Greece, Greece, Greece. I’ve had it up to here with Greece. I’m tired about writing about Greece. Apparently, I am not alone; after the conference call today, Jean-Claude Juncker said that he was confident that a “decision” on a bailout for Greece will be made at the next meeting…on February 20th. Gee, that would be great, Jean-Claude. If it’s not too much trouble, you know.
I grow more confident by the day that the Greek default is reasonably imminent. Today there was also talk about the possibility of a ‘bridge loan’ to get Greece past the March bond payments. Aside from the fact that the mere possibility of a bridge loan will keep holders of the March debt from agreeing to the PSI (gee, get paid at par or get paid 30% of par. Hmmm.) in the hopes that they get paid out, and the fact that (as TF Market Advisors points out) paying the March redemption would add about €8bln to the total cost of the bailout, my question is: what good does more time do? Have the last months and years not been enough, so that another month will allow you to reach a solution? If that’s the case, then by all means fritter away another €8bln, but that’s one heck of a leap of faith if the only thing they could resolve on the conference call today was to have another meeting on February 20th. Can I hear an ‘Amen?’
More likely, the foot-dragging now is to figure out how best to effect the default so that it has the most salutary (or least-hurtful) effect on the political careers of those currently on the stage. For example, a certain French President announced today that he is going to seek re-election, a prospect which is fairly dim at the moment since Sarkozy is trailing the Socialist candidate (Hollande) by a healthy 7-9 points in the polls and, more importantly, losing by a huge 59-41 margin in a hypothetical head-to-head runoff matchup with Hollande. It isn’t clear what Sarkozy can do to salvage his re-election, although with two months to go anything can happen, but I can’t imagine it would hurt to stop shipping French taxpayer money to Greece. What do I know, I’m not French, but my point is that the political pain of keeping Greece may finally be outweighing the political pain of sending her on her way.
There are more reasons to be wary of the equity market here. As readers know, I’ve been reluctantly long in this rallying (but expensive) market, but this is no time to be a hero.
One of the other reasons is the news this evening that Moody’s is considering cutting the ratings of Morgan Stanley, Credit Suisse, and UBS three notches, and Goldman, Barclays, BNP, Deutsche, JP Morgan, Credit Agricole, HSBC, Macquarie, RBC, and Citi two notches each. Oh, and for good measure, Bank of America, Nomura, RBS, and Soc Gen are potential single-notch downgrade targets. They also acted today to cut some European insurers’ ratings. While we all know that ratings should be taken with a shaker of salt (if not altogether ignored and replaced with actual analysis), in a world of CSA (collateral support annex) ratings triggers, downgrading the whole financial system would have the effect of pulling a Lehman/AIG on the whole mess. All of these counterparties would suddenly have to post large amounts of additional margin with each other. Financial companies’ leverage has declined markedly over the last few years (in contrast to households, for example, where leverage hasn’t changed much), but this could still conceivably require a strong, concerted central bank liquidity injection of massive proportions.
A 3-notch downgrade to Morgan Stanley would put them at Baa2, which it might share with Citi and Goldman only slightly better at Baa1. Now, in 2008 both MS and GS became commercial banks, so they have access now to the Fed window – a Bear/Lehman moment would thus be unlikely. However, either or both could conceivably be in a BOA/Merrill shotgun wedding situation.
I don’t want to sound alarmist, because no ratings actions have yet been taken on the banks. And I obviously don’t disagree with Moody’s reasoning, when I have said as much here myself. They said
Capital markets firms are confronting evolving challenges, such as more fragile funding conditions, wider credit spreads, increased regulatory burdens and more difficult operating conditions. These difficulties, together with inherent vulnerabilities such as confidence-sensitivity, interconnectedness, and opacity of risk, have diminished the longer term profitability and growth prospects of these firms.
Yes, agreed, but the point here is that the ratings downgrade itself can cause a contagion, because of the existence of (well-intentioned) credit triggers. Those credit triggers are the papier mâché palm trees in the Coconut Grove.
I haven’t the faintest idea where those triggers are, and which ones may be triggered. And because no one else does either, it will not surprise me a bit if interbank lending grinds to a halt again. And this time, JP Morgan can’t step in as the big man on campus, because they’re in the same boat.
