Editor’s Note: In this series of articles, we include important or interesting videoclips with our comments. This
is an article that expresses our personal opinions about comments made
on Television and in Print. It is NOT intended to provide any investment
advice of any type whatsoever. No one should base any investing
decisions or conclusions based on anything written in or inferred from
this article. Investing is a serious matter and all investment decisions
should only be taken after a detailed discussion with your investment
advisor and should be subject to your objectives, suitability
requirements and risk tolerances.
The more things change, the more they stay the same. Berlusconi goes, Monti comes; Papandreou leaves, Papademos enters. So? The problems in Europe worsen every week and the yields on non-German European Bonds go up every week. And this week, the German shoe began to fall. The Daily Telegraph wrote on Thursday:
- Asian investors and central banks have begun to sell German Bonds and pull out of the Euro Zone altogether for the first time since the debt crisis began, deeming EU leaders incapable of agreeing on any coherent policy….Jean-Claude Juncker..fueled the fire by warning that Germany is no longer a sound credit with debt of 82% of GDP.
These sentiments were echoed by the New York Times on Friday evening, meaning they have now become the consensus. The evidence was easily seen in the week long liquidation in European Bond Markets and the sell off in German Bunds on Friday.
Peter Fisher of BlackRock told the New York Times on Friday “It’s a pretty terrible spiral“. Rebecca Patterson of JPM Chase described this action as “contagion is out of control at this point“. But she felt the turmoil makes it more and more likely that “ECB does rise to the rescue”. This was also the wish expressed by Stephen Walsh of Western Asset Management (see clip 4 below).
But Mario Draghi, the new President of ECB, made it clear on Friday the ECB would not become a lender of last resort and pump money into the financial markets. This position was bluntly affirmed by Jens Weidmann, president of the Bundesbank. Both placed the onus on the European political leaders with Herr Weidmann explicitly describing inefficiencies in other European countries.
We have always been afraid of a definitive decision in or by Europe. The worst decision might actually be Germany’s acquiescence in using their balance sheet to buy European Debt. Because that decision will immediately trigger a sell off in German Bunds, we think. The destruction in financial markets from such an exodus from German Bunds will create a global outcry for IMF intervention.
This is perhaps why Kyle Bass of Hayman Capital thinks the ONLY solution is a massive restructuring of European Debt (see clip 1 below). The only “other solution” is massive printing of Euros. But will Germany stay in an EU that prints so massively?
2. Germany – Mittel-Europa all over again
Germany has been Europe’s problem and Europe has been Germany’s problem. Too strong a Germany makes Europe unstable. Such instability makes the rest of Europe unite against Germany. The result of a pan-European conflict with Germany has always been a break up or partition of Germany.
Rather than weakening Germany relative to pan-Europe, the EMU ended up making Germany much stronger. The rest of EU ended up becoming Germany’s captive markets. As Foreign Affairs noted this week:
- Between 2000 and 2007, Greece’s annual trade with Germany grew from 3 billion euro to 5.5 billion; Italy’s doubled from 9.6 billion to 19.6 billion, Spain’s almost tripled, from 11 billion to 27.2 billion, and Portugal’s quadrupled, from 1 billion to 4.2 billion. Between 2001 and 2009, moreover, Germany’s gross savings rate increased from less than 19% of GDP to almost 26% over the same period.
And Herr Weidmann, president of Bundesbank, blames this on inefficiencies of other European countries.
Germany walking away from the game at this stage, would be like a poker player walking away from a game after taking the money from all the other players. In the Wild West, this behavior resulted in a gun battle. Actually, a political gun battle has already begun with scathing anti-German articles in Foreign Affairs, Stratfor, and protests & cartoons in European countries.
Germany, if it walks away, would see it’s currency explode to a ridiculous level, it’s exports shot and it would face a deflationary recession. Germany, if it stayed in the EU, would eventually have to pay up big. Either way, Germany could lose big – financial debacle or political suicide. Can the Government Bond market of such a country be considered a legitimate safe haven?
Germany can only escape from this trap if France remains it’s ally and this German-France Core forces PIIGS to write down their debts, “voluntarily” of course without triggering a CDS event.
If Germany & France cannot agree, then just like in 1914 and in 1939, America will eventually be asked to intervene.
3. America’s Own Mess
Next week, the Super-Committee of the Congress will reveal its debt reduction plan. The consensus in the markets is a punt. Nobody wants a divisive fight on this issue at this time. The issues involved should be decided by the American people in the November 2012 election. Even the financial markets do not want to see a fresh outbreak of turbulence, especially in the Treasury market.
