Thursday, August 11, 2011
Do you ever have one of these days where you wake up with a burning feeling with respect to a trade and that the rest of the world just can't see it but they are about to? When all the little bits of information that your brain have assimilated while you have been asleep has some how coalesced into a nugget of conviction? Well TMM has that feeling right now but is scared stiff by it because they can't really pin it on any one thing in particular and are worrying that it is emotional rather than rational. There are 2 ways of coping with this: the first is to act on gut feel and get the trades on before it moves on the basis that gut response often beats reasoned response. This isn't as daft as it sounds as Malcolm Gladwell describes in his book "Blink" in which, as "wiki" says, "describes our ability to gauge what is really important from a very narrow period of experience. In other words, this is an idea that spontaneous decisions are often as good as—or even better than—carefully planned and considered ones".
But we are more cautious than that so have at least had a quick scan of what has been going on to substantiate this mornings "feeling". The past few weeks have seen pretty uniform panic across the board and TMM have as usual seen a lot more noise than signal in market moves. So, lets step back a bit and look at what is going on here: Europe is still messy but anyone looking at peripheral bonds will see that JCT and the A Team are not messing around. All that dangerous vol and chop in BTPs appears to be getting suppressed harder than a Syrian block party (see chart below).
While haircuts are still above where they were a few months ago if they keep this up they won’t be for long. TMM are not sure how long the ECB can keep up the heavy lifting but for now it is working and the market seems to be ignoring it. Assuming the ECB can credibly continue buying the dip here the carry monkey cannot be far behind.
In equities, TMM are coming to the view that this has an awful lot more to do with a couple of high profile liquidations than anything else. As often happens in this business, people who practice the same kind of investing tend to do well together, get AUM together, and then when what they do stops working get stopped out together. Incredible dumps in names like Microsoft, Bank of America and the like appear to have a lot more to do with positioning than anything else. How does TMM know this? Lets look at it this way – if the US housing market were to explode then Annaly Capital Management would be in serious trouble and a lot of the action in banks would be consistent with that. As it happens, Annaly has not done much while Bank of America has traded down 50%+ YTD. TMM are generally of the view that US banks will be sued for an indefinitely long period of time and could be a longer term value trap as they de-lever. That being said, 0.33x Price to Book seems crazy – it is even lower than Japanese banks now which have been on the low-to-mid single digit ROE grind for some time and took much longer to have their “come to Jesus” moment on marking their books. Even during the 90s the Topix Banks index (see chart below) traded consistently higher than that.
But what about European banks? Here TMM would like to point out that not all banks are created equal. One party trick we learned from a guy in equity research is that if you want to know how much AAA or sovereign stuff is on a banks’ balance sheet and you can’t be bothered to read the annual report then compare total equity/assets to tier 1 capital. You see, if the bank is long a lot of AAA stuff and you think there is a AAA/sovereign bubble then those things will be a long way apart – as is the case for Soc Gen, BNP etc. What TMM cannot work out, however, is that regional banks in Europe with much lower leverage and are not facing insane sovereign issues or a deflating real estate market trade at the same multiples. Regional French banks in particular. This is another indication to TMM of how utterly disjointed the markets have got and in particular how cheap quality is to systematic risk land mines. Which brings us to European equities and European industrials in particular. Looking at Eurostoxx Industrials, Net debt to EBITDA is… wait for it... a whopping 1.2x EBITDA. Down materially since the start of the decade and way down since the bad old days of 2008. When things like Hochtief with a net cash balance sheet trade at 4.2x EV/EBITDA you really have to believe the world is going to end and while TMM are concerned about that, selling Dax futures is not the way to do it. If that is the case then there are plenty of other things we don’t like that don’t do so great in a global growth shock (BRL, AUD, ZAR) and which are plenty expensive already.
TMM's version of the Fed Model (see chart below) now shows equities as cheap as they've been since 1981. Of course, a good part of this has been due to TIPS yields falling sharply, but that is the aim of the Fed. And while arguments can surely be made about a return to the policy chaos of the 1970s - something that has been forced front and centre in recent weeks - TMM are not buying those arguments just yet, especially given the Fed's message on Tuesday.
TMM aren’t sure that we are out of the woods, but being a carry monkey in FX looks a lot less appealing than being a carry monkey in Eurostoxx or, our real favorite, European dividends. Having been through all of the above that original waking up feeling hasn't gone away. It's just got stronger. Rather than dawdle ECB-esque and miss any potential moves we are going in to pick our weapons of choice and fight back against the recent rioters in the markets. So armed with long EUR/CHF, long FTSE and SPX and short Dec11 EuroSwiss (more details on this next week...) and protected by exceedingly tight stops we are fighting back. For today we call a turn.