Monday, 30 January 2012

Crisis and democracy. Downgrades.

Proconsul, no thanks
Over the weekend rumours surfaced that the EU would want to put the Greek government under administration. According to apparently well-informed sources, the EU commission, supported by the German government, should be interested in making further help depending on the Greek government accepting an EU representative, who would have the right to veto its economic decisions.

It is a very dangerous route to take. As long as the EU is built on the principle of conservation of national sovereignty (as opposed to what the UK government often claims for public consumption), such a move would only give a new momentum to those who see EU as a fundamentally anti-democratic construction.

On the other hand, several reports are very clear: There is no willingness or indeed understanding in Greece that fundamental reform is necessary. There are too many votes to be had on simple populist messages. I perfectly well understand the exasperation on the part of the European leaders, who are being asked to shell out billions only to be met with obstruction from broad groupings in Greek political and administrative institutions. I had mixed feelings reading Michael Lewis’ witty description of the mood in Greece and other crisis countries.

There is no other way forward for the euro-zone than having Germany accept a assistance package that may be comparable to the Marshall aid after WW2. The northern countries must accept that helping Greece and possibly Portugal is the price to pay for rescuing the euro-zone in the short/medium term. Putting in a pro-consul will not help. Maybe is the moment to bring in IMF as a neutral arbiter.

Fitch downgraded 5 euro-zone countries. Yawn! It seems already to be forgotten. Maybe it was because it was “better than expected” since rumours had it that 6 countries would be downgraded. Ireland kept its rating, as did France and Italy.

French president Sarkozy is facing a very difficult run-up to the presidential elections on 22 April. His main opponent Francois Hollande of the Social-democrat PS is consistently showing a significant lead in the opinion polls.

To those who have accepted the French claim that the country represents a “cultural exception”, it will be disturbing to observe that electioneering in France is exactly like elsewhere. Hollande promises to solve the economic problems by lowering the pension age (sic!). Sunday night Sarkozy went on all national TV channels to announce a tax on financial transactions that has neither chance of neither being implemented, nor ability to solve any problems if it ever were.

If Hollande is elected, it could at least for a while throw a spanner in the works for the German-French joint initiatives. But it would only a question of time before the new (and completely inexperienced) French government would find out that Berlin is in charge.

The somewhat weaker than expected US GDP data from last week will focus attention on this week’s data for personal income and spending. Several EU countries will release PMI data that for sure will be scrutinised in every detail. For your investments, it is not important what the economists have to say, but how the markets perceive the data.

My colleague Frank proved to be right. My pious hopes of a stronger dollar could do nothing against a market aggressively positioned against the euro. In the past two weeks, the markets have begun to unwind short EUR positions and all talk about a “collapse” just disappeared. Another element in the risk-on trend.

American banks
Yesterday we had another reminder how grateful we really need to be to the banks. Representatives of US banks pointed out that if the stronger capital requirements and the limitations on prop-trading are introduced, it will lead to slower economic growth and lower liquidity for EUR denominated securities. Please!

The very banks that were saved by the taxpayers continue to resist reforms necessary to avoid a repeat performance of 2008.

However, I agree that the higher capital requirements need to be introduced over a longer period. The demand for a 9% Tier 1 capital on 30 june 2012 is already having a negative effect on the credit markets. Banks prefer to bring down their balances rather than raising new capital.

Friday, 27 January 2012

Fed. Data. Restructuring

Slow recovery in the US – and elsewhere
Federal Reserve’s decision to announce that short term interest rates would be kept low until at least mid 2014 took many, including me, by surprise. But it makes sense. The current recovery was never going to be a strong one, since the deleveraging of the household sector will put a lid on private consumption. Such deleveraging historically takes 5-8 years, and if we take mid-2008 to be the starting point, it makes sense that growth will return to normal in 2014-15. The same goes for three other economies hit by similar consumer leveraging: UK, Spain, and Denmark.

But the interesting thing is of course the investment consequences. Since 2008 money has been earned in reflation trades. Fed’s announcement was a statement that reflation is still very much on the table and it should feed the current risk rally further. It will weaken the USD at least until we see the second tranche of ECB’s 3-year LTRO in March. US T-bonds were flirting with calamity, but have now pulled back. We need to study our indicators, but at the end of the day, I believe that this will give investors one more chance to get out at very attractive prices.