Curtis Arledge, CEO of BNY Mellon Investment Management, opines that a punt from the Super-Committee would be bad for risk assets (see clip 4 below). Andrew Busch of BMO Capital thinks the Committee can come with $1.2 trillion of cuts and that can settle things down a little bit.
4. US Stock Market
Clearly, the US stock market does need to settle down a bit. This past week was the worst in the last two months. Fitch was ‘brilliant’ in its ‘prescient’ warning that a prolonged bad recession in Europe could impact ratings of US Banks. Fitch also its timed it wonderfully at 3:25 pm. This was enough of a trigger to take US Financials to lows in a ugly close. The worse action, in our opinion, was the next day when US Financials did not bounce back.
This ugly break down in US Broker Dealers and Money Center Banks made Mary Ann Bartels of BAC-Merrill Lynch decidedly negative. She now feels S&P will test 1100 early in 2012 and she said that Bank stocks will visit their October lows (see clip 2 below).
Laurence McMillan of Option Strategist argued that the SPX is still clinging onto the old support range (1215-1230) and he still thinks this market can rally. But he is clearly nervous. Thursday’s action probably made every one nervous. Liquidation seemed in the air. The McClellan Oscillator settled on Thursday at an oversold reading of -158. This is oversold but not panically (?) oversold.
This week, Gold acted as a risk asset alongside stocks. Was this liquidation-related selling or was it due to deflationary fear?
Why did Treasuries act in such a lukewarm manner? Was it due to fears of a downgrade of US Debt if the Super-Committee punts next week? Or was it a sympathy move with the Bunds? Treasuries are the obvious and the only safe haven left in Bond markets. So why the lukewarm action? We don’t know.
Both Stephen Walsh of Western Asset Management and Curtis Arledge of BNY Mellon described rather disturbing conditions in large, Institutional Bond markets.
- Walsh – Over the course of the last 90 days, liquidity has really evaporated. I think there’s a dearth of risk capital in our markets… the ability to asset allocate, to shift between the sectors within the bond market in any sector of the market outside Government Bonds is almost prohibitive.. (see clip 5 below)
- Arledge – you have gigantic bond markets
that really have lost institutional sponsorship. You can’t have a
market moving 50 basis points a day, be a market that large investors can really have in their portfolios. As volatility goes up, position limits have to go down (see clip 4 below).
Why, under these conditions, are Treasuries not acting exuberantly? Where are David Rosenberg & Gary Shilling when we need them?
Kyle Bass on BBC Hardtalk on Tuesday, November 15
Mary Ann Bartels on CNBC Fast Money Half Time on Friday, November 18
Robert Savage on CNBC Fast Money on Thursday, November 17
Curtis Arledge on CNBC Fast Money on Thursday, November 17
Stephen Walsh on CNBC Squawk on the Street on Thursday, November 17
1. Massive Debt Writedowns Needed in Europe (02:50 minutes) – Kyle Bass on BBC Hardtalk – Tuesday, November 15
- Bass – The only way to “resolve” any problems in Europe is to have massive debt restructuring, is to have these right-downs. One of the things we say in our office recently.. “you know how screwed up Europe is when you have a German Pope and an Italian Central Banker.” The very important thing to understand is that Debt has grown globally in the last 9 years from $80 Trillion Dollars to $210 Trillion Dollars. So Global Credit Market Debt has grown at 12% a year for the past 9 years while Global GDP has grown at 4%. So we are in a scenario where the PIIGS, you have Portugal, Italy, Ireland, Greece & Spain, all in a scenario where they have sailed into a zone of insolvency. And when you sail into the zone of Insolvency, there is no “solution” for you. The only solution is the Bill is Due and you have to Pay the Bill. What has to happen, in our opinion, is that these debts have to be written down. It is that simple.
- BBC Anchor – If the Euro Zone effectively becomes one country, Germany stands behind its southern neighbors? Does that not resolve the problems, the earning power of Germany?
- Bass – Oh Gosh, No. Look, first of all, Germany has restructured its debt, defaulted twice in the last 100 years. Germany has 81% on balance sheet Sovereign Debt to GDP today and they haven’t recapped their banks yet. Only the UK and the US have recapped their banks. The rest of Europe hasn’t recapped any. Europe’s Banks are 3 times as levered as the US Banks today.
