driving total private non-financial sector debt to almost 200% of GDP, among the highest in the euro area economy.
In stark contrast to the Icelandic situation, however, the Irish economy has become stuck in a debt-deflation spiral. The government has lost all other options but to accept the €85 billion bailout package from the EU and the IMF. The big problem for Ireland is that fiscal austerity without a large currency devaluation is like committing economic suicide – without a cheapened currency to re-create nominal growth, fiscal austerity can only serve to crush aggregate demand and precipitate an economic downward spiral. The sad reality is that unlike Iceland, Ireland does not have the option of devaluing its own currency, implying that further harsh economic adjustment is likely.”

The graph below exemplifies the result of both policies: the winning one is quite obvious…
The major mistake made by Ireland in 2008 was to guarantee the debt of Irish bank.
I disagree with the ECB and many European politicians who do not want bondholders to participate in mending the current crisis: bondholders must take a haircut in a package designed to manage an orderly default of at least the PIGS countries, like any investors they must pay for their wrong analyses and bad investments. It is how capitalism successfully works. The taxpayer should not pay for the private sector.
Politicians and others at the ECB fear that investors would not invest again in European sovereign debt? Bullshit; investors have short memories, and more importantly, good investors are able to do their own analysis of risk/reward profiles; offer them an interesting story and they will invest, otherwise reform yourself to present such a story.
Banks are going to be under pressure? Yes, and so what? They would need additional capital? Ok, raise it with shareholders. Probably unsuccessful due to the sheer size? Sell assets. Not enough? Sell yourself. OMG! We are going to risk loosing control of “national” banks; we can’t do that! Ok, get the taxpayer to become shareholder and get rid of the Management and the Board, then sell back to the private sector at a profit.
I continue to believe that we should not test the German resolve to act as taxpayer of last resort, otherwise Germany will take its currency back accompanied by the virtuous Europe (and France will not be part of it) – just look at the trade balance GDP growth, unemployment, etc. to figure out.
BCA Research: Iceland, Ireland And The Role Of The Currency

06 December 2010

A E-bond: a good idea? Certainly not!

Jacques Attali, the former advisor to French President, François Mitterand, has been a strong advocate of E-bond issuance for some time, in particular in his book “Tous ruinés dans dix ans? Dette publique: la dernière chance”. This idea was repeated at the Luxembourg for Finance conference in June 2010 attended by Jacques Attali and Jean-Claude Junker, Prime Minister of Luxembourg and President of the Eurogroup.
Today, in the Financial Time, Jean-Claude Junker and Giulio Tremonti, the Italian Finance Minister, floated the idea of an E-bond. Under the premises that
© Markets & Beyond
Europe must convinced markets and European citizens of the irreversibility of the Euro, their reasoning is as follows:
  1. The issuance of E-bond in sufficient quantity would provide investors with a deep liquid secondary market, second only to the US Treasury market.
  2. Up to 50% (read at least!) of EU members sovereign debt issuance would come from E-bonds.
  3. Up to 100% of debt issuance would come from E-bonds in case exceptional EU members could not access capital markets under “normal” conditions.
  4. Sovereign debt could be switched to E-bond at a discount to reflect the credit risk which in turn should strongly incentivize countries to reduce their deficits.
  5. A single e-bond market for the Eurozone sovereign debt would reduce the necessity for emergency interventions in the secondary market.
  6. “A new market would also ensure that private bondholders bore the risk and responsibility for their investment decisions”. Investors (read banks) would have a better collateral with the ECB by switching from sovereign debt to E-bonds whilst they would take a loss on conversion; this would also ensure transparency regarding solvency ratios.
  7. In case of difficulty, the new mechanism would allow borrowing states to be able to secure  funding at better rates than presently and not to be exposed to short term speculation
  8. Profits coming from conversion discounts would accrue to the European Debt Agency (“EDA”) that would in turn permit lower rates for borrowers. And the taxpayer would not be in line.
I am afraid in the real world, there is no win-win situation. Let’s review this fairy tale:
  1. Fine. In normal market conditions, this might translate in a lower cost of funding, not by a lot, maybe a few basis points, everything being equal.
  2. So, they are talking about moving debt from one place to the other: Debt will not be reduced whilst one of the keys to the crisis is over-indebtedness.
  3. In case of crisis, more debt could be issued under the EDA, and less at the sovereign level; again, no debt reduction but more debt.
  4. Well, I would be interested to know how the discount would be decided/calculated, since if transparency there is, this is quite a key point (more later). And I do not see why countries would be more incentivized to reduce their deficits via the discount mechanism than currently when they are under tremendous stress.
  5. The intervention in the secondary market by the ECB was implemented (1) to manipulate the cost of borrowing of the sovereign states and (2) to allow banks to get rid-off of bonds resulting from bad investment decisions. This the path Europe decided to follow, rejected any other solution, as displeasing they might be for their ego.
  6. No need of a new market: just let bondholders take a haircut right now. And I do not see any difference for banks taking a haircut in the current situation or via a discount mechanism on conversion. Opacity has not been the result of markets but of continuous intervention by the ECB and refusal by politicians of an organized Greece default and possibly the failure of several banks, meaning shareholders wiped out and bondholders severely affected.
  7. Indeed, they would access the market at better rates, since Germany would pay for it via the E-bonds. These E-bonds would result in an increasing cost of financing for virtuous European countries to benefit profligate ones. Believing that the E-Bonds would be at German rate is just plain foolishness.
  8. Yes, the EDA would benefit buying at a discount from PIGS countries, but what about Germany or The Netherlands? The EDA would buy at a premium, hence a loss.
 All this mechanism does not address the point: European economies must deleverage. Jacques Attali, a very clever man, sells his idea by stating that the EDA would have no debt and could therefore borrow huge amount of money… Well, hold on and what about existing debt? Would it have disappeared? Would the economy had grown much more? Would the European population suddenly increased much to maintain the per capita debt? Come on, this idea is just to institutionalize the mutualization of the sovereign debt across Europe and its associated costs which in turn would force a fiscal integration (without a social integration, it does not make much sense anyway).
This proposition aims at fostering a European integration much farther whilst the root of the problem -the one-fits-all does not work- is not addressed, and make the euro irreversible.
European politician are not ready to admit their failure. Dogma instead of pragmatism still governs Europe, sadly.
Financial Times: E-bonds would end the crisis