No matter what Fed did, it is not a negative for the current return to risk willingness in the markets. Since the main reason T-bonds and Bunds are trading at too low yields is risk aversion, a correction is due as the risk willingness returns.

The German IFO index of the business climate for January came out better than forecast. Together with the PMI numbers from earlier this week, it confirms the possibility that Germany will avoid a recession for this time. Next week we will have a raft of data for the US but nothing really indicative of the European situation. Today we will have US GDP. It could come out lower than expected, given what we have seen from Fed.

Auctions – again
Italy sold 4.5bn EUR of 2 year notes at a yield of 3.7 per cent and 10 year yields fell below 6%. It did not draw any headlines, proving that the coverage of the Euro crisis is still biased towards the negative. But it does not matter. It was yet another step away from the Euro-Armageddon.

Discussions about the Greek restructuring have stalled, and there is a lot of bluffing going on. The banks have made their “final offer” and Merkel has threatened the banks that if they do not accept a bigger de facto haircut, there is always the possibility of just declaring a default. And so on.

The most entertaining statement came from outgoing CEO of Deutsche, Josef Ackermann. He claimed that if Greece/EU did not accept the final offer it would mean that fears of “contagion would come back in the markets”. Hmmm. He admits that contagion fears have reduced significantly – which is good, as it rhymes with my perception of the risk-on situation in the markets. He also indicates that the situation around Greece could lead to a new round of “contagion”.

Using my definition of contagion – a panic-like reassessment of risk in an investment – Ackermann is off the wall. The next possible source of contagion is Portugal, which has been priced out of the market. But of course, Ackermann is trying to bluff us into minimising the banks’ losses. It is his job, and his statements should be seen in that light.

Wednesday, 25 January 2012

Investor protection. Davos. Consensus building

Yesterday’s January PMI from Germany and the euro-zone confirmed our views – held since September, for those who care – that the European recession is likely to end within a couple of months, and Germany may avoid recession altogether (recession defined as two consecutive quarters of negative growth). Today’s IFO indicator from Germany will show whether we are moving further in that direction.

In the UK, a new consumer protection watchdog wants to protect “irrational investors” from dangerous financial products, as such investors cannot be relied upon to find out what is in their own interest. Well, given the amount of brainpower the financial sector has poured into making their products completely impenetrable, it would be about time. At the same time the UK government is finally flexing its muscle when it comes to greedy bank chiefs. Equipped with a clearly conservative government, UK is establishing itself as the leader in how to change the ground rules for the financial sector.

Before you shake your head at those poor private investors who now have to be protected from their own ignorance, a fresh study commissioned by Financial Times from Yale and Maastricht universities shows that there is no conclusive evidence that Private Equity creates value for the investors. It is, however, established beyond any doubt that substantial wealth is created for the owners of the Private Equity firms. New compulsory reading for pension fund managers, I guess.

Probably it is with Private Equity as it is with hedge funds. The early movers have earned fabulous returns, primarily because of their ability to fly under the radar and outside of prudential regulation. With huge money to be made, more people and more investors move in, and after a while the average return falls towards market returns. The only thing that proves a remarkably resilience is the ability of the investment managers to shroud themselves in a cloak of invincibility and keep their own remuneration up.

FT reports that US pension funds have had an average 4.5% return on their investments in PE over the past decade. But management fees have been on average 4%. Add all the other fees and received by the PE firms.

For once, this year’s World Economic Forum in Davos seems to be a place where serious things are discussed. In the running-up to the conference, Lagarde of IMF and even Zoellick of the World bank joined forces with 4 other leaders of international institutions issued a statement about the international economic situation.

Despite the more urbane wording, it was another rebuke to the German belief that austerity-based programmes can save the world in the short term. Zoellick – a man of impeccable conservative credentials, then went on to explain that Germany has to transform herself from a participant in Europe to a political leader. It means to resume responsibility for all of the area, and not, NOT, think of their own domestic situation first. Interesting, and very much in line with former Chancellor Helmut Schmidts insightful comments from 2010.

It is equally interesting to see that some of the leading consensus-makers, UBS and Citi, are now joining Origo in pointing out that a risk-on rally is ongoing. Citi even jokes that ECB has created “artificial life”. Whatever! It probably means that they had not seen it coming. I do not care as long as it works. Now we wait for all the other major banks to join.