- Bass – Think about what you just asked me. Basically you are saying that if Germany goes joint and severally liable with the profligate idiots of Southern Europe, will that “solve” the scenario? Think about this.—- Every single time from now on, Germany is in the exact situation it is in today,… in Texas, we call it the Mexican Standoff, meaning there is no winner. The profligate members will always have Germany by the short hairs every single time this scenario comes up. So I disagree. I don’t believe Germany will end up going all in. It will not be the benefit of Germany to do so in the long run.
2. Ten-Year Yield at 1.50%, Bank Stocks Take Out October 2011 Lows? – Mary Ann Bartels on CNBC Fast Money Half Time – Friday, November 18
Mary Ann Bartels, Head of Technical Strategy at BAC-Merrill Lynch, is no stranger to readers of these articles. We have followed her technical work since August. Here she speaks with CNBC’s Simon Hobbs and the Fast Money Trader team.
- Hobbs – Where are you on the S&P at the moment?
- Bartels – well, we’re locked in a range, Simon. We’re locked between the 200-day moving average on the S&P which stands at 1271 and 1200. The market has tried twice to break the 200 day and has failed. Now I think we are going to test the 1200 level and if we fail to hold 1200, we’ll go down and test in a range between 1150 and 1100.
- Grasso – … but below 1200, … but I think we get back down to 1100 sooner rather than later. For me, if we break that 1200 mark, I think it’s lights out.
- Weiss – Volume – is it changing how you look at levels and look at confirmations of moves?
- Bartels – Volume is about average. But on the past two days as the market has been going down, volume is actually been expanding. So I’m viewing volume as a confirmation of the move down within the markets. But what’s really troubling me, what’s leading the markets lower are the technical breakdowns that we have in the Broker Dealers & the Money Center banks. And when we do measured moves on those, we think they’ll take out their October lows.
- Bartels – I think if we take a much longer term view and you really go down to certain stocks and themes whether you’re taking about high quality, what we call very high yielding stocks, we do see very long term attractive opportunities within the market. But we’re concerned between now going into the first quarter, we’re going to continue to have above normal volatility in the market.
- Hobbs – Where does that leave you on the dollar then?
- Bartels – well, the Dollar we think is going to be a beneficiary. This is a safe haven. We think money will continue to flow into the dollar. we can see DXY going up to 80 or 81. The other beneficiary is Ten-Year Treasury yields and we’re tracking them down to 1.5% to 1.4%. We haven’t ruled out that we’ll eventually see 1%.
- Grasso – Mary Ann, since you have that inverse relationship between the Dollar and the S&P, does that make you — even though you said range bound, does that make you err on the side of testing that range you said between 1150 – 1100?
- Bartels – Yeah, I think we are definitely going down to test that 1100 range. May not be in December, may be in the first quarter. we can test the intra-day low of 1074. If Europe really has major problems, we have put our 50% probability that the S&P would hit 910, but that would have to be a very severe contagion in Europe.
- Karabell – what about other side of it? what about the possibility that there is some sort of resolution that’s at least temporarily satisfactory? where are you on the upside?
- Bartels – if there’s a resolution you have again to get above that 200-day moving average. If we can get above the 200-day moving average with volume, then the market could track up closer to 1350. And there’s a lot of cash on the sidelines that could propel this market a lot higher.
- Hobbs – but that’s a huge thing to say. if we can get down to 1%, the capital appreciation, let alone the yield, the capital appreciation that people would make on that bond market would be huge, Mary Ann, would it not?
- Bartels – it would be. And Simon, Treasuries are still the most hated asset class we have.
3. Computers & Currency Trading – Robert Savage on CNBC Fast Money – Thursday, November 17
Robert Savage, Track.com CEO, was previously Managing Director of FX Macro Sales at Goldman Sachs. He is known for his perspectives on Currency Markets. He speaks with Melissa Lee and Guy Adami of CNBC Fast Money.
His conversation with Fast Money was on two separate topics. We begin with the second.
- Adami – Everybody has been looking for the Euro to go back to the 110s. But it’s not working for them. If you take a step back, shouldn’t the Euro be 105 to 110 or is it right at 135?
- Savage – I think that there are three things that are going on in foreign exchange.
- One is politics. So given the politics in Europe, you are scared out of your wits. Of course, we should be at parity.
- The other is positioning. Everybody and their cousins and cab drivers are all short Euros. So it’s just not going to happen. The amount protection in the Euro down to 125 is significant in the options positions.
