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Draghi, Assad, Putin and me

Well, since mid-june, not much has changed on the European front. And today, Draghi’s declaration wasn’t really exhilarating either; all European equity markets are down again. I won’t comment on the “irreversibility” (Draghi’s own words) of the Single Currency anymore. The market, by pricing negative rates for “core” country debt and junk level rates for the periphery is effectively saying, “it’s a matter of time”.

Europe’s sovereignty is put to test. If it wants to keep some sovereignty, it will have to act like one sovereign state, or else…today, the urgency is about reversing the risk of a Euro zone breakup instead of trying to figure out if the risk exists and how big it is.


This problem is blinding another one: Over the summer, the Syrian civil war will probably come to an end with the furnace of a Holy month of Ramadan in August. The world is (only) watching and I sense some nervousness in the dark corridors of the Kremlin. Putin has unconditionally supported the Assad regime so far. When it falls, Russia will have lost a good client (for weapons) but also a gentle host for its only Mediterranean naval base in Tartus. This may explain Putin’s eagerness to lend cheap money to Cyprus to bail out its banks (July 5th, Reuters) as Europeans hesitated. And still do.  Having read Isaac Asimov’s foundation novels, it sounds “Very Russian” to provide support with (serious) strings attached. If the Europeans keep on passing the decisional bucket from the ECB to politicians and vice versa, Russia, in the middle of the crisis, may also have a financial role to play, besides being a dangerously quasi-monopolistic energy provider to some European countries. This is not Science Fiction. If I were Russian, I would think, “this is my time”.

Enough of doom saying…as it’s been three months I thought I should look back at the exchanged investment ideas and see how they did in the turmoil. Even though rates were already low, we kept to fixed income instruments. It made sense: Bond indices (JPM Bond Index and Barclays Aggregate Corporate Index) are up by 7 to 9% year to date. Then, reading back my own writing:

1)   17 April, We reduced overall equity exposure and hedged the € against US$. Equities didn’t move much (actually they did go up and down) but the Single European Currency lost serious ground from 1.3123 to 1.2271

2)   2 may, we bought some Belgian real estate. The relevant index went from 109.20 to 113.62 over the period.

3)   8 may, we bought US property. The relevant index went from 67.87 to 70.65 over the period.

4)   8 may, we sold out of the money put options on solid equity index components.  Most of the equity indices are either flat or higher, while volatility crushed. Options died worthless. We keep the premium.

5)   16 June, we bought some VIX futures. That was a bad idea. Volatility crashed dramatically. This is really a professional instrument for which structural demand is difficult to assess. We won’t get into that again.

What’s next? I like to stay in fixed income, more in high yield and emerging markets. As alternatives, I stick to real estate in Belgium and the US, while I add some exposure to global convertible bond funds. Lower structural volatility, lower interest rates and depressed share prices make this asset class a defensive component within the equity realm. Also, I add some sustainable (and ethical) investments, via dedicated funds.

Expect some volatility after Greek and Egyptian Elections

First, I want to apologize to my readers and followers for having been absent for so long. As the markets were going only one way since I last wrote something, there was not much to say. Conversation is best at convex moments, when it could go either way. And it might happen next Monday.

G20 officials declared smartly, on Friday 15th of June, that central banks are ready to act to calm markets if needed. “Action” for a central bank means providing liquidity to banks or lower interest rates. The ECB seems ready to do the latter (it was about time for this big change. Inflation won’t be back so fast, says Peter Praet) while the Bank of England will prefer the former. But is that enough? There are not many possibilities: Solving the crisis will save the currency. We are (or not) at the eve of major political choices to be made in Europe. Simply because economic actions didn’t work, and the only remaining and yet untried “political toolbox” is supranational, federal: We are moving towards a more federal Europe. Only a stronger European integration can solve the crisis and save the Euro.

Even if Syriza win the elections on Sunday, Greece will have to commit to the bailout conditions or lose access to any aid. It means, “default” within a month. But Syriza feels strong because the €100 billion granted to save Spanish banks is a proof, according to them, that blackmailing the Union may carry fruit. Wrong bet, I bet.

The markets on Monday will therefore be driven by 3 probability sets:

1)   The probability of more harmonization across the Eurozone to happen within a couple of months;

2)   The probability that Syriza, if they win over New Democracy, forms a government courageous enough to risk returning to the Drachma;

3)   The probability of Spain, Italy, Portugal and Ireland (after Greece) to need a full state bail out within twelve months.

No wonder, then, the € strengthened, the equity markets are up: every speculator is covering his/her short positions because everyone has a different view on these issues and you can’t model political risk, even if you are a rocket scientist.

On Sunday, Egyptians will be voting too. Their choice will have to be made between an ex-military, close to the old regime, and the Muslim Brotherhood’s candidate. As if it were a choice. Either way, I fear there will be turmoil in the streets of Cairo. The Middle East will not be stabilized tomorrow. Oil prices will probably be more volatile too.

It is worth buying some VIX (volatility index futures traded on the CBOT) here at around 23. They were at 28 in mid may, and expectations of volatility should be much higher on Monday than they were then. If equity prices crash, I would buy, European blue chips (CAC40 or DAX). Most of them make the vast majority of their benefits outside the Euro zone anyway. As for fixed income, no change. Quality corporate bonds.


The Drachma’s eventual return

Trade unions’ negotiation power is at its strongest when factory capacity utilisation is high.Last Thursday, IG Metall obtained 4.3% rise in salaries for 800,000 workers of the steel industry in the Land of Baden Wurternberg . This follows a 6.3% rise for federal employees. This confirms Germany is definitely on its way to allow some inflation. The Bundesbank and after it, the ECB are, at last, giving up their priority of price stability targets. This is in line with talks this weekend at the G8, about austerity and growth in the Euro area. Of course, the main topic remains Greece and its staying or not in the Euro.

The EU officials deny any scenario involving the return of the Drachma…Meanwhile, when Mr Schauble, German Finance Minister, declares his wish to see Greece within the Eurozone and that the confidence crisis should be over within a year or two, I am concerned.  Does that mean they will let the situation rot over another two years, as they have so far? Or does it mean that with some action, it will be resolved within two years?

Can they afford buying time? Provided they had money to buy it with…

After the G8’s wishful declarations about the Eurozone and Greece, the press, who didn’t buy them, is rather articulate, this morning, about the possibility of the Helens returning to the Drachma. Let’s suppose it happens, it has to happen quick so that the man in the street doesn’t have time to withdraw all his money, avoiding a mega “bank run”. One way to keep the monies inside the country and the banks will be that “what is in an account remains in Euro”. The rest of your life will be in Drachma, Kostis.

As the Central Bank won’t have time to print Drachmas, all euro notes in circulation in Greece will have to be “marked”. The Drachma, whatever its value at that very moment…will be worth much less in the following minutes.  Salaries will be paid in Drachma and Greece will regain competitiveness. Tourism and exports (what did they export again?) will explode and there will be inflationary pressure, to say the least. The Euro can only strengthen…because it will be freed of this heavy weight.

the EU will have to be creative. It is time to rethink seriously about the issuance of European Brady bonds or Trichet bonds, as was discussed at length last year in June. And regulations as well as definitions of default have to be re-written, to avoid a run on credit derivatives contracts by those who have bought protection on Greece, and possibly other countries such as Spain, Ireland, Portugal and Italy.

A “Brady/Trichet solution” may have to be softened by the inclusion of the Drachma in the equation. The value of the debt will be reduced. Away from a “full Drachma Jacket”, bond principals could be denominated in Drachma while coupons could still be paid in Euro. Expensive but the only way to keep some confidence. If, before maturity (which will have to be dramatically lengthened), Greece returns to the Euro, principals could be paid back in strong currency then. It’s hard for current bondholders, but any other solution (issuance of zero to guarantee principal etc…) would probably cost much more to the European Union.

Spain wrecks while Fannie gets better

When a Country in economic dire straits like Spain is obliged to nationalise a moribund bank (Bankia…It just happens today) while it could spend taxpayers’ money in much better ways, it doesn’t bode well for its image and credibility. The EU had actually enough to worry with Greece, which is on the (high) way not to form a government, which will, anyway, be unfriendly to European “ingérance” in its finances.

As it looks now, Greece can only get out of the Euro or default on its debt. I can understand why nobody wants the latter. Too many institutions are still full of Greek bonds, and Spanish too…who’s next?

As to the former, it would simply mean  “getting out of the EU”. According to polls, 70% of the Greeks want their country to remain in the currency union. Something’s gotta give then, and it starts with Central Banks being softer…as the rates can’t go much lower, they will have to be creative. The Bundesbank’s announcement this morning that it would not seek price stability as a priority is a clear sign of its willingness to accept some inflation in Germany to allow for other European countries to catch up a little with German competitiveness. So we agree Germany is competitive. German equities look better then Spanish and French. It is clear economic growth comes from either productivity improvement or from demographic change. As productivity improvement in the EU ex-Germany is only possible through dramatic structural changes in labour rules etc… and that the EU can’t enlarge its population (outside of accepting Turkey in), Europe has to spend in infrastructure, new energies, R&D, training of its workforce, and allow its lower-middle classes a higher purchasing power and push them on the streets to resume consumption. France will try just that. Let’s see if it works. The legislative elections in June will give already the tone of the easiness if this process…or else.

In the meantime, a small and angry country under the sun couldn’t care less about consuming more…Back to square one: Greece defaults while Spain wrecks further in slow motion.

By the way, if you think we can’t afford these investments, why don’t we cut drastically in defence spending?

At the same time but on the other side of the Atlantic, Fannie Mae recovers from its wounds back in 2008. The residential mortgage giant posted a hefty profit of US$ 3.1 billion, thanks to much lower credit losses in the first quarter. Maybe it’s time to buy property back in the US. And US equities should follow. 


Difficult tomorrows

Usually, if the financial operators are truly negative about an event, it shows immediately in the next day’s closing. I have to admit I was uncomfortable at yesterday morning’s opening, when I saw the CAC considerably lower. It didn’t make sense that François Hollande’s expected victory would have such an impact.  It is just not “market efficient”. Then yesterday afternoon, the CAC 40 closed 1.65% higher. Followed by other European bourses… all celebrating the return of growth policies? Well they haven’t returned yet, all this has to be confirmed, at the national policies level, but also at the Union level.

I was obviously not discounting the terrible electoral results in Greece, which impacted all European markets and the currency itself, starting overnight in Asia. This weighs dramatically on today’s opening in European Exchanges.

Yesterday, over lunch, the 3-4 times oversubscription of the BTP (French T-bills) auction at, evidently, lower rates brought confidence. Of course, these are not longer than 51 weeks though, meaning that the market doesn’t expect over-issuance by “Red François” within the coming six months. This good piece of news was again comforted by the rating agencies spraying “Hollande seems OK”. I always found funny that rating agencies can pretend to make and unmake Kings while they have been so often so late, so wrong, so tart. They Just provide an Anglo centric opinion. Nothing else.

Back to bonds; the important issues will be the long ones, and as far as I can see this morning, OATs’ (French Government bonds) yields are a couple of basis points lower than Friday, and holding well.  It’s a strong message.

Well, the Union level is going to be harder to assess: I was positively surprised by Germany’s stance: Mrs merkel’s declaration of “no recess for austerity” was very quickly softened to “Growth Yes, but no deficits allowed” and will, I guess, be softened further as we go by…The point is we may be in a situation where the “weakened” (anti austerity) countries’ negotiation power at the European Council gets heavier handed. The dangers of divide loom when the blocking minority is easily reachable if France doesn’t back Germany. I leave to my readers the verification of the vote arithmetic at the Council.

Yet, we’re not out of the woods, every movement Greece does will be followed and its ability to jeopardize the Eurozone’s stability is a reality. Solutions will be sought while Volatility remains. Selling out of the money put options on volatile assets makes sense then.


Of Hollande, traders and Pasteur

I thought it would be too easy to write on the French presidential election after it happens, so I decided to speculate on it. Not on its issue, which seems certain, but on its impact on the markets.

Obviously, if instead of what I think, Nicolas Sarkozy wins, traders “who can only talk their books” will celebrate by buying the CAC40 index at large, with a strong bias towards financials, and then the soufflé will go flat, because nothing will have changed.

If Hollande wins, some may believe “c’est la catastrophe”…Well, nothing is less certain. Let’s see if what follows makes sense:

The South of Europe is mired by deep recession. “Voters-of-tomorrows” are in the street protesting against austerity packages everywhere, while up North, the Dutch government couldn’t finish its budget talks and resigned. The Italian Prime Minister clearly talks of Growth pact instead of fiscal compact. We’re turning mildly Keynesian here. At last? If Hollande goes through, he will certainly join the ranks…If he doesn’t, French trade unions will bring the country to a halt and the coming legislative elections in June will look even uglier than the polls predict, with extremes scoring even better than at the “Premier Tour”.

If Sarkozy wins, the same scenario holds. Celebration will be short: political instability is much worse than political change in a democratic parliamentary system, for political change has to work within the framework of the existing state, while instability may result in a systemic change.

If the socialists manage to implement their program:

Taxing the rich and the multinationals? Nothing to write home about. They both can move away and lodge profits where it is not taxed. Buy real estate in Belgium.

Spending on infrastructure, healthcare, sustainable energies when France is already stretch on debt? Well frankly…why not? Why couldn’t you have “too much debt” when the economy slows down? Shouldn’t you borrow when you need it? Duh…

If public spending brings productivity improvement and demographic changes (for example an evolution in consumption patterns of the middle class), it should end in sustainable growth, and higher tax volumes levied, and therefore stronger ability to repay debt.

So, public spending related equities should go up while government debt issuance should weigh on the long end of the yield curve. Expect therefore some steepening for maturities from 5 to 30 years. Will there be buyers? Those new regulations for banks and insurers are kind enough for holding “Govies”, the EU could think of further incentives (tax exemptions maybe?) to shove their paper.

Germany won’t be happy and Mrs Merkel will voice that if she doesn’t get the fiscal compact as designed, she won’t help…and here we go for the Euro Crisis again.

Greece (and then the other three) will have to default. At least, they should. It’s their only way out! Let’s be honest. The only reason they’re not let to default is because European banks would go bankrupt, so much they hold crap-bonds, notwithstanding CDS’s (credit default swaps), the economies will never recover without bank lending…and the streets will look ugly again, with cohorts of jobless men and women.

Then, the “obvious” solution is that IMF, CBE, EIB and whatever friends they still have agree to a securitization program whereby bonds issued by Greece and the lot are parked and sliced into tranches and sold to the investor community with incentives attached. That product is called a CDO…Not so popular name since 2008, is it? Necessary evil I guess. It certainly is, as an antidote. Ask Pasteur. Tough times for the Euro and the Union’s very foundations though…It was about time anyway.

17 April 2012

IMF report on the global economy (World Economic Outlook) was out Tuesday 17th of April.

In a nutshell it raises 2012 and 2013 Euro zone forecasts, with some growth expected in the latter (+0.9%) following a milder than expected contraction of -0.3% in the former.

If we consider that Germany, the largest economy in the region IS growing, it confirms a deeper recession for the rest of 2012 concerning Greece, Portugal, Spain and Italy. It obviously doesn’t bode well for any further Euro crisis not to happen « as long as, says the report, the underlying issues are not resolved”. I don’t know that the EU has taken any action to resolve its paralysis through further federalisation of taxes, labour rules or public spending, to be able to act in unison like the US, as it would need to. Therefore, the lack of confidence in the Euro will keep on dragging on its recovery…No sense being Bull the Euro then.

Either reduce or hedge against the USD. Lucky the Swiss National Bank supports Swiss exporters with their biggest trading partner. EUR/CHF will remain as boring as it gets since September 2011.

Given low level of short-term interest rate differentials, hedging is cheap if we want to remain exposed to European assets. Do we? Not to financials in the Euro zone, as its bank financing requirements to replenish their capital buffers (Core.  Tier 1 ratio at 9.00%) are estimated at 23 percent of the zone’s GDP…unless one believes that bank shares have been so badly battered that it could be an opportunity. That is the “what goes down goes up” type of thinking. Well, after 23 years following the markets on a daily basis, this is truer on the downside than on the upside. Often what goes down stays long down. Banks are deleveraging, economic growth will be hit, and so will the banks. Unless we let them speculate, as they are provided cheap public funding to survive anyway…that is what the IMF proposes. Keep on giving to the begging banks, so that they can put too much money at too much risk. So I suggest we don’t let them and we don’t invest in bank shares.

Deleveraging of banks will strangle companies that have borrowed too much. Yet there are plenty of good companies out there, full of cash in their war chests, ready to either chase cheap targets or invest in growing ideas or markets. We then look for balance sheet value in world equities, with deep pockets even better. We actually also look for value in corporate bonds and we base our choice on that company on which you wouldn’t mind selling a put option on its net assets. Can the company pay back its debt if we sell off its net assets? We buy bonds of those, maturing in 4-5 years, where the yield curve is the steepest.

Back to equities, we want to be careful with the use of  “growing markets”…emerging comes to mind but signs of slowing down appear in BRIC’s an MIST’s alike, notwithstanding inflation, friend of the looming crisis in the Middle East; Israel attacks Iran. Hezbollah and Hamas fight back. Israel retaliates. The Arab world is in fire, at a moment where it is getting more prone to Islamist leanings. Oil price goes up. Inflation is confirmed. Central banks start raising rates. The dream of a growing world economy collapses. So we leave emerging markets on the side for the moment. There will be a time to return. We keep some gold aside, in case this latter scenario goes live.

Talking about growth, equity markets have done extremely well since the beginning of the year. They have actually outperformed all forecasts. This means appetite for risk should be lower now than it was at the beginning of the year. If we believe that risk appetite drives investment in shares, we reduce equity exposure at large; build up some fixed income, including cash.