Thursday, April 29, 2010

What We Learned

OK, here's what we learned yesterday:

* The Fed is nowhere near putting rates up or, evidently, moving towards asset sales

* RBNZ tightening will be fairly modest

* Brazil's central bank is taking the more aggressive route, as they hiked by 75 bp yesterday

* The Grim Reaper at S&P has now scored a hat-trick, as Spain was downgraded (following on from similar moves in Greece and Portugal)

*Oh, and there's an agreement in principle between Europe and the IMF to stump up €100 - €200 bio for Greece over a thee year period, thereby obviating the need for the Hellenic Republic to come to market over that period.

€100 -€200 billion over three years. That is a LOT of money. The good news, of course, is that if such funds were actually delivered, Greece should effectively disappear from radar screens...especially as the Europeans seem committed to avoiding bondholder haircuts.

The bad news, of course, is that €100 - €200 billion is a lot of money...and someone's gonna have to stump it up. Needless to say, the IMF's portion would blow away by many multiples Greece's quota, necessitating further contributions from the Fund's members. While the BRICs might be content to contribute, thereby accessing more SDR bonds, it's not altogether clear how well writing a big check will play in fiscally-challenged countries like the US and UK.

Moreover, the Europeans themselves will be adding to their own aggregate fiscal borrowing, as that kind of dough doesn't grow on trees. They had best hope that this package deflects sovereign risk fears more or less permanently....for what would happen if similar or greater amounts were required to rescue other PIIGS?

A back of the envelope calculation suggests that German and French banks each have €300 -€350 billion worth of exposure to Greece, Portugal, and Spain. That's yet another reason to hope that this package succeeds.

Yesterday Macro Man suggested that the equity trade was better than the currency trade. Here's an example of why. Financials make up some 30% of the Eurostoxx 50 (versus roughly 17% of the S&P 500.) Among the top 13 stocks in the European index include luminaries such as Banco Santander, BBVA, and Unicredito. As you can see, the market projection of 2011 dividends has eased off recently, and remains well below the early January highs.

Small wonder, then, that the S&P has outperformed the Eurostoxx by a fairly dramatic margin. (The chart below shows the price ratio between the SPX and SX5E.) This is the shape of line one would expect to see in a European meltdown scenario, not the meandering path taken by EUR/USD shown yesterday.

If (and it's a big if) you think that the European rescue package will prove to be a panacea, then this will prove to be a wonderful opportunity to take the other side of the trend. If you remain sceptical, however, that taking the other side of any temporary outperformance of European equities would be richly rewarded.


Nemo Incognito said...

If I were a German private citizen, I'd get my molotov cocktails mixed at this point. NFW I'd pay for those Hellenic jokers.

Note to all New Zealanders: I'm sure Skippy and I are on the same page if you guys ever blow up.

Jochum said...

Unfortunately this German private citizen's bank and pension fund lent his money to these jokers, so molotov cocktails might not be the best way to get any of it back.

Nemo Incognito said...

Jochum, that may be the case but if Argentina is any guide a 50c haircut on $x is better than a 75c haircut on $2x.

Gramps said...

After decades of propaganda and political elites discussing a "European Union", the concept still exists only on paper and not in the real world.

The paper EU consists of countries whose economies rely on a strong stable currency (basically the northern continent) and economies that rely on currency depreciation and inflation to pay the bills (PIGS + UK).

We can all argue the merits of each economic game plan, but whichever side of the fence you sit on -- the two economic systems simply cannot co-exist inside the same currency regime

This "crisis" will continue until one of three things happen:
1) Germany (Netherlands, ...) adopts inflation and accepts a much lower standard of living
2) Greece (PIGS+UK) adopts a hard currency, accepts a lower standard of living, and slashes government payrolls
3) The Euro breaks up into pieces that actually share common economic policies in real life, not just on paper

Nic said...

The ultimate Euro-crats rock and a hard place. Who is more unpopular with your voters ... Hellenic jokers or banksters?
Holding pressers pretending you are going to help, and going on TV and blaming Hugh Hendry & the evil short sellers so far has not worked.

Nemo Incognito said...

MM, viz some of the metals complex are you hearing similar stories of margin calls on those fabled pig farmers?

Richard said...

I'm puzzled about the theory that this massive bailout of Greece will somehow prevent the contagion spreading to the other PIIGS. How does that work?

Given a choice between Hellenic jokers and banksters, I'd let them both go down.

Richard said...

I'm starting to form the opinion that financial crises are not "real" crises. They can always be fixed by governments changing the rules - bailing out, relaxing accounting standards, printing money etc. This may irritate people who believe in a free market, and presumably does have serious economic consequences, but it does get the immediate crisis fixed.

Examples of "real" crises that can't be fixed by government hand waving would be earthquakes, plaques, nuclear wars or conventional wars between major powers, meteor strikes etc.

Rossco said...

@Richard, I tend to agree with you.

Faced with the prospects of not being able to pay themselves via taxation and not being able to fund their retirements with a reflation of risk assets, governments will just do whatever it takes. The "free market" is a idealogical construct.

There isn't much point in indulging in a polemic about it and playing the percentages it would seem that moral hazard wins in the end.

Nemo Incognito said...

I think there is some merit to that Rossco but ultimately in a credit contraction / crisis something has to get destroyed: the value of cash or the value of assets. Take your pick. There's no easy out for every single portfolio.

Rossco said...

well at present it is clearly the value of cash as risk assets have not been wiped out....but it's all a relative game so if everyone's cash is worth less and governments have more of it........

Right Field said...

Inflow Argument Helps Risk Assets Travel Hopeful ----- The SP500 (large caps) is +3.2%, SP400 (Mid Caps) is +6.3%, and Russell 2000 (Small Caps) is +8.7% in the month of April, the majority of professionals benchmarked to these strategies have factually underperformed and net long exposure has been reduced. The call over the weekend by historians and various media outlets will be “Sell in May and Go Away”. Weekend Sovereign credit and US Regulatory risks are other professional arguments against end of or beginning of month inflows. Conversely, data, earnings and rate policy are supportive of retail inflows keeping real money in control and looking for higher prices. Japan is closed next week and Monday is a UK holiday, and with inflation related assets continuing uptrend (Gold, Reits, etc.) the risk becomes greater CTA participation with monthly confirmations and a sovereign relief rally. Today and Monday are about money flow and the extensions of trend, the argument of inflows over outflows is superior. Risk assets travel hopeful into job data next week with positive expectation, SPX 1200 is support.

deke said...

Coeur d'Alene Mines Corp. (CDE) is an american miner whose history had been to never make any money except for it's management...and then the CDE bolivia mine finally opened

look for a short in a bolivia miner off this news!

deke said...

SPX been green the last 6 first sessions of a month, and the may historical is very strong until 5/11

bulls certainly need a stick save on the euro, and a discounting of this:

China’s central bank said on Sunday it will raise the amount banks must hold in reserve for a third time this year, the latest move by Beijing to cool its booming economy.