Tuesday, 24 January 2012

Risk rally arrives on time

Since November we have been adamant that we were heading into a situation where a tendency to “risk-on” could accelerate into a real risk rally. We are there now. Financial stocks are moving up (phew, they will not go under). Spanish, Italian, Belgian government bond yields are falling quickly (phew, they will not go under). Commodities are about to join in (phew, the world is not going under).

Dollar is (unfortunately for Europe) weakening under a combination of a short-squeeze and a stronger belief that the euro will not fall apart in 2012. HY bonds are doing very well, thank you, as corporate earnings do not really reflect the apocalypse vision of early December. Will this positive sentiment ever end? Of course it will. But just like nobody knew how far the risk-off collapse could take us down in August, nobody knows how far this rally will carry us upwards.

If anybody claims to know, we will question their credentials. But for now, all indications are that we can continue for a while. Until then, enjoy the party. You will be joined by more and more consensus thinkers. UBS and Citi have joined us in the past two days.

The last shoe to drop
Just like we have been keeping tab on the Euro bond auctions, as a sign we are moving away from the pits of the risk-off downdraft, we are now eyeing the T-bonds/Bunds. If the revaluation of risk assets continues, we will eventually see a major calamity in those two types of assets. Once we get there, the risk-on rally will probably on its last legs.

And on the sidelines
We have a lot of rumours going on. Germany and France should be ready to accept a slower implementation of the 9% Tier 1 capital requirement in order not to put too much pressure on the credit market. Germany should be ready to accept “solidarity” with the problem countries and “long term solutions” in order to solve the underlying problems in the euro-zone. Germany suggests to move the ESM forward and let EFSF and ESM operate in parallel for a while. Lagarde from IMF wants more money in order to have bigger reserves if needed. The policy rules in the Euro-17 will be more flexible.

Why am I not surprised about all this? If there is some truth to any of the rumours it appears that a healthy dose of pragmatism is now being brought in. But only after Germany managed to get her way in forcing a deeply destabilising set of long-term upon Europe. Quid pro quo.

Finally it feels as if the ideology is beginning to take back seat to some practical action. There is still a long way to go before anybody can declare “mission accomplished”. But there is no doubt that now is the right time to be pragmatic. It always works best when the market is in a mood to believe that things are heading in the right direction. It seems to be now.

Monday, 23 January 2012

Quotes and time zones

Quotes and time zones
I have been quoted a bit in the press recently and have now joined the club of those “quoted out of context”. It comes with the territory, so I am not going to complain about it. I only want to make a couple of things clear to the readers of this column.

Most importantly, at Origo we try to work in Real Market Time (RMT). It is rather different from Economist’s Hypothetical Time (EHT) or even Newspaper Headline Time (NHT). It is also quite a risky endeavour.

Switching for a moment to EHT, I do not know where the world economy will be in 9 or 12 months from now. There are simply too many unknowns at play. I have an opinion about a lot of them, but those opinions are irrelevant when it comes to today’s practical investment decisions. Those decisions are made in RMT.

The only thing I know is that in RMT, we are right now putting the doom-and-gloom-and collapse scenario of the past four months behind us and that is enough to make the markets react. Another setback may come later, but it is not visible in any economic indicators right now,. We will jump off that bridge when we reach it, i.e. when it becomes relevant in RMT.

Europe is in a crisis, and for several reasons. In EHT, government debt, inadequate institutions, and way too weak banks are central ingredients. But in RMT, a crisis accelerates dramatically if a country or a bank cannot roll over existing debt. The European inter-bank market is pretty much dysfunctional, but ECB has taken over the role as a clearing house. It is certainly not optimal, but it works for now.

The almost weekly auctions over European government bonds is the space to watch (in RMT), when it comes to the government debt situation. As long as the euro-zone countries can refinance themselves at almost normal market conditions, the crisis is not spinning out of control. That is enough for now.

Everywhere the game is to play for time, time to stabilise the economies, and time to revive the economic growth. As opposed to financial markets myths, it is really the only way to solve the problems. There is no quick way out. The best we can hope for is that the train does not run off the track in the meantime.

It is a question of perceived probabilities. Every time the markets perceive a change in the probability that we remain on track, it is good or bad news. And that is exactly what we at Origo try to monitor.

Despite some last-ditch brinkmanship, the negotiations between the private sector bondholders and the Greek government continue, and now appear to be heading for some kind of resolution. It will mean that the official debt write down is 50% while the real haircut (once the new, longer-dated bonds are issued) will be some 68%. Let us get it in the bag so we can move on.