- And then the third thing is a little more complicated. It’s the PMI world. Europe is going into recession. So is the rest of the world. I think Europe has a leg up in clearing what they — their banks right now are under so much pressure. They are selling every asset they can. In 2007, 2008 we saw the same trade in the U.S. Dollar… The Dollar went up. U.S. Banks sold assets. There was a dollar shortage. The Fed actually had to print tremendous amounts of dollars to make it even come back to semi-normal level.
- One is politics. So given the politics in Europe, you are scared out of your wits. Of course, we should be at parity.
- Savage – I think the ECB is the only way to see the Euro go to that parity level. It should go to parity if the Europeans want to grow their way out of this. That’s the only way out. You can also talk a little bit about China. China is actually very happy that all of this is going on to a degree. But my biggest fear for 2012 right now is that China is going to be surprised about this weakness in Europe…leading them down the hard landing route as well.
The first part of the conversation is a bit more philosophical and technical. Therefore we left it for the end.
- Savage – well, let’s be clear. Computers are better than humans at trading generally. So a model is a model. and they are going to work in certain market states. What is different now is that the cycles of what’s going on are much quicker. Unfortunately what we’ve seen, not just in foreign exchange but in equities, in bonds, is a much faster market. And not everyone is prepared for that…so bottom line, the computer models that we are talking about, they all need to be put together in a different way. And I think that really most of the people that are algorithmic in this world are coming up with a new word which is risk management. We’re in a world where it’s not about trends. it’s not about chasing positions. it’s about risk management and not losing your shirt, period…. a winner, by the way in today’s world is defined as somebody that’s making 4% or 5% return. I don’t think there are a lot of hedge funds getting tremendous amounts of leverage. And, you know in a world where everybody has zero interest rates, get 3% or 4% return is good. I think the characteristics of the winners are the people that learn by their mistakes.
4. Trading the Super Committee & Europe – Curtis Arledge on CNBC Fast Money – Thursday, November 17
Curtis Arledge is the CEO of BNY Mellon Asset Management. CNBC tells us that he serves on the Treasury Borrowing Advisory Committee, a group of 13 financial leaders who advise Treasury Secretary Tim Geithner. His comments begin at minute 02:37 of the 07:54 minute clip.
The Super Committee is expected to announce its debt reduction plan before Thanksgiving. That is what CNBC’s Melissa Lee asked Curtis Arledge to address. Fast Money trader Karen Finerman and Ron Insana, ex-anchor & now a CNBC contributor joined the questioning.
- Arledge – I think the market is looking for them [the Super Committee] to come up with $600 billion to $700 billion, mostly stuff already baked in around defense spending. I think it would be surprising to the market if they got all the way there. There have been rumors they were going to do some things and looked like those rumors got quashed. It’s really too bad. I think the markets right now both in the United States and Europe are looking at this. It feels like policymakers are playing a game of chicken. The markets are trying to figure out whether or not they know it. Both Democrats and Republicans think they can wait until the election. Germany can wait until all the austerity programs get put in place and Italy in the periphery. I just think, the markets don’t work like that. Adam Smith’s invisible hand is working quicker than policymakers can stand for.
- Finerman – what do you think the response would be if they essentially punt and come up with some way to put in a mechanism that delays the decision without implementing the automatic cuts they first talked about in August?
- Arledge – I think there’s a linkage here between the United States and Europe. So if really bad things are happening in Europe, the market, you have gigantic bond markets that really have lost institutional sponsorship. You can’t have a market moving 50 basis points a day, be a market that large investors can really have in their portfolios. As volatility goes up, position limits have to go down. If Europe continues to be a problem, it’s going to put a lot of pressure in the U.S., if they punt and don’t do anything, I think everybody looks at punting in the U.S. means suddenly Treasuries trade off. I think it means the economy is going to be in much worse condition and it’s going to be bad for risk assets.
- Insana – this is fascinating to me. As you and Karen just suggested, after the downgrade, Treasuries rallied. Whatever the super-committee does if they fail to meet the deadline it seems to me more likely that stocks will go down but bonds will do fine.
- Arledge – I think about it the same way you do. If they punt, it’s bad for risk assets. And I think the market has already got some level of punt built into it. So if they can’t even get to 600 or $700 billion. if they can’t talk about what they might do long-term, i think it’s going to mean they are just pushing it down the road. The market is looking for policymakers to become credible. They’ve lost credibility in many ways. I think that’s a U.S. issue, a European issue. And I think it’s bad for risk assets. U.S. Treasuries today are really an offsetting risk position. If you take risk you have to hedge it. people are using treasuries. the reason treasuries are doing so well is because investors don’t feel confident owning risk assets.
