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.

14 September 2010

BIS and new capital rules: God bless you!

The world’s top bank regulators agreed Sunday on new rules intended to make the global banking industry safer and protect international economies from future financial disasters.
The centerpiece of the agreement is a measure that requires banks to raise the amount of common equity they hold from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. If banks needed to dip into that 2.5% buffer, they would face restrictions on how much they could pay executives or distribute to shareholders. An additional mandatory 2.5% countercyclical buffer was however dropped and replaced by a discretionary amount in the range of 0% – 2.5% of common equity or other fully loss absorbing capital to be implemented according to national circumstances. This buffer will only be in effect when there is excess credit growth that is resulting in a system wide build up of risk.

For banks, this is good news. The new minimum ratio of core tier one capital to risk-weighted assets will be 7 per cent is quite lenient, and the implementation is phased gradually until the end of 2018. Banks would have to begin raising their common equity levels in 2013. The implementation of the countercyclical buffer will be subject of lobbying from banks to make sure it is kept to the minimum possible, i.e. 0%; a lot of politics is going to get in between; the BIS should have imposed it despite cry foul from banks (European ones in particular that are undercapitalized).
Return on Equity of banks will mechanically decrease having to put aside more equity for the same amount of assets, everything being equal. And it is probable however that part of this will passed onto customers, especially retail ones: credit will not come cheaper.

BIS: Press release - Group of Governors and Heads of Supervision announces higher global minimum capital standards

13 September 2010

Greece - January-August budget analysis

This week the Greek Government is undertaking a roashow through Europe's financial centers to explain how great the implementation of austerity measures is going in order to convince investors that they shouldn't have to pay ruinous interest rates on their sovereign debt (11.6% on Friday on the 10 years bonds, over 5 times what Germany pays).
Markets & Beyond spent hours going through the details of the Greek budget since January 2010 and looking at 2009 data as well. The conclusion is simple: whilst the budget deficit is being reduced the crisis is not over and far from it.
A simple view of the progress between revenue sand expenses shows that during the January-August 2010 period (representing 67% of the whole year):
  • Revenues received by the State represent 59% of what was budgeted in the revised numbers presented by the Greek Government in June, i.e. behind schedule (they should be at 67%). The Greeks are saying that the new measures are being implemented and additional revenues will come in to match the Economic Policy Program. I doubt it due to a continued contraction of GDP(-4% expected in 2010) and rising unemployment (11.6% at the end of June).
  • In the meantime, expenditures reached 64% of budget forecast more or less where it should be at this time of the year; interest payments are however well ahead at 84% which is due to increasing short term financing (the only way Greece can raise fund in the markets) and increasing risk premium asked by investors combined to the 5% interest payment on the rescue package extended to the country for longer term refinancing.
  • The Public Investment Program (P.I.B.) deficit is also behind schedule at 56%. I guess this is used as an adjustment variable to plug (at least partially) any large divergence from the budget by postponing investments to next year.
  • My view is that the budgetary situation for Greece will be deteriorating until the end of the year mainly due to a shortfall in revenues direct corollary to the negative economic situation. Even if one believes Greek’s budgetary projections, the debt will increase in the turn of minimum EUR 21 billion and the Debt/GDP will reach 130% (115% in 2009).
I do not know when the day of reckoning will occur: in 2011, Greece could probably continue financing its requirements via short term TBills and the rescue package for longer term funding; in 2012, Greece has to repay EUR 42.8 billion (including 11.1 billion in interests) on its bonds and EUR 36.7 billion in 2013. In 2014 and 2015, Greece will need to repay the IMF and the EU approximately EUR 70 billion per year. How long markets will wait? When German patience will run out?
The EU shares the Greek concerns because a big chunk of the country's debt is held by the region's banks (mainly French and German in the turn of EUR 111 billion according to March BIS numbers).
Greece needs time to reform its economy and witness this bearing fruits: we are not talking about 3 years (the initial length of the EUR 110 billion rescue plan) but at least 10 years. A debt restructuring is the only way to avoid a bankruptcy, whatever euro-dogmatics are saying, and the sooner the better.
Oh! And I forgot the +/- EUR 600 billion of pension liabilities the Greek state is the happy owner which represents 875% of GDP…
Last final word: a MUST-READ article written by Michael Lewis in Vanity Fair about breathtaking corruption, startling failure of societal norms, an absolute collapse of ethics on a national scale.

BIS: The international banking market - statistical annex
Vanity Fair: Beware of Greeks Bearing Bonds -Michael Lewis
Hellenic Republic - Ministry of Finance: Stability and Growth Program

09 September 2010

Europe’s bank stress tests: Follow-up

On September 7, the WSJ published an article which outlined why the criteria used for the 91 European banks stress tests minimized the debt risk in their portfolios. In particular it pinpointed discrepancies between data published by the BIS and the stress tests. The CEBS did respond to the article, unconvincingly however. If transparency was real one should be able to reconcile the numbers or at least explain the differences.
There is however a series of information that corroborate a widespread skepticism about these politically motivated tests triggered in July in a panicky mood which I expressed at the time of their release (Europe’s banks stress test: not really stressful…).
  1. Among the five Greek bank tested only one failed. The National Bank of Greece successfully passed the tests with a 9.6% tier 1 capital ratio in the adverse scenario and 7.4% if a sovereign shocked was to occur, well above the 6% required. This week, the very same bank announced plans to raise EUR 2.8 billion via an asset sale (EUR 1 billion) and a combination of equity and convertible bonds (EUR 1.8 billion); these EUR 2.8 billion are to compare to the EUR 3.5 billion that the 7 banks that failed the tests had to raise… European politicians and regulators are lacking credibility indeed.
  2. Portuguese banks increased their borrowing (+0.6% August/July) from the ECB to reach EUR 49.1 billion. This is another sign of the failing health of Europe’s banking system. Irish, Spanish and Greek banks are also reliant on the ECB for funding.
  3. In July, the European Central Bank loaned 132 billion euros for three months to 171 financial institutions. ECB President Jean-Claude Trichet on Sept. 2 extended emergency lending measures for banks into 2011. The ECB has bought €61bn in government bonds – mostly of the weaker eurozone economies of Greece, Ireland and Portugal – since it launched its intervention program on May 10 as part of the multibillion-euro international bailout.
All this has resulted in a surge in the risk premium the market is asking to hold PIIGS debt which are moving towards their record highs.

And with Basel III more stringent capital ratios to be discussed at the November 11-12 G20 meeting in Seoul, I continue to stay clear from European banks.


The Wall Street Journal: Europe's Bank Stress Tests Minimized Debt Risk

Markets & Beyond: Europe’s banks stress test: not really stressful…

The Financial Times: ECB steps up eurozone bond buying

The Financial Times: Portugal suffers as lending costs soar

Bloomberg: Europe's Banks Stressed By Sovereign Debts Regulators Ducked

Committee of European Banking Supervisors: 2010 EU Wide Stress Testing