That’s not the only reason that the landscape suddenly looks less inviting for investors. Let’s talk about Apple. Now, I am a big fan of Apple products. I will note the Graham and Dodd admonition that a good stock differs from a good company in that a good stock is also cheap, but I’m not passing judgment on the valuation of Apple stock. Frankly, it’s not even a stock I watch very much, because it doesn’t pay a dividend and stocks of that type don’t generally interest me (firms that distribute dividends historically have tended to have a higher ROE). But today, when a highly-touted stock hits a new high and then reverses on huge volume – especially in an otherwise-somnolent market – it is a bad technical signal. When I say huge volume, I don’t just mean it was the highest share volume since January of last year. Keep in mind that the price is also some 45% higher now, and also keep in mind the aforementioned sleepy-market context. The chart below shows what I mean: Apple’s dollar volume today (with no news evident that I could see), on a day it set a new high and then reversed, was an absurd 5.2% of the total dollar volume traded on the Nasdaq. And frankly, that understates the point since I valued the dollar volume as the total shares traded times the closing price, and the closing price for Apple was the low of the day and more than 5% below the day’s highs.
So this is bad behavior from one of the generals.
Finally, back in geopolitics, Iran threatened to cut oil exports to six countries. It didn’t cause much distress in the oil markets, since these are six countries that were already planning to embargo Iran in the summer. So Iran’s “you can’t fire me because I quit” routine should have scant effect. That said, Brent Crude was already at highs not seen since last summer, and NYMEX Crude was near the top of its recent range as well. I don’t expect any spike (although the ideal time for an Iranian provocation would be in the midst of a Greek default-related turmoil in global markets, wouldn’t it?), but it’s another risk that is turning acute at the moment.
None of this stuff is deterministic. They are all warning signs, and they might be completely ignored tomorrow, outweighed if there is a strong report from Initial Claims (Consensus: 365k), Housing Starts (Consensus: 675k), the Philly Fed Index (Consensus: 9.0), or all three. But the possibility of a very bad payoff, and a worsening edge/odds calculus, implies that investors should be scaling back long-stocks bets. (I wrote something similar back on March 1, 2011 in a piece called “The Market’s Pot Odds,” which references in turn one of my all-time favorite article from back in 2010, “Tales of Tails,” talking about the implication of the Kelly criterion for investing. I submit these may be worth reading if you are interested in the edge/odds reference I just made.)
Implied volatilities, as represented by the VIX, have recently begun rising again, but protection is still relatively cheap considering the risks. If you feel this is a passing thundercloud, it still might make sense to buy an umbrella just in case.
So the EU laid down the law last week: Greece had to prove that it was serious about austerity measures. It had to get all political parties who might win in elections this year to agree to maintain the austerity measures, and they did. It had to pass a bill detailing the austerity measures through parliament, and it did. The government and the major political parties went further, and sacked anyone who voted against the measure – displaying a fairly hair-raising resolve to ditch democracy if that was necessary to make a buck. And it had to find a few more hundred million in austerity measures, which it was working on.
Then a group of Euro finance ministers was to meet on Wednesday, sign off on the deal, and move the process forward so that the March bond payment would be covered (assuming a few other things, like the IIF agreement, moved forward as well).
Well, that meeting has been canceled. It is being replaced with a conference call. Jean-Claude Juncker said that they had not received “assurances” from Greek leaders about the cuts. You may read between the lines here with some ease: it is hard to imagine how greater assurances could have been given than sacking all of the dissenters and passing a law despite protestors outside threatening to burn the ancient city down.
The Euro ministers may have been surprised by the report that Greece’s economy contracted by 7% (annualized) in the latest quarter, but although that was larger-than-expected it wasn’t so different that it should completely change the EU’s perspective. To me, Juncker’s downgrading of the meeting looks like a fairly clear indication that the EU is not at all united about whether Greece should be saved, allowed to default while remaining in the EZ, or kicked summarily out of the EZ (or even the EU). It sounds like an excuse. It is hard to see how Greece could have done more than they did this weekend. I don’t believe Greece can be prevented from defaulting, and I have said that now for a very long time. I think that enough in the EU have come to the same conclusion that the default is going to happen, probably in March – and the way the EU has gone about it, frankly, is going to cause bad blood in Athens for a generation.
