Felix Salmon

Chart of the day, Swiss franc edition

Felix Salmon
Aug 22, 2011 05:07 UTC


This chart comes from Eric Burroughs, who calls it “one of the best gauges for showing the extreme nervousness over what the endgame really is in Europe”. But I’m assuming here that you’re not the kind of person who looks at FX volatility surfaces on an everyday basis, so it might be worth a little bit of explanation.

The chart is showing how expensive it is to buy options on the EUR/CHF exchange rate — that is, the number of Swiss francs per euro. When the Swiss franc strengthens, as it has been doing of late, the exchange rate goes down. The current exchange rate can be seen in the middle the “Delta” axis, where it says “ATM” — that stands for “at the money”. So everything to the left of that line — the PUT contracts — shows the price of a bet that the Swiss franc is going to strengthen. And everything to the right of the line — the CALL contracts — shows the price of a bet that the Swiss franc is going to weaken.

Now the Swiss franc has appreciated a lot against the euro of late — you could get more than 1.5 Swiss francs to the euro this time two years ago, while a couple of weeks ago the exchange rate dropped to as low as 1.03, and it’s still at 1.12 right now. To put it another way, a 100 Swiss franc meal in Zurich would have cost you €65 two years ago, €76 one year ago, and €89 today. At this point, the Swiss franc is so strong that the Swiss National Bank is doing everything in its power to try to weaken it. So the time to bet on a strengthening Swiss franc was clearly in the past.

But just look at the chart — it’s much higher on the left-hand side, the PUT side, than it is on the right-hand side. That’s known as “skew”, and it means that the market is decidedly bearish on EUR/CHF. If you want to bet that the exchange rate is going to go back up, that will cost you quite a lot of money. But if you want to bet that the exchange rate is going to continue to decline, that’s going to cost you an absolute fortune.

And in fact the market seems to think that even if the Swiss National Bank manages to weaken the Swiss franc in the short term, over the long term its efforts won’t count for much. The lowest parts of the chart — the cheapest bets of all — are the ones saying that the Swiss franc is going to weaken over the long term of 18 months to 2 years. Meanwhile, the highest parts of the chart — the most expensive bets you can make — are the ones saying that the Swiss franc is going to strengthen a lot over the long term of 18 months to 2 years.

Some of this activity is hedging, of course, rather than speculation. Let’s say you’re one of those corporate chieftains attending Davos in January as a Strategic Partner. That’ll cost you 590,000 Swiss francs. In 2011, that was €457,000. But as of right now your Davos membership fee has already risen to €523,000; you might well want to lock it in right there before it goes any higher. (If you’re unfortunate enough to be paying in dollars, it’s even worse.)

But the main message of the chart is that people are almost irrationally worried right now. The Swiss franc is a classic flight-to-safety play, a bit like gold or Treasury bills. That’s why it has appreciated so much of late. But the markets are saying that its recent appreciation might only be the beginning, and that the Swiss franc might well end up being worth more than the euro pretty soon. Here’s how Burroughs puts it:

When the skew starts to normalize, then the market may be convinced that Europe is getting a handle on this crisis. We are far from that point.

I’ll trust Eric to keep an eye on this chart — I wouldn’t know where to start even trying to build such a thing. But it seems clear to me that he’s right: we’re going to wait a long time before this chart stops sloping down and to the right. Which is another way of saying that we’re going to continue to have a crisis in Europe for the foreseeable future.


Interesting to note that while the Swiss Franc is high against the Euro, the Euro is still at the upper levels of historical values against the US Dollar. You need $1.44 to buy €1.00 today, but back in the days of the post launch “market test” of the Euro’s strength IIRC one Euro could only buy $0.87.

In global terms, aren’t they the only ones that really matter since they are the two world currencies fighting it out to be the World’s main Reserve Currency?

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Felix Salmon smackdown watch, earnings-yield edition

Felix Salmon
Aug 14, 2011 13:47 UTC

The economic historian James Macdonald emails with a very different version of my earnings-yield chart. Instead of going back to 1985, he’s found annual data all the way back to 1920. And instead of using Treasury bonds — a sui generis asset class with its own dynamics surrounding flight to quality and the like — he’s uses the yield on BAA-rated bonds instead. The result is fascinating:


Writes Macdonald:

It is not reasonable to relate earnings yields to T-bonds. They are not comparable investments. The proper comparison is with the corporate bond yields. My preference is not even AAA, since that is quite rarefied, but rather BAA – definitely investment grade but more reflective of the typical corporation and more susceptible to market jitters.