Speedy solution to EU crisis?
Germany and France now wants to speed up the resolution of the crisis and the final designs of the new EU institutions. It does not make the overall plan more correct. There has been an interesting change in the language. Germany’s foreign minister Westerwelle now talks about solidarity with the countries in trouble. He also talked about long-term solutions. If we could please hear some more about this solidarity, please. Westerwelle also wants to speed up the creation of a European rating agency.

Friday, 20 January 2012

Auctions. Downgrade. Banks. USA. Risk

Yes I am a bit OCD about bond auctions these days. It is because that is the place where we have the clearest view from the frontline of the euro-crisis. As long as the euro-zone countries can finance themselves at reasonable costs in the open market, there is no real crisis. At least for the moment.

France and Spain sold a total of eur 15bn worth of government bonds at lower yields than before the S%P downgrade. Spain has now sold close to 20 percent of the planned issuance for 2012. And we are only 20 days into the year.

Has this started a rally in risk assets? No, that one started in late September.

Another downgrade coming
Fitch, the smallest of the three major (i.e. US-chartered, free-speech protected) rating companies is likely to downgrade 6 euro-nations in the coming days. That will be yet  another non-event. Then we will wait for the inevitable downgrade from Moody’s, and we can all move on.

I look forward to see if Fitch will also make an attack on Germany’s plan for the “fiscal compact”. In the good old days, Moody’s was the most openly political of the three. Now they try to reposition themselves, so maybe Moody’s will now drop the political comments.

Commerzbank, MPS
If the euro-crisis is on the backburner for the time being, the European banking crisis is still simmering. Commerzbank is banging the drums that they almost have found all the new capital they need. One of the tricks is that Allianz appears to be willing to convert a holding of non-tier 1 capital into an equity holding. From Italy we hear that the world’s oldest bank, Montepaschi di Siena, is pulling off a similar stunt. It is a beginning. We need far more action on this front.

Good data from the USA
Please do remember that you read it here first (or in my blog back in August): The US growth pause ended in September and growth improves nicely. Initial jobless claims fell in December, housing starts increased and manufacturing output accelerated. At the same time the US budget deficit is shrinking – as it always happens when the economy accelerates.

We know that the fears of a “new” recession is over when the likes of CNBC and Bloomberg TV again begin to interview people who offer “stock tips”. We are on our way. The perpetual bear, the original Mr Doom and Gloom, Marc Faber now assures us that the stock market will not collapse. Time to exhale!

Risk indicator
It will come as no surprise that I am a harsh critic of risk control methods based on “portfolio diversification”. When the things really heat up in the markets, correlation between asset classes increase and the diversification of portfolios lose its effect. 

At Origo we have made an indicator of this, and guess what: it signals that we are moving back towards normal. The risk management departments of this world are soon back where their models again work. I would not be surprised if the message going out from the risk controllers in the banks is “risk is falling, you may take more risk on”. Stock pickers will also feel it is worth going back to work again.

Wednesday, 18 January 2012

Mario. Yields.Economic news. Gross.

Super-Mario II
No, not Mario Monti but Mario Draghi. In a testimony to a committee of the European Parliament he is quoted to have said that “As regulators we should learn to do without ratings. Or at least we should learn to assess creditworthiness in a way in which ratings or credit rating agencies are one of the many components of our information”.

I could not agree more. I have even been quoted for saying so: There is no alternative to doing your homework. Even if it implies that you will have to read up on what creditworthiness means. Or to employ staff that know.

On Monday, I quoted S&P’s musings in their reasoning for the downgrade of France. It was an unashamed judgement of the shortcomings of the European initiatives to shore up the Euro. The fact that I agree with their judgement should not take the attention away from the fact that it revealed one crucial fact. The ratings agencies are as much political players as they are analysts or indeed paid marketing agents. Draghi’s words should be taken to heart and the ratings should be taken as “one of the many components”.

I am happy to see that S&P’s downgrade was largely ignored by the markets.

French bond yields fell at the auction Monday, a Belgian auction went well, and even Greek bond yields fell Italian and Spanish two year yields have stabilised and 10-year yields declined. I interpret this as a resounding proof that ECB’s 3-year loans are having the desired effect for now. The stock market is picking up the baton.