Meanwhile, in Japan the Bank of Japan overnight added ¥10 trillion (about $130bln) to their version of QE, and declared that it now has an inflation target of 1%. The BoJ didn’t state over what period inflation is to return to 1%. I will say that it’s about time – the country that has had the most need of QE, the most reason to weaken its currency, has for the last couple of decades refused to apply meaningful monetary stimulus to its deflation problem. I’m fond of saying that the BoJ correctly diagnosed the disease (deflation) and correctly prescribed the treatment (more money) but completely blew the dosage. “The body economic has cancer: radiation is prescribed. Here is a prescription for one hour in a tanning bed.” With this action, they are finally starting to increase the dosage.
I showed a couple weeks ago that core inflation in Japan, just as in Europe, the UK, and the US, has been rising (in Japan’s case, rather fitfully) for several years. But that is mainly from global factors – the rising money tide raises all prices, no matter its source. The quickest way for Japan to increase its own inflation is for it to intentionally weaken its currency. That they’ve never done this is hard to understand, and must be tied to a sense of national honor and pride in the currency. A weaker Yen would help growth and raise inflation. It boggles why a more-aggressive monetary policy hasn’t been pursued before now.
If Japan is serious, then currency-hedged Nikkei is going to finally be an interesting investment. Since 1989, the only way you wouldn’t get smoked being long the Nikkei was because you were usually buying Japanese stocks with cheaper yen than when you went to sell. While the Nikkei in Yen terms has lost about 77% over the last quarter-century, in dollar terms it has only lost about 57%, thanks to the ever-appreciating currency. If the BoJ is really going to print, and has the guts to outprint the U.S., then the Nikkei may appreciate while the currency actually weakens.
The economic news in the U.S. continues to be okay, but not great. Today’s Retail Sales report was better-than-expected as core Retail Sales was +0.7% versus expectations for +0.5%, but December’s numbers were revised lower and essentially offset the weakness. These are not depression numbers, but they aren’t also robust expansion numbers. We continue to stumble forward economically…but at least we’re stumbling forward.
On Wednesday, the pace picks up a little further. In addition to finding out what comes out of the conference call of the EU ministers, the February Empire Manufacturing report (Consensus: 15.00 from 13.48), January Industrial Production (Consensus: +0.7%) and Capacity Utilization (Consensus: 78.6% vs 78.1%), and the minutes of the latest FOMC meeting will be released. This last will be carefully scrutinized for details about how to interpret the new communications from the Fed, but I actually don’t expect we will learn much new: the FOMC went out of its way to tell us exactly what they wanted us to understand from the new approach.
Once again, dawn broke on Thursday with great excitement. A Greek deal was at hand! Stocks were higher, although not very much higher, and commodities were bid as well as disaster was at last averted.
Now, this next part probably won’t surprise you as much this time as it did the first two dozen times: the deal was something less-than-advertised.
Yes, there was a Greek deal. But the deal in question was a deal among the leaders of the various parties in Greece about how to promise austerity. That deal must then be discussed with and approved by the Troika (ECB, EU, IMF). Oh, and this has nothing to do with the private sector initiative (PSI) discussions, which are still not done. So this great deal that we waited breathlessly for was pretty much the first stages of an agreement that would be meaningful even if doomed to failure.
You probably also won’t be so surprised when I tell you that the deal the Greeks agreed to among themselves did not pass muster with the rest of Europe, who are the ones who are supposed to put up the money for Greece. “In short: no disbursement without implementation,” said Jean-Claude Juncker, in summary of the EU policymakers’ meetings. According to the Bloomberg story, “he set another extraordinary meeting for Feb 15.” I wonder how many extraordinary meetings you can have, before they become ordinary? Apparently the Greeks left a little wiggle room, in that their parliament needs to vote on this new deal in a vote that the finance minister says is tantamount to a vote on membership in the EZ. This is all supposed to be done by February 15th. Don’t these guys have any respect for Valentine’s Day?
Love is definitely not what is in the air at the ECB. The central bank held policy steady today, but ECB President Mario Draghi said as his press conference that he no longer sees substantial downside economic risks. (And yet, like the Fed, inflation should stay above 2% for “several months” and then decline, I guess because that would be convenient to him.) Whatever is in the air at the ECB, they should pass it around.