03 December 2010

The Eurozone crisis and competitiveness

Several times, I wrote on this blog and in articles that the premises of the construction of the Euro were flawed from the beginning, mixing countries displaying stages of economic development too far apart, increasing debt and artificially low cost of financing creating a smokescreen. I also wrote that, in the absence of a two tier Eurozone (strong countries/weak countries), only a fiscal and social integration, with a loss of sovereignty (a German Europe), was a viable solution since the competitiveness gap has increased instead of decreasing for the past ten years or so: this is at the heart of the current crisis.
All the EU/IMF sponsored rescue packages and ECB intervention -buying PIGS debt from banks to lower their cost of financing and relieve banks which loaded themselves to play the yield curve (encouraged by the ECB)- are not mending the root of the problem: lack of competitiveness of the PIGS countries (I always hesitate do add another “I” for Italy) that will take at least 10 good years to improve.
The World Economic Forum published “The Global Competitiveness Report” which exemplifies this:
The World Economic Forum: The Global Competitiveness Report http://www.weforum.org/en/initiatives/gcp/Global%20Competitiveness%20Report/index.htm

30 November 2010

Ireland rescue package: some more details

Further to yesterday’s information contained in the EU press release, I found some additional details that may be of interest to readers:
  • The EUR 10 billion capital injection will raise core tier 1 ratios to at least 12%.
  • The Irish National Pension Reserve Fund will provide EUR 12.5 billion.
  • Any banks whose core tier 1 is seen falling below 10.5% will receive additional capital through a EUR 25 billion contingent capital facility established through the program. The stress tests will include a third party review of asset quality to garner additional credibility.
  • Liability management of subordinated bank debt will be "more widely applied" than just Anglo-Irish bank.
  • A special distressed banking law will be introduced in 2011 for the small 'credit unions' sector
  • The 5.8% interest rate is an average since the maturity of loan will range from 4 ½ years to 10 years.
  • Ireland will have an extra 12 months, i.e. until 2015, to lower its deficit down to 3%.
  • Ireland will discontinue its financial assistance to the EU loan to Greece.
The Irish contribution coming out the INPRF represents 50% of its total assets: as noted yesterday it is a disgrace. I do not understand how Ireland accepted this.
Still, this agreement has to be accepted by the Irish Parliament; the vote should be passed successfully despite only 2 seats majority (2 independents).

The new loan participation breakdown for any new EU rescue is:


France and Germany bear 50% of the total burden: unsustainable, at least for French finances if its AAA rating is to be retained (necessary for the EU lending vehicle to be AAA rated); I have therefore difficulties to see how the EUR 750 billion package decided in May could be raised in its entirety. My conclusion is that European countries cannot afford a Spanish bailout.
© Markets & Beyond
Deutsche Bank: Thoughts on Ireland's aid programme

29 November 2010

Ireland bailout: what’s next?


