Thursday, July 07, 2011
We have been pondering for the past 4 days what to do and our preponderance has been based on our heads saying buy equities sell vol and gear for a phase of growth, especially in the US, but being tempered by our concerns that Europe can blow up again dragging everything down again. But our indecision on how to handle this has been simply rectified. Having yesterday asked the question of how contagious Europe actually is to the rest of the world, we are going to separate the two concerns and play this as a decoupling.
As far as we are concerned Europe can sink, but it needn't necessarily take everything else with it. So we are looking for the recent Italian noise (TMM have been receiving BTP yield charts from every Tom, Dick and Harry) to die down and return to the "not systemic" price action of decreasing intra-EMU spread correlations and a range for the bipolar currency. With such a (justifiably) large market risk premia priced into BTPs, TMM find it difficult to get bearish here with the country only running a Current Account deficit of a little over 3% and essentially running a primary surplus. TMM reckon the past few days have seen a spike in "Tourist Traders" getting short that reminds them of the Egyptian-driven Oil spike and subsequent stop loss sell-off back in February. For what it's worth, TMM's naive and simple macro model of the BTP-Bund spread shows Berletchsconi's IOU's around 100bps too wide (see chart below).
Now we don't know if our overseas readership is keeping up with the latest "its disgraceful" public outrage in the UK, but the newspaper News Of the World, owned by Murdoch's behemoth "News Corp" has been accused of tapping the phones of victims of crime in times of grief for salacious tidbits. The result has been a humongous backlash from the public that has destroyed the credibility of News of the World but, as importantly, has damaged the credibility of the parent group to the point of threatening other major projects the company has for expansion (e.g. the BSkyB takeover deal). Doesn't this sound remarkably familiar to the major market story we have been tracking for the last 18 months in Europe? Where a small subsidiary has wrecked the credibility of the whole conglomerate? TMM can not imagine that News Corp will now be preparing to follow the model Europe has employed over Greece. We can not imagine the Times, the Sun, Fox News and Sky TV, together with all sorts of overseas holdings, being cajoled into supporting a bail-out plan for the News of the World. We can not imagine News Corp arguing that the death of NoTW would mean the end of the whole of NewsCorp. and so will be kept alive at any cost. We can not imagine NC issuing moral guarantees backed by the high moral ratings of The Times of London and being on sold to Asian readers. No. TMM expect NC to amputate NoTW, probably after kitchen sinking every other dodgy deal into it, and rising forth morally cleansed. Which is exactly what Europe should have done and yet do with Greece.
To the consumer, the problem with such huge institutions losing credibility is one of substitution. Trying to find a news publication that isn't owned by N.C to move to in protest is difficult. The same applies for the ECB and Europe. Europe has spent the past 15 years selling the credibility of its single currency to the point that it has become the world's first choice reserve currency for many. If the credibility is threatened further where does one go with ones currency reserves? TMM have noted various papers suggesting that the likes of CAD, CHF and AUD should be considered as a separate reserve bloc and certainly they have been major beneficiaries of safe haven and reserve manager flows. But these countries are tiny compared to some of the flows being thrown at them and distortions affecting local economies are becoming more than worrisome.
We could ramble on now about the plights of CHF and AUD and the effect the current FX rates are having on the local economies but will do more on that soon. For now we will leave it at that as we await the predictable outcome of ECB rate rise foot in mouth insertion.