The historical pattern seems to me to be as follows:

  • a twenty-year period from 1920-1940 when bond and earnings yields were more or less comparable
  • a twenty-year period from 1940 to 1960 when earnings yields were significantly higher than bond yields
  • a twenty year period from 1960 to 1980 when the two yields were more or less comparable
  • a twenty-five year period (?) from 1980 to 2005 when earnings yields were significantly lower than bond yields. (I put a question mark, because there is also a major divergence of yields in 2009. However, I take that as a temporary aberration because of the collapse of S&P earnings during the Great Recession thanks to the losses of the financial sector).

Now the two yields are more or less the same. Are we supposed to take that as a signal to sell bonds and buy shares?

I am not at all convinced, at least on the basis of the historical evidence. We may be entering a long period when the two yields track each other. Or we may be entering a period (perhaps to be expected after a major financial disaster) when investors demand a premium yield from shares compared to bonds. In any case, the period from 1985 onwards can scarcely be taken as the historical norm, since, as we know from other statistics, such as long-term PE ratios, shares have been overvalued for almost the whole of this period.

My feeling is that a long-term period when investors demand a premium yield from shares compared to bonds is precisely the kind of period that a long-term investor wants to be putting her money into shares rather than bonds. Again, there are market timing issues here — shares might fall rather than rise for much of that period, especially during times when the premium is rising rather than falling. But if you just go back to basics and look at securities as giving you ownership of an income stream, then it seems perfectly sensible to me to pick the larger stream, given the choice.

If there’s a big risk to this strategy, it seems to me, the risk is overleveraged companies. If companies get in over their head and find themselves unable to make their interest payments, then their equity can be wiped out, and ownership transferred to bondholders. But in this particular economy, I don’t see that as a big risk — certainly not for BAA-rated companies. We saw during the financial crisis that nearly all non-financial public companies had been decidedly conservative with respect to the big debt binge known as the Great Moderation; if you were looking for massive corporate leverage, you needed to look to private equity deals.

And what if we’re just entering another period akin to the 60s and 70s, where the two yields track each other while rising? Again, I think I’d rather be in stocks, if only because they’ll do much better than bonds if and when inflation kicks in.

Finally, there’s the possibility I raised in my original chart — that stock prices are uncommonly cheap relatively to bond prices right now. Which certainly seems to be the case if you think that history began in 1985. If stocks revert to the post-1985 norm of yielding less than bonds, then moving from bonds to stocks at these levels would probably make a fair amount of sense on a mark-to-market basis. As a long-term investment, though, stocks might look a bit less attractive: you’d be less reliant on earnings and more reliant on capital gains to make up the difference.

What really surprises me about Macdonald’s chart, however, is nothing to do with the difference between stock yields and corporate bond yields, but rather the way in which nominal corporate bond yields move very slowly and smoothly. There does seem to be something reassuringly safe and reliable in that orange line. So if your priority is preservation of nominal capital, rather than maximizing your long-term net wealth, there’s something pretty attractive about corporate bonds, too.

Update: I missed this on Friday, but Jake from EconomPic Data has his own version of the chart, using T-bonds but going back even further than Macdonald does. I love this:


What happened in 1970 or thereabouts that this correlation suddenly became so strong, after barely existing before that? Could it possibly be the arrival of Modern Monetary Theory and Modigliani-Miller?


Just came across this – a great post – many thanks for providing this information :-)

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Chart of the day: The great earnings-yield divergence

Felix Salmon
Aug 12, 2011 22:49 UTC


After I wrote my post on Monday about the huge divergence in yields between stocks and bonds, I wondered just how historically unprecedented this divergence was. And now, with the help of this fabulous chart (many thanks to Nick Rizzo, Dan Burns, and Stephen Culp), it’s pretty easy to see: we’re at levels which match those at the height of the financial crisis, and which are otherwise historically utterly unprecedented.

Indeed, from 1985 through about 2002, it was just as common for the S&P earnings yield to be lower than the Treasury yield as it was for the yields to be the other way around. The two tracked each other, and the spread between them almost never moved beyond 2 percentage points either way.

In 2002, everything changed. The spread between the two jumped up to a very high level and stayed there, all the way through the onset of the financial crisis. This was the Great Moderation.

And when the Great Moderation imploded, the spread only widened further. Today, it’s about 7 percentage points. At these levels, it’s almost impossible to see how stocks could possibly be a worse long-term investment than bonds. Yes, earnings can fall. But even if they fall in half, stocks will still yield double what bonds do.

I have to admit that I really don’t understand what’s going on in this chart at all. While any given spike can always be attributed to a fearful flight to quality, that doesn’t explain the decade-