Ireland bailout

The 12% of GDP Irish budget deficit (32% including a banking rescue) was unsustainable and a few details emerged about the bailout agreed Sunday:
The contribution from Ireland will come from the cash pile the Irish Treasury has accumulated and the National Pension Reserve Fund - a disgrace; the fund, which holds EUR 24 billion of assets, was set up in 2001 to pay pensions from 2025. This means that Ireland is its own contributor for 20% of the total rescue package which worries me.
The loan has a 7 ½ year tenor and will bear a 5.8% interest more than the 5.2% granted to Greece (which I do not know where it comes from since a 5% ceiling was agreed for Greece).
EUR 10 billion will immediately go to recapitalize Irish banks and EUR 25 billion for further needs, the balance, EUR 50 billion, covering budget deficits.
It is worth noting that Germany dropped its demand of having bondholders taking part of the burden. The ECB, and other European countries, feared that such a move would translate into higher cost of financing and even close the market for more countries adding new losses for banks. Banks have played the yield curve by borrowing at near zero cost with the ECB and investing in longer date sovereign (riskless!) bonds, compounding the crisis.
Another interesting paragraph not linked to Ireland: “The Eurogroup will rapidly examine the necessity of aligning the maturities of the financing for Greece to that of Ireland”. This confirms my analysis that Greece is in no position to reduce its budget deficit down to 3% of GDP in 2014, and even less to be able to repay the emergency EU and IMF loan after 2013. Is the interest rate going to be adjusted? Is it going to be the same as Ireland? In any case these rates are administered like Albania in the good old says… Where is capitalism?
One last question (and I did not find any answer anywhere or even any question about it anywhere): how do these rescue loans rank compared to senior debt…?
Finally, the EUR 40 billion loan represents an additional EUR 8.8 billion for Italy, EUR 10.0 billion for France and EUR 1.7 billion for Belgium (if Spain is not excluded as I did, it would add EUR 4.9 billion, or 4% of its debt requirements for 2011, and reduce pro rata the other countries ).
2. What’s next
Looking at the market this morning, this plan fails to alleviate fears of contagion:
  • After a short (small) rally bank stocks are down again
  • The EUR is also under pressure after a short rally
  • 10 year bonds in PIIGS countries are more or less unchanged
  • German 10 year bund yield is at a 6 months high
The second bailout of the eurozone is nothing more than hiding dust under the carpet; the rescue package is not a game changer since it does not improve competitiveness and does not reduce the debt overload, to the contrary: liquidity support does not work out insolvency. There are calls to double the EUR 750 billion commitments, since the current one would be insufficient to rescue Spain and Italy (besides Portugal and add Belgium and France).
Portugal will be the next country to ask for a bailout and Spain will follow quickly behind due to its exposure to Portugal (EUR 78 billion at the end of June); then if Belgium or Italy fails, France would be engulfed with an exposure of EUR 253 billion and EUR 418 billion respectively.
In order to repair their balance sheets instead of cleaning them up one for all, the ECB and European politicians (lobbied by banksters) encouraged banks to play the yield curve by investing in peripheral European sovereign debt to get a nice spread pick up over their financing cost, and then, when things started to look ugly earlier this year, the ECB bought this sovereign distressed debt whatever the rating (against the ECB rules, but who cares…). The only effect has been to compound the crisis for gaining 1 year maybe 2 or 3 at most.
And Trichet, alongside most European politicians, continue to play this game by refusing bond holder (read banks) to share the burden (I even do not see why we, the tax payers, should we pay for any bailout when investors made wrong decisions). This, in effect, (temporarily) transferred the insolvency from banks to States without getting to the roots of the crisis.
It will carry on until and unless Germany stops playing musical chairs; in-between the crisis will deepen with debt continuing mounting and inflating it late seventies/early eighties style, the only way out.
I continue to believe that an orderly bailout of over indebted countries and banks is the only way to cleanup the house and build again on sound foundations. This is not the way Europe has gone so far, preferring dogma over sound governance. Europe is facing enough challenges (an ageing population and pension payments being the most important) without having to drag ongoing debt problems: let’s investors who made wrong investment decisions bear the burden, this is how capitalism works and wash aside the socialist and interventionist approach which repeatedly failed.
Continue to stay clear of financial shares and buy precious metal on setbacks.
Council of the European Union: Statement by the Eurogroup and ECOFIN Ministers