German bonds (and other “Safe haven” assets) are worrying me. If suddenly bonds from other countries are perceived as being not-so-risky and if even Portugal manages to sell a small amount of 10-year bonds, what will happen to German yields? It does not take a genius to see that one of the world’s most overvalued assets would be in for a rough time if investors drop their obsession with avoiding risk.

If you are ultra-long in these assets despite their ridiculously low yield, take care that you will not suffer the same fate as the (almost) proverbial frog in the water being brought to boil.

The frog story is proven to be a myth. The losses on your bottom line will be real.

World Bank economic forecast
The less thinking part of the financial press will today dedicate too much space to the World Bank’s economic forecast. WB expects global growth of 2.5% in 2012, down from last forecast’s 3.5%. The previous forecast is from June 2011, so most of the downgrade merely reflects the economic development since then. If the European banks break down and the euro-zone enters a deep depression, it will lead to a global recession, according to the WB. That has no news value whatsoever. I notice that the World Bank does not assign a subjective probability to neither the main scenario nor the doom scenario. Do read the report, but take it as a history lesson rather than anything forward-looking.

Good news amid too much gloom
We, Origo, my business partners and I, want to have it on the record that the European recession is a fact here and now, and we are beginning to pull out of it. Some people appear to agree with us (the stock markets, just to mention a few). ZEW’s data for German investor and analyst expectations rose for the second month running. It was the biggest monthly increase in 20 years of data.

Market rumours now report that the negotiations on Greece’s restructuring will result in a haircut of 68% - it appears to be a good number – for Greece, at least. An anonymous source said that “a lot of brinkmanship is going on”. Sounds about right. Playing this one right may hand a big Ka-Ching to those who blink last. Why else should hedge funds have gotten in there recently?

Sometimes I wonder what it really takes to have one’s name mentioned in the headlines. I do my best by being mean and sarcastic. PIMCO’s Bill Gross managed to get a headline on Bloomberg for telling the obvious truth that some institutional investors have rules according to which they will be forced to sell bonds that are rated lower than a certain threshold. That may lead to a sell-off. Toe-curling stuff. I promise myself not to quote Bill Gross again until he makes a correct call on US Treasuries.

Monday, 16 January 2012

Downgrade. Euro.


One should always be prepared for a hefty surprise in these markets. Suddenly I find myself agreeing with S&P! In the explanation for the downgrade of France the following gem is hidden:

“The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements from policymakers lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems. (...)  We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone's core and the so-called "periphery." As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues.” (My emphasis).
Also very useful to read how S&P are justifying their broad sweep.Somebody have been reading up on their Kindleberger and the history of the crisis in 1929-32.

The only question is: what would S&P have done if France (and Germany) had introduced reforms and tax changes to spur domestic demand and had offered long-term loan programs to Greece and Portugal to help productivity development. Or if Italy had embarked on a long, slow reform program to set free the country from decades of bad management of the laws?

Probably they would have downgraded France and Italy anyway, so in that respect the above quote is just a proof how much of a political institution SP really is. We now wait for the next chapter: The downgrade of Germany. Ultimately it is Germany that has forced a wrong solution upon the rest of the euro 17.

Will it mean anything for France and the 8 other downgraded euro-nations? Too early to tell. But for sure a lot had been priced in already.

More interesting, is this a game-changer? My feeling is that it is not. After all, I cannot remember a rating change that was forward-looking and indicative of any changes that were not already visible to everybody else. But we will be able to see it in the risk appetite in the coming days.


The euro has fortunately weakened further as a result of the ratings. Good for Europe! However, Colleague Frank points out that the number of short positions betting against the euro is at a historical maximum. But I found a piece on Bloomberg that left me puzzled. Who had understood that the reason for the surprising strength of the euro was that it was propped up by the AUD. Silly me! I thought it was the belated reactions on the part of ECB that had caused the euro to remain stronger than the other main currencies. Never too late to learn something new...

Reuters carry an interesting story – and they appear very keen on telling us that it is well-researched: Hedge funds have apparently bought sufficiently many Greek bonds to actually force a default. That would immediately release the payments of CDS according to ISDA rules.

Friday, 13 January 2012

German growth. Schizophrenia. Banks


Italy and Spain sold more short term bonds than expected at lower yields than expected. ECB’s 3-year loans are working their magic. The “euro-collapse” is postponed further.