5. Rising Bond Yields Raise Contagion Fears – Stephen Walsh with CNBC’s David Faber – Thursday, November 17
Again, Stephen Walsh is some one we have featured before, CIO of Western Asset Management that manages $433 billion in fixed income assets.
- Faber – We talk so often lately about lack of liquidity in the equity markets. I know you’ve been starting to see that in the bond market as well in terms of liquidity drying up. What’s going on and give some historical context?
- Walsh – It’s one of the untold stories within the bond market. Over the course of the last 90 days, liquidity has really evaporated. I think there’s a dearth of risk capital in our markets. There are probably two theories for that. One is there’s so much uncertainty surrounding Europe and uncertainty about the economy. So people are naturally pulling back as we go into year end. But I think may be a more compelling story is this is the early stages of a change in the financial markets with regard to Basle III or Dodd/Frank or even the Volcker rules that released in early October. If they were taken as they were written, it could potentially be a game-changer for the fixed income markets in terms of secondary trading.
- Faber -For example you have big banks that are going to have to hold a lot more capital against their fixed income holdings and therefore are not participating in the market to the extent that they might have previously?
- Walsh – Absolutely. For Western Capital and for other large fixed income firms, the ability to asset allocate, to shift between the sectors within the bond market in any sector of the market outside Government Bonds is almost prohibitive. We..tried to buy 100 million French bonds yesterday in the bond market in Europe out of our London office – the bid-offer spread was one point – that’s about seven times the bid/offer spread of US Government securities. And that’s for a French Government bond. Anything away from German Bunds or U.S. Treasuries is markedly less liquid today than we’ experienced at anytime except maybe since the fall of ’08.
- Faber – 100 million on 433 billion is not a lot. but nonetheless why?
- Walsh – We’ve been non-weighted to France at all throughout this period. The bond spreads have moved out to 200 over German Bunds. We start to think that represents some value. France is still the core of Europe. So we’re not talking about the periphery. At 200 over,we start to feel it makes sense to nibble into that marketplace. We began to do that yesterday, may be a day early. We think there is some value in French bonds at 200 over Germany.
- Lee – if there is such a difficulty in shifting your allocations now, does that auger a different sort of normal when it comes to returns? if you’re handcuffed, to some extent, in terms of how much you can go in and out, does that work against you?
- Walsh – I think it does work against us. It makes it more difficult but it also works against the Issuers. The cost to capital will rise for everyone. To the extent the capital markets have more friction or less liquidity, it has to raise the cost for anybody that participates in that market. So Western Asset will sit back and say, wait a minute, I need to be paid more to take that risk because of the liquidity, therein widening spreads. The interesting thing is Bernanke & and the Fed are doing everything they can to pump in the liquidity and bring down buying costs. Yet, the proposed regulatory changes are almost having the adverse effect.
- Faber – I want to get back to Europe since it is so central to our equity markets. You buy French bonds. You obviously don’t seem to think it’s going to break apart and fall apart. You mention the periphery. Italy is not the periphery – $2.6 trillion worth of debt. How is this thing going to end up?
- Walsh – The markets are going through a transition. The transition is the growing realization that government bonds are not always risk-free. We grew up with the perception that government bonds are risk-free. Government Regulators let Banking Institutions hold them with zero risk capital. So they’re held widely. As we start to transition to, wait a minute, maybe these things are more of a credit product, they’re not risk-free, the universe of buyers becomes dramatically less, even if their fundamentals stay the same. You just can’t buy as much as of a credit product as you can an asset that you perceive to be
risk-free.That is a transition going on. the markets are not deep enough. so the markets are clamoring for a consistent, credible, large buyer of European government bonds that don’t exist today.
- Faber – Do you buy Italian Bonds?
- Walsh – No. We’re under-weighted Italy, we’re under-weighted the periphery. You need to have the ECB. You need a big balance sheet. May be IMF comes in. We need to have a large credible buyer in the European sovereign market.
- Faber – Do they need to print Euros?
- Walsh – I think ultimately they do to buy time because the European Union is a work in progress. They need to buy time. There’s not enough appetite for Italian or Spanish bonds in the marketplace today. I do think the ECB needs to step in. whether they will or not, I don’t know.
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