26 November 2010

Ireland, PIGS and the Eurozone: Here we are…

1. Bailout, bailout and bailout
A few numbers on loans provided by the IMF and the EU:
Greece: EUR 29 billion (+ EUR 9 billion to be paid in January)
Ireland: EUR85 billion (will see during the WE what the final number is)
In January, Greece will get EUR 9 billion for its third installment (I have no doubt that even if they are dissent countries, arm-twisting will do the job), representing a total of EUR 38 billion i.e. 35% of the EUR 110 rescue package dedicated to Greece. Ireland will get EUR 85 billion i.e. 11% of the 750 billion EU and IMF backstop line.
The EU/IMF bailout will take total debt to GDP of Ireland to well in excess of 100%, and, realistically, it is most probable that the total burden of debt will be shared with creditors.
The cost of a bailout on the Irish scale for Portugal would cost EUR 100 billion, based on a package of 60% of GDP. According to Bloomberg, for Spain a bailout of 60% of GDP would cost EUR 632 billion. For Italy, the region’s second-most indebted nation after Greece, the figure would be EUR 820 billion, but I am not so worried about Italy, for reasons I will explain later, I am more worried about France
The EUR 860 billion double barreled package looks rather thin when the uphill task is contemplated. Even based on 30% of GDP, there is a shortfall, and don’t forget that a number of banks would not be able to sustain the shock.
Wednesday in Paris, European Central Bank council member Axel Weber said governments can increase the size of the European Union-led bailout fund if necessary to restore confidence in the euro. “If not [the EUR 750 billion recue], it will have to be increased.” In a worst-case scenario, the fund would need an additional EUR 140 billion, an amount that would not jeopardize the survival of the euro, Weber said Thursday in Berlin. EUR 140 billion? Why not 250 or 300 or 100? And which worst-case scenario is he talking about? And can governments that are already over-indebted increase their commitment? I doubt it, and in any case not in the current format.
2. The Eurozone is a (sad) farce
I note that all the Irish banks successfully passed the EU regulators’ tests in July; as discussed in this blog at the time, these tests had no credibility being designed to defuse the risk of a EUR collapsing even faster at the beginning of the summer: fact have stayed, waffle has gone. Likewise, ongoing declaration from European leaders have no credibility at all went they explain that the crisis is under control and that Spain will not need a bailout: why Spain should be much different from Ireland when they also had a real estate bubble of the same magnitude (true there are difference regarding the solidity of the banking sector, but in essence the situation is similar)…
On November 18, the Irish Finance Minister said, as reported by the FT:
“...Brian Lenihan, Ireland’s finance minister, told Irish radio early on Wednesday the banks had “no funding difficulties.”
On November 25, asked in an interview on Punto Radio in Madrid if Spain risked having to seek a rescue like Ireland or Greece, Salgado said “absolutely not.
” The euro faces “speculative attacks”. [Ah! The speculators are back, the usual scapegoat for politicians]
“I should warn those investors who are short-selling Spain that they are going to be wrong and will go against their own interests,” 
Zapatero said in an interview with Barcelona-based broadcaster RAC1 today.
Bloomberg continues reporting:
“Merkel and Sarkozy are “impressed” by government’s budget cutting plans, today’s statement said.”
Really? I am also impressed by their consistent denial of reality. Anyway, during a financial crisis do not trust banks and politicians the least.
Let’s carry on with some spice from Portugal’s Prime Minister latest declaration: 
“There are those who think that the best way to preserve the stability of the euro is to push and force the countries that at this moment have been more under the floodlight to that aid…But that is not the vision or the political option of the countries that are involved”
Add Austria Finance Minister Josef Proell who mid-November said the EU was postponing the payment to January to wait for a final estimate of Greece's fiscal numbers, since denied. However, the IMF added:
"So far the government has been able to offset these [revenue] shortfalls by underspending at a state level, that's why the overall targets are still being met. That's clearly not a sustainable strategy going forward…The sustainability of achievements to date will only be maintained if there is a very determined effort to move on structural reform".
Whatever, it shows that dissenting is getting more voiceful, after the Slovak parliament refused to participate in the bailout for Greece on 11th of August.
This crisis is moving towards a fully blown political crisis.
This is a farce, a sad screen play written by incompetent and dogmatic politicians who are driving Europe to the wall and its citizen to poverty. Nobody listened when I claimed numerous times to some European elites that the over-indebtedness of Europe will drive to lower standard of living unless tough and unpopular measures were implemented quickly: just watch Ireland, Greece, Spain, France et al. And this is only the beginning since countries have no longer money available to soften the effect of the crisis, to the contrary. The chart below gives you a flavor:

3. The foundations of the Eurozone are flawed
As written several times, the one-fits-all does not work. A union that was meant to foster economic convergence has fueled divergence. I can only agree with David Fuller:
“The Euro is based on the assumption that one monetary policy would be appropriate for 16 different fiscal policies. The peripheral Eurozone debt crisis highlighted how incorrect that hypothesis is and policy initiatives are currently being put in place to improve fiscal cohesion. However, this does not heal the very real debt problems that were allowed to develop over the last decade.
Without currency union, countries such as Ireland, Portugal, Greece, Spain or Italy would have recourse to a significantly weaker currency to help defuse their debt problems and improve competitiveness. On the other hand, today's Euro is probably considered by many at the Bundesbank to be too weak to contain nascent inflationary pressures in Germany. This is another contradiction that will eventually have to be dealt with.
German, French and UK banks are most exposed to bank and sovereign debt in the periphery. Greek and Portuguese sovereign debt, Irish banks and Spanish banks and Cajas pose a serious threat to already weakened financials in the rest of Europe. It is for this reason that governments have been forced to absorb private sector debts. The core Eurozone quite rightly expects those who borrowed to pay their debts. Bailouts on the periphery are seen as preferable to defaults and bailouts in the core. It remains to be seen whether voters in high deficit countries will be willing to accept the amount of economic hardship required to bring debt levels back into line with Eurozone requirements.