German growth

Germany has announced a negative growth in Q4 of -0.25%, and newspaper stories have it that the German Federal government will reduce its forecast for economic growth in 2012 to about 0.75%, Negative growth in Q1, zero growth in Q2 and a slow recovery in second half of the year. It is entirely in line with the view I have stated several times before: We are in the middle of a European recession and sometime around March/April we will reach the turning point.


On 19 July last year, Origo made a call that stocks were in for a major correction. We based this forecast on a number of factors. Most important was that on a backdrop of sharply falling growth, stock markets had their Wile E. Coyote moment, while the (high quality) bond markets were right all along.

Again, we have a situation where the stock markets are on average trending upwards, while the (high quality) bond markets stubbornly cling to excessively low yields. But this time it happens as the growth prospects are in fact improving or about to turn the corner. Despite heroic attempts from the London-based financial press to keep the pressure on the euro, the various initiatives to lighten the financing squeeze on Europe’s troubled countries appear effective. The European recession may well end up having an average length (7-9 months) and an average depth (a total output loss of 0.75% to 1%).

Where does that leave us in terms of asset allocation? Well, judge for yourself. One can side with the bond markets and remain depressed. Or decide to see the positive signs and side with the stock markets. As opposed to the turn in March 2009 or August 2011, the signs are not yet all pointing in the same direction. But it appears that the “perma-bears” have a harder time to make their way into the headlines.

According to FT, a certain large CSwiss bank is now offering its hedge fund clients a product that allows them to short European banks – even if shorting bank stocks is banned in several countries. I will not discuss the morality of this manoeuvre. Would be akin to discussing something that does not exist. Pure metaphysics!). One thing is, however, clear. Once this particular product is offered to retail investors, the European banking crisis is close to being over. Yet another of my “hillbilly indicators” based on nothing but a long memory.

European Banks
RBS is caving in to demands from Bank of England and the British finance ministry (who owns a not insignificant 83% of the shares in RBS). It will mainly lead to cuts in the investment banking activities. Deutsche Bank wants to sell its asset management division. I am afraid none of it points to a solution to the banking crisis.

The banks trade at depressed prices because nobody can figure out which banks are really rotten. They all mark their assets to fantasy instead of using mark-to-market. They have not yet taken the necessary write-offs on goodwill. If we could finally get a couple of major banks to fold, it would end up being good news for the sector – after the initial shock. As it is now, the entire sector is priced for a meltdown.

Wednesday, 11 January 2012

Pensions. Auctions. Banks.

Well, well, well. I have given a couple of presentations in Copenhagen and Stockholm about the Euro crisis. One of my points is that the current situation regarding government finances also has a lot to do with the fact that Europe’s baby boomers are retiring in large numbers these years. It has been pre-programmed for years (about 60 years to be specific) but politicians have too short an attention span to focus on it. Now the story has been picked up by Bloomberg. Chapeau!

It goes to confirm that we have a number of different problems occurring at the same time: Debt cycle reversal, cyclical slowdown, badly capitalised banks, inadequate institutional design in Europe, and the pension squeeze. If anybody wants to receive the slides from my presentation, let me know.

Tomorrow and Friday Spain and Italy will sell up to 22bn of short and medium term bonds. The yields in that part of the yield curve have dropped sharply since the beginning of December, meaning that the refinancing costs will not increase as dramatically as the markets believed just 3 months ago. In fact, the refinancing costs are far from being bad.

So I cannot understand why the headlines continue to focus so much on the 10-year yields?? They have been volatile but on average moving sideways for three months. Why is it that the headlines need to focus on that as a sign of impending disaster when things are getting better in the auctions? Sensationalism!

I wrote in November that place to watch is exactly the Spanish and Italian bond auctions. As long as those two countries can issue all the bonds they need at reasonable yields, we do not have a real euro-crisis. We may still have a crisis, but it is not one driven by the euro.

If it were to happen that those two countries cannot refinance their debts or that the yields they would pay increased to a point where they cannot stabilise their debt/GDP ratio, we should all head for the hills.

Banks - again
As the pressure is easing on the euro and the sovereigns, it mounts on the European banks. Presumably, The ECB saw the 3-year loans to banks as a way of helping the banks to buy some government bonds from Spain/Italy. It has worked. But now it appears that the banks also want to use that money to refinance some of their own bond issues. It is another sign that the region’s banks prefer to solve their lack of Tier 1 capital by shrinking their balances.

