25/27 EU. Portugal. RBS.

25/27 EU

So 25 of 27 EU member states decided to sign up to the new fiscal policy agreement, and the Czech Republic may sign up later due to democratic procedure. The UK decided to remain on the sidelines – again.

I have nothing new to add. The agreement is asymmetrical and will always have a deflationary bias. Unless, that is, it is completed by a solidarity agreement whereby the surplus countries agree to stimulate growth when other countries are forced into budget cuts. It is not on the agenda and the German understanding is that they have no such responsibility.

President Carter’s security advisor Zbigniew Brzezinski gave this description of the UK: “Its ambivalence regarding European unification and its attachment to a waning special relationship with America have made Great Britain increasingly irrelevant insofar the major choices confronting Europe’s future are concerned. London has largely dealt itself out of the game”. It cannot be said any clearer.

There was some flowery talk about creating more jobs for the young unemployed and for making some initiatives to help small and medium-sized companies. It will not improve the economic growth.

Auctions

I continue my focus on European bond auctions. European nations including Italy, Belgium and Spain plan to sell more than 33 bn euros this week. Italy sold 5.5 bn euros out of a target of 6 bn euros of five- and 10-year bonds on Monday, and issued 1.9 bn euros out of a maximum goal of 2 bn euros of 4-year and 9-year bonds. Belgium sold 2.58 bn euros of bills, with Spain, Portugal, Germany and France issuing 13 different maturities in coming days. Italy’s auction did not go down as well as hoped and there will be some focus on that issue in the coming weeks. But overall the results point to continued improvement.

Portugal

The country’s 10 year yields now stand at a sky-high 16.40% after having been higher than 18% last week. Predictably, it has led some to believe that Portugal’s refinancing costs have increased just as much, and that the country is about to be insolvent.

I am surprised some people still have not realised that the purpose of the bail-out from May 2011 was to allow Portugal to stay out of the markets for something like three years. The country steadily makes some auctions but they are small enough not to imply an imminent insolvency. Contrary to the case of Greece, nobody has accused Portugal of lying about the true situation of the public finances.

It does not imply that Portugal is safe yet. The government has embarked upon a major labour market reform. About time to clean up after the dictatorship imploded in 1974. But that kind of initiatives only work slowly, however well-intended they may be.

RBS

The fall-out from the RBS story continues. Sir Fred Goodwin, the ex-CEO of RBS is now ex-Sir Fred. He was stripped of his knighthood, just because the government had to step in with a modest GBP 45bn to save the bank. He must feel that he is being treated very harshly.

As a small compensation, I guess that Fred will keep his bonuses, contrary to the current CEO, who was brought in to clean up. Steven Hester waived his bonus of less than 1mn GBP after a public outcry that had nothing to do with his actual results.

We still need a serious discussion about how to device bonus systems for bank CEO’s. I still believe that looking at the returns created on the balance is better than the current obsession with return on equity. Using the RoE creates a strong incentive for the likes of Fred Goodwin to gamble. And as we see, again a ruthless and greedy bank CEO privatised the gains and socialised the losses.

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.

Downgrades

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.

Sarkozy

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.

Data

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.

Dollar

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.

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.

IFO

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.

Restructuring

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.

Investor protection. Davos. Consensus building

PMI

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.

Help!

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.

PE

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.

Davos

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.

Consensus

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.

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.

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.

Greece

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.

Auctions. Downgrade. Banks. USA. Risk

Auctions

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.