Over the medium-term, the big question is about competitiveness. The last decade saw countries such as Ireland, Greece, Spain and Portugal substitute a focus on exports and balanced budgets for spending and higher wages and inflation. The contraction in labour and other costs, if allowed to run its course, will improve competitiveness and set the stage for a medium-term recovery. Longer-term, it is to be hoped that voters display the fortitude and integrity necessary to make sure politicians with a focus on fiscal responsibility are put in power, lest the boom to bust pattern of development prove interminable. “ [emphasis mine]
It is time for weak European countries to sit down with creditors and agree on an organized debt restructuring and an haircut; I have advocated this since the beginning of this year as I do not see any other proper way out.
4. Who is really at risk?
The data provided by the Bank for International Settlements provide some useful information which I tabulated in the following table with some added flavor.

France, Germany and the UK are by far the most exposed to PIGS countries with EUR 1 trillion. Portugal is rather over-exposed considering the size of its banking sector. One big surprise is the very low exposure of Italy, particularly when compared to France.
When the net number is calculated (even if netting does not really work this way, but at least it provides a better idea of the real exposure and the arm twisting that can be used – remember Iceland), Italy and the UK are in an enviable position, being net negative.
This is the first reason why I am more negative on France than Italy.
The next table, borrowed from Morgan Stanly, confirms that French banks are the most exposed (besides the usual winner: RBS).

The second reason is derived from the following table:
Whilst France is less indebted than Italy, the sovereign debt growth is 4 times quicker in France than in Italy, and France will catch up Italy in absolute terms next year.
In addition, Italy has a trade balance in equilibrium whilst France is heavily in deficit, showing that Italy is more competitive, an important ingredient for a recovery and eventually the reduction of the sovereign debt.
A last word, this morning, I was hearing on the French radio that residential real estate in Paris was up by 13% so far this yearwith the average square meter above EUR 7,000, , a record high, thank to low interest rates and revolving credits again available: Central banks low interest rate and liquidity creation policy is again fuelling asset bubbles (including the mother of all bubbles: government debt).
Have a nice week-end!
FT: Dublin fails to dispel eurozone debt fears
Bloomberg: Portugal Says EU Can't Force Governments to Accept Rescue Aid
Bloomberg: Salgado Dismisses Bailout Risk as Borrowing Costs Surge to Euro-Era Record
Moneynews: Greece Cleared to Get Next Bailout Installmenthttp://www.moneynews.com/Economy/EU-Greece-Financial-Crisis/2010/11/23/id/377895
BIS: Locational Banking Statistics
Eurostat: European Economic Forecast - spring 2010

Quantitative Easing explained...

... with a touch of humor, but sadly true.