They prefer to shrink their activities instead of raising new capital. UniCredito’s bungled rights issue is certain to scare other banks from trying the same.

It will only undermine Europe’s growth if the current credit shortage continues. At some point in time politicians will have to understand that the banks do not play along as long as it is not in the interest of their management and/or their shareholders. With an essentially insolvent bank sector, I cannot understand that European politicians do not begin to use some muscle. The banks are already dependent on government support in one form or another. This is the moment to seize and to force fundamental changes. The Swedish experience from the ‘90s still beckons as a good example.

The quote “Once You Got Them By The Balls, Their Hearts and Minds Will Follow” is ascribed to Teddy Roosevelt. Barack Obama missed his moment in 2009. Europe, anyone?

Monday, 9 January 2012

Euro growth. US Data. New kind of risk. Euro down

Economic data from the Euro-zone
Rather bad data from the Euro-zone were published on Thursday and Friday. Retail sales fell by 0.8 per cent in November and economic (consumer) sentiment fell half a per cent in December while business sentiment has been picking up. Unemployment rose by 45,000 in November. Even if the numbers are the most recent, they are not up to date, and that is important for understanding them. Inflation continued to fall.

I do not think that those numbers are harbingers of harder times ahead. But they are a confirmation that the Euro-zone stalled sharply in Q4, fully in line with our claim that the maximum downward pressure is just behind us. We will still see bad numbers in Q1 but they will not fall as sharply as in Q4 and a stabilisation will be visible around the turn of Q1-Q2.

It means that I am not in line with those who only now begin to forecast a European recession. They are too late. The recession is a fact. The next game in town is to figure out when the recovery will begin, however anaemic.

While we think of that one, it is worthwhile remembering that the financial markets react to perceived changes in trends and growth. For those who still remember their high school math, it is not the first derivative (growth rates, inflation) that are interesting, it is the second derivative.

Economic data from the US
The US entered the “soft patch” at the end of Q1 2010. In August, when the stock market found out, the economy was about to move on. It stabilised in Q4 and is now in recovery. Even that most unreliable of American indicators, unemployment, is falling (just in time to improve Obama’s possibilities of being re-elected?). It is in line with our forecast from August and so far we see no signs of that recovery faltering.

A new kind of risk
What a joy to work in a profession that is so flexible as to invent new terms when the old ones are not any longer adequate. After having complied with European standards when writing the prospectus for out new fund (Origo Total Return Fund), I thought I knew every kind of risk relevant  to the financial markets. But no. Now there is a new one that has established itself over the past months. It is called “Headline Risk”.

Don’t try to find it on Wikipedia - it is not there (even if Investopedia has an entry). It simply covers the situation that occurs when market participants show up in the office and a headline carries news about a story that the said market participants did not even know existed. How did we manage before we invented Headline Risk?

Euro is falling
Personally I am happy about the “Headline Risk” undermining the Euro. I see that some strategists now predict a collapse to the region of 1.25 against dollar. Wow. Let us get that euro weakened so the Euro-zone can regain some of that growth that went to other regions as the Euro strengthened because the ECB was slower out of the starting blocks than other central banks. 1.00 against USD would be a huge advantage for our exports.

Friday, 6 January 2012

Boring. Economists. Hungary.

Yesterday I found that the US and the European markets were sort of boring. The stories of the impending collapse of the world as we know it are not really having a lot of traction and it tends to reduce volatility quite a bit. There was a French 10-year auction which drew “better-than-feared” demand and the 10-year yield only rose a few basis points. Spanish and Italian bond yields had increased and they fell as the French auction did well. All very normal, and while not headline stuff, quite important. As long as we do not have hiccups we remain on course for a revaluation of risk assets. Origo’s risk indicators continue to improve.

Geopolitical choking point
Do not underestimate the potential trouble brewing in the Strait of Hormuz. 40% the world’s oil (traded) supplies pass through this narrow straight. The place has for years been recognised as a major “choke point” in case of international crisis (the other main choke point is the Strait of Malacca). We are less than one year from the completion of a major pipeline that would dramatically reduce the importance of the Hormuz, since oil tankers would not any longer need to pass there in order to load up with oil.