Let’s try and work through the logic here:
- There is no substantial downside economic risk.
- For Greece to default or to leave the Euro would mean the end of life as we know it.
therefore There is no substantial risk that Greece is going to either default or leave the Euro.
I think I have the syllogism (oh, that word comes from Greek) right, although it’s probably not important that I do so since neither 1 nor 2 is correct.
From logic to mathematics we travel: Draghi did say generously that the ECB is willing to give up its “profits” on Greek bonds in order to help the solution, as long as they don’t sell at a loss since that would involve monetary financing of governments. In what la-la land are these guys living that buying bonds at $50 and selling them at $25 produces a profit? It would make my job a lot easier if I could use Draghian math. Unless the ECB bought bonds at $50 and then marked them at par, or carried them at cost rather than marketing them at all and is counting as “profit” the coupon income, this is nonsensical. So I conclude that the ECB is in fact doing one of those two things, either of which would get them jailed as a private investor.
Maybe I am too cynical (also a word that comes from Greek and means literally “doglike, currish”), but if this is how they steer ships in Italy then…oh, too soon?
Meanwhile in other central bank follies, the Bank of England tossed another £50bln log on the fire, bringing the QE total to £325bln. You know, core inflation in England is only at 3%ish, so it’s important to guard against incipient deflation!
In the U.S., Initial Claims was again a little lower-than-expected at 358k. We can probably at this point reject the null hypothesis that the underlying rate of claims is still around 400k, where it was until the second week of December; until now, the error bars around the estimate prevented such a conclusion at least in a statistical sense. Is the level now 375k or are Claims still improving? It’s too early to say. I expect that it is still improving, but I also expect it’s not going to continue that way.
Bigger news was that the Justice Department reached a settlement with Wells Fargo, Citigroup, Bank of America, Ally, and JP Morgan over the ‘robo signing’ flap. Those firms are on the hook for $26bln between them. JPM fell -1.2%, Citigroup dropped -1.7%, Wells was -0.2%, and Bank of America, which took the biggest hit, of course rose 0.6%. I do not understand the fascination of buying financial dinosaurs now that there are big dinosaur hunters around, but investors are delighted to jump into BofA at an 0.5% dividend yield. I’ve been saying it since 2008, and it hasn’t changed yet: the business of large trading banks has fundamentally changed, I think forever. Return on Equity is going to be much lower in the future in the past because (a) volumes of all products are lower, (b) balance sheet leverage is lower, and (c) margins have not widened, and if anything are under further pressure as most products move to exchanges. Banks sell the product with the most elastic demand curve in the world: money. If your bid for the five year note is 100-04+ and the market is 100-05/5+, you will print essentially zero business. (This is why banks love highly-structured product for which a price is not readily available many times.) You cannot count on margins going up, ever. And those three parts, (a), (b), and (c), are the three parts of RoE. Bank stocks may be great trading vehicles, and some banks may gain at the expense of other banks, but as a whole the industry is dead money, in my opinion.
The Treasury today announced that they will auction 30-year TIPS next week. The auction size was only $9bln, compared to expectations generally of $10bln, but the roll still opened quite wide (implying that you get more yield to roll forward to the new issue than you ‘should.’ The Street is either quite concerned about trying to auction 30-year inflation-linked bonds at a real yield of 0.75%, and they probably should be, or dealer risk budgets have been so desiccated that the limited number of bona fide TIPS dealers aren’t sure they can underwrite the issue at something close to the current price. In any event, after the announcement the long end of the TIPS curve was crushed, before bouncing and ending only 4bps higher in yield on the day. The nominal 10-year note sold off 5bps to 2.04%, and 10-year breakevens were down 2bps.
Commodity indices gained 0.5% despite a very soft performance from grains and softs. The energy group rose 1.2%, industrial metals put on 1.5% (now up 10% over the last month), and precious metals rose 0.6% (+8.2% over month ago).
The only data of note on Friday is the University of Michigan confidence number for February (Consensus: 74.8 vs 75.0). I predict that we will head into the weekend expecting a deal to come out of Europe over the weekend, as we will be told it is “imminent.” Why not try that old chestnut again?