19 November 2010

Ireland, PIGS, QE2, the Euro and the melting pot

Today, I am going to reflect on the continuing crisis within the eurozone and the usefulness QE to spur the economy, a nice melting pot.
Greece is back behind the curtains and Ireland is on the stage under the spotlights for the continuing show of the eurozone crisis.
Summary of the previous acts
Policy makers did not want to face the harsh consequences of 20 years of easy money that led to over-indebtedness (act 1) and take the tough measures needed due to cronyism and the human nature of politicians who prefer to spend money to buy votes instead of telling voters the difficult reality of past policy mistakes. There is one reality that central bankers did not want to see is that excess liquidity leads to mal-investment, since lower returns are deemed reasonable and outright speculation becomes the norm (from individual with real real estate or stock markets - some succeeded, most failed - to CEOs who engaged in huge M&A deals to flatter their ego and grow their bank account - most created value for themselves).
The act 2 started with the financial crisis in August 2007 which reached its peak in the aftermath of Lheman’s debacle and the collapse of the real estate market. Central bank opened without any restraint the liquidity tap (should I say fire hose…) for banks 1) to get rid of junk assets (they still have quite a bit in their accounts) and 2) play the yield curve to repair their balance sheet and gain time via short term financing at no cost and investment in longer dated Government securities (you know, the famous riskless sovereign debt), making a couple of hundreds of basis points (by the way the most profitable business since you only need a couple of people to do it and you can leverage!). There is no reason to stop since Ben Bernanke QE2 is a clear signal that the FED will continue managing the yield curve to limit the cost of financing of the US Treasury whilst letting banks carry on playing the curve.
Banks (European ones in particular) poured cheap money given by central banks into government securities, without properly analyzing the inherent risks of such assets, replicating with Greece, Ireland and other PIGS (add France and Belgium), that same mistake as for CDOs and et al to gain some tens or hundreds of basis points of additional return: complacency at best...
This led to the eurozone debt crisis during H1 this year with Greece. Now, Ireland is taking the stage. In both cases, the sins lied with them, even if they are of a different nature: on one hand a cheater which did not reform itself and is totally uncompetitive and on the other hand a country that had balanced budgets and let its success running away with real estate speculation that drove its banks to the knees, hence their costly rescue and a spiraling budget deficit expected to reach 32% of GDP in 2010 despite austerity measure taken in 2009 (the first country in Europe to do so)!
This profitable yield curve play had in itself the seeds of a contradiction: why should banks lend money to a depressed real economy when they have to be more strict in their lending practice (well, financing a speculative property market is not really the same as financing the real economy, but this is an other part of the debate) and can easily make money at “no risk”.
Ant now we arrive to act 3.
Act 3
Germany had enough to pay for the sins of profligate countries; after all, and until proven differently, Germany is not a Charity. Merkel, with a reason, is fed up for Germany to become the tax payer of last resort and wants other stakeholders to pay their share of the burden: shareholders should be wiped out and bondholders (banks among the largest ones…) take a haircut. I would add, and it may be the most important act for any sustainable recovery, Boards and management should be fired (politicians too - an other story).
Large European countries, Brussels and weak eurozone countries are bullying Ireland to accept a rescue package from Europe and the IMF, while Ireland has no immediate need for funds (EUR 22 billion in their coffers). Different reason for the same objective: weak eurozone countries fear contagion and the Franco-German axis together with Brussels are targeting Ireland’s low corporate tax rate. This is the first clear of arm twisting to impose a converging taxation (upwards of course) within the eurozone. This is stupid: Ireland will be able to get out of this mess quicker than most via its competitiveness and attractiveness for foreign companies, and a low corporation tax rate is part of the solution; not the case wit Greece which has not much to show and seems however better treated than Ireland...
Between Irish and Greek bonds, you know where I would go for if I had to choose between the two. If I were Irish, I would play hard balls with the French, Germans and Brusselites to get as much as I could: this is the annoyance power since arm twisting is more or less the only language understood in Brussels, Berlin and Paris.
QE 2
The second QE decided by the FED will fail to stimulate the economy. Whilst it allowed interest rates to substantially decrease during QE 1, and therefore release pressure on many homeowners and relieve banks as well as spur the stock market, QE 2 will not add much to consumers who are either out of job with no prospect of a rapid improvement, and the wealth effect is more than dubious this time (after the crisis we are muddling thought which demonstrated that not only assets cab go down as they go up, but also collapse, who, with some sanity, is  going to borrow in order to consume on the back assets that went up thanks to the FED actions?).
QE is merely boosting asset classes, not the real economy, and attempting to inflate in order to reduce the US debt burden and debase the USD to increase export will not work, but may be temporarily - and I even have doubts (Germany have always had a revaluing currency in relative terms and continued to be the world n° 1 or n° 2 exporter; they got the products clients want: consumers want BMWs not GM cars). Playing the currency card only works if at the same time structural reforms are undertaken to become competitive on the international stage by offering the right products at the right price.
On sure thing, savers and pensioners are going to loose at this game.
I attach an interview with Jeremy Grantham, Chief Investment Officer of GMO, one of the best value investor in a generation or two, who discusses QE 2 and prospects for asset classes.

07 November 2010

Chart of the Day: Stock market rallies since 1900

Chart of the Day had an interesting chart showing the length of bull markets; as they commented:
the current Dow rally (hollow blue dot labeled you are here) is still somewhat short in duration and below average in magnitude when compared to all the stock market rallies that occurred since 1900
Chart of the Day adds:
Most major rallies (73%) resulted in a gain of between 30% and 150% and lasted between 200 and 800 trading days.
Whatever the imperfection of such data (where are the rallies in bear markets, that can be extremely profitable), this a useful reminder that the current bull market (or rally in a bear market) is not yet de end if history repeats itself.

Chart of the Day: http://www.chartoftheday.com/20101105.htm?T

29 October 2010

Greece’s Budget Execution Program: Jan-Sep 2010

As readers of Markets & Beyond know, I am closely following the implementation of the Greek budget. Its most recent release (20 October) leads me to conclude that the Economic Policy Program (“EPP”), which takes into account stability measures decided in March and May and implemented since, will not be met.
At the end of September, cumulated revenues were running behind schedule at EUR 36.5 billion whilst they should be standing at EUR 41.4 billion (EUR 55.1 billion projected for 2010); the gap between projection and realization is widening: the latest data from the Greek Ministry of Finance indicate that EUR 2.4 billion revenues will not materialize with direct tax and indirect tax 10% behind schedule so far. The growing gap between tax revenues and EPP leads me to also doubt about the GDP growth forecast.
Expenditures have been reduced more than what was planned in the EPP. However, the Public Investment Budget (P.I.B.) is nearly 20% behind schedule, minimizing expenditures by roughly EUR 1 billion (I am pretty sure that this one of the adjustment variables to make the final implementation closer to projections- another one is EU grants with EUR 2 billion left in the backburner in case over a total of EUR 3.1 billion planned for 2010…) and interest payments are well ahead by nearly EUR 2 billion and this is not going to improve as the year goes.

Overall the improvement compared to the disastrous 2009 is obvious but trailing projections despite the harsh measure taken by the Greek Government and money poured y the ECB (for banks), the EU and the IMF (to match the borrowing requirements). This leaves us with a budget deficit which should be close to EUR 21-22 billion (pending numbers massaging by the EU and the Greeks). As stated in previous articles, Greece has the problem with revenues more than costs; yes, they must slim down but due to the sheer size of its debt, it is a substantial increase in revenues that will save Greece from default/restructuring, and frankly I do not see how they can avoid it.

Finally, on 20th October Eurostat released an update for EU 2009 budgets deficits for all member states but Greece:
“Eurostat has completed its enquiries on statistical compilation of the Greek fiscal data and is now undertaking a process of quality assessment of statistical source data from public accounts, in cooperation with the Greek Statistical Office and the Greek Court of Auditors. Following this process, and the release of the annual report of the Greek Court of Auditors at the beginning of November 2010, Greek fiscal data will be published by Eurostat by mid November 2010.”
On October 27, the Finance Minister, George Papaconstantinou, said a review of the 2009 budget showed the deficit was greater than 15 percent of gross domestic product, more than the 13.6% previously estimated, and more than what he said on October 7…
The final number will be published by Eurostat by mid November.
As for banks, it is time to stop bailing out cheaters and incompetents: imagine to what productive use and wealth creation the trillions of wasted money could have bee channeled to.
Greek Ministry of Finance: Budget Execution 2010 – September
Greek Ministry of Finance: Presentation on Budget Execution / January-September 2010
Eurostat: Euroindicators - Second notification of government deficit and debt figures for 2009
Bloomberg: Greek Bonds Tumble as Government Says Tax Revenue Falling Short

21 October 2010

The US economy: no double dip! Long equities

Whilst the double-dip theory is waning these days, I thought it would be good to review a few economic indicators that cry that no double-dip is to be expected (but for economic/monetary mistake or exogenous shock).
First, the output gap turned around and whilst still negative is not pointing to a downward tipping point. The graph below clearly shows that employment is lagging the output gap indicator. In addition unemployment peaked four months after the recession ended, which is rather short compared to 1991 and 2001 recessions where the numbers were 15 and 19 months respectively vs. 1 month for 1981 recession: it seems that the deeper the recession the shorter the recovery time (that does not say anything about the magnitude of the improvement and unemployment is still very high by US standards).
Second, retail sales have also strongly rebounded and continue to forge ahead. We are back to April 2007 and September 2008 levels.

Third, despite a high unemployment rate, individuals have largely repaired their balance sheet to levels not seen since 2000 and the 1985-1990 period. I am convinced that the debt service payment/disposable personal income ratio will shrink further however that will weigh on GDP growth but make the economy much sounder longer term. In the meantime, the savings rate has stabilized in the 6% area.

Finally, we also analyzed US federal tax receipts from the 2006 tax year (ending in September) which present an online view of the real state of the US economy, since data are provided each week. The graph below plots monthly taxes received from individuals, corporations, excise and all contributors compared to the previous year.

Data clearly point towards an improving economy since February-April 2009; this corresponds to the trough of equity markets in the Western world in March 2009. The dramatic improvement in corporation taxes paid (+20% for the 2010 tax year) show that the economy definitely turned around whilst taxes paid by individual are still sluggish but have gained traction for a year now.
Excise taxes are as close as we can get for the exact picture of the economy: they improved a lot late last year and are now in a consolidation phase but nowhere near a double dip. It is worth noting the correlation between tipping point of the excise tax collection amelioration with the stock market trough in March 2009 and the sluggishness of 2010.
All the above lead me to think me that equity markets should at worse do alright at least to the end of the year.
US Treasury: Financial Management Service
Federal Reserve Bank of St. Louis: Economic Research

29 September 2010

The magnificent 7 and equity markets - Review 9

In my previous review (10th August), I concluded: The 15% correction seems to have just been a pause in a bull market ... I stick to my no tightening by the FED expectation … and the ECB any time soon despite the rhetoric. This will be supportive to equity markets and a major tailwind.”
I have not changed my view of no double dip and the FED QE2 (USD 1 trillion dollar additional liquidity) if confirmed will fuel asset prices.
After a low reached late August on the S&P 500 at 1050, the market has since regained 100 points and is trading around its 200 days moving average which has been flat since the beginning of the summer (watch if it is turning down). The S&P500 is at the same level as in January and has yet to pass the 1200 mark again which I expect to be done by the end of the year.
Economic news from the US continue to point towards a slower GDP growth and still high unemployment, but no double dip; Europe has also showed recent signs of better growth, mainly due to German exports. Fast growing economies in the rest of the world do not show signs of weakeness.
One interesting indicator is the Commercial and Industrial Loans at All Commercial Banks in the US released Monday: it displayed the 3rd consecutive month of growth, the first time since October 2008; whilst at an extremely slow pace (USD 4 billion increase over the 3 months compared to USD 404 billion decrease between October 2008 and June 2010), it shows that banks are again net lenders to the economy and the sector is healing.
S&P 500 Banks index: the index has traded range bound for a year and has yet to decisively to breach the 165 level; there is no sign this happening any time soon and, conversely, there is no sign of a deterioration either. In my opinion, the level comes from a continuing reappraisal of the future profitability of banks with new rule domestically and new capital ratio to be adopted at the next G20 summit in Seoul in November versus their ability to pass on additional costs to customers. Positive.
Global 1200 financial index: Since July 2009, the world financial is trapped within a 20% range, 800 representing a solid floor and 1000 a ceiling difficult to pass. Reasons are equivalent to the US: new domestic/regional rules and new BIS capital ratios. However, in Asia, banks are slightly under pressure due to persisting questions about the magnitude of non-performing loans in China in a booming economic environment, whilst in Europe fears about the health of Eurozone banks regularly comes back to the forefront together with problems in Greece and Ireland in an economic environment lifeless. The index continues trading around its 200 days moving average which turned negative during the summer. Positive.
TED spread (LIBOR USD 3 mth - US 3 mth T-bills): the spread is now well below its 20 years average. OIS (displays the same pattern. The interbank market shows no stress thanks to massive QE and balance sheet repair. Positive
USD bank BBB 10 yr - US 10 yr yield: The spread continues to evolve above historical average but at stabilized in the 3% region i.e. the pre-Lheman crisis level. No sign of deterioration. Positive.
OEX volatility: OEX volatility is in the low 20% but still above its pre-August 2007 crisis. We need this indicator to stay at or below 20%. Positive.
S&P Case Shiller house price index: The latest data (July) published Tuesday continue to show improvement in the price of US home values which are back to the levels where they were in late 2003. Although home prices increased in most markets in July versus June, both Composites saw these monthly rates moderate in July.
The unadjusted data continue to be positive (2009 numbers in bracket):
Composite-10: July 2010: m/m +0.79%; y/y +4.05% (m/m +1.70%; y/y -12.70%)
Composite-20: July 2010: m/m +0.65%; y/y +3.18% (m/m +1.66%; y/y -13.25%)
As the report comments:
“While we could still see some residual support from the homebuyers’ tax credit, which covers purchases closing through September 30th, anyone looking for home price to return to the lofty 2005-2006 might be
Disappointed. Judging from the recent behavior of the housing market, stable prices seem more likely.”
“… the monthly rates also seem to be weakening. The next few months may give us an idea of the true strength of the housing market, as the temporary economic stimuli will have ended. Housing starts, sales and inventory data reported for August do not show signs of a robust market, and foreclosures continue.”
Signs are mixed and do not point towards a rapid recovery. Average.
Oil price: The oil prices continue to be trade in a $70-82/b tight range. Not much happening on the energy front. In the US natural gas prices trade well below $4/btu from $6 I January. Uranium went up $3 to $48 since our last review early August, level where it was in October 2009, still 3 times below its peak in June 2007 at $138: Positive.
Conclusion: All these indicators are positive but for the housing market. The 15% pre-summer correction seems to have just been a pause in a bull market having recouped over 50% of the losses. The magnificent 7 are telling us that equity market continue to be resilient with no sign of turning negative (do not forget, this is a trend view not a trading view).

The corporate results season for Q3 will soon start and should be supportive; I however do not anticipate anything more than a slow increase in equity markets over the next few quarters.

Continue investing in high yielding equities / net cash companies with strong franchise and selected stocks in fast growth economies.
Despite the strong showing of some financial stocks, I continue to stay clear.