So now  Iran is trying to use a last chance to threaten the Western world with closing the Hormuz. The purpose is to blackmail USA and Europe into lifting a trade embargo on Iran, imposed because of Iran’s nuclear ambitions. Major preparations for a confrontation is already on its way. Iran will likely try to use “swarming” with small, light vessels that will hard to catch by the US Fifth Fleet, based in Bahrain. Iran may also mine the Strait. The US, on the other hand, is apparently preparing a drone defence. This could accelerate in a very nasty fashion, particularly as both Iran and the USA have serious geopolitical interests at stake.

I will not guess how much oil prices could increase. But it would be enough to slow down growth here.

Economists and money
The American Economic Association has published new ethics guidelines for academic economists. AEA is the association of research economists in the USA and has hosts of foreign members, too.

Now this venerable institution demands that its members disclose their economic interests when writing academic articles. That is good news, since economists have a tendency to pass off their points of view as science, even when they are highly politically charged. About time, one could say, since financial analysts have had to comply with similar rules for years.

Personally, I am more worried that one of the best sites for jokes about economists has been closed. Where will we now go to find wise words like these?:

There are two types of economists:
- those who cannot forecast interest rates, and
- those who do not know that they cannot forecast interest rates.

Hungarian Horntails
Hungary’s conservative government has taken some major steps in a rather worrying direction. Having won a 2/3 majority in parliament, the government has fired the president of the supreme court and announced a constitutional reform that appears to reduce the protection of civil liberties. That kind of stuff is usually not the worry of the financial markets.

But the Hungarian government also wants to reduce the independence of its central bank by granting the government the right to hire and fire the banks council almost at will. That has brought the EU Commission and IMF out of their seats. Hungary received emergency loans three years ago and asked for a second bail-out in November 2011. IMF and the EU Commission appear ready to withhold the help unless Hungary guarantees the independence of the central bank.

If this situation ends in a stalemate we may well have a Hungarian government default. Since Hungary is not in the Euro, it should not affect the markets. Unless of course, foreign (ie. EU) banks holding Hungarian debt have not yet made provisions.

Wednesday, 4 January 2012

Back to Normal. Weaker Euro. Risk Rally

Back to normality?
It's boring out there. And it is perhaps the best piece of news in a long time. After reaching a crescendo in early December, the amount of headlines dealing with the euro crisis is now in a clear decline. I choose to take it as a sign that the ECB's three-year money has stabilised both inter-bank market and the demand for government bonds from Italy and Spain.

More bad news is certainly still possible. As an example, I expect that a major European bank or two will go belly up, as no decisive action is yet taken at a European level to clean up the banking sector. But a collapse or two is probably already built into the soaring risk premiums in financial sector shares. It is more and more urgent to get EFSF and ESM up and running.

A weak euro is a strong euro
I have always wondered a little about the media fixation on the positives of having a strong currency. It smells so badly of Neanderthal nationalist policies (or of man-talk in the locker room), especially when looking at the headlines in recent months. As if it was negative to have a weaker euro!

Since the beginning of the crisis, several countries have profited from a weakening of the currency: USD, GBP, NOK, and especially the SEC. These countries all have central banks and finance ministries able to act quickly. The Euro-zone's institutions were too slow and the result was that the euro strengthened, together with CHF and JPY. This moved growth from the Euro-zone to the countries with weaker currencies. So I can only see it as good news if the EUR / USD were to trade at par. It has been there before, and it was not the end of the world. (My colleague Frank Jensen says: “It will be no surprise if EUR strengthens in the short term as a result of short-covering”. Go figure!)

Back in 1992 we saw the last major crisis in the European Exchange Rate Mechanism, when GBP fell out of the ERM and we had a wave of devaluations against the Deutschmark. Italy devalued by almost 30 percent. That crisis began with a dramatic weakening of the dollar, and it revealed the tensions in Europe. The current euro crisis is similar to the situation at the time - but now we do not have devaluations as a means to remove those tensions. A weakening of the euro will reduce tensions significantly.

Risk Rally
New Year has brought the traditional amount of forecasts for this and that. Obscurity will mercifully descend upon most of them. So let me give my own anti-forecast: If we are moving towards a normalisation of the conditions in Europe, and if risk premiums have finally stabilised, there will be room for a significant shift in the relative prices of the different classes of risk assets. Some will rise dramatically (shares? Bank shares?), while some will fall with a bang (Bunds, T-bonds?). It could conceivably happen in 2012. There are just 241 things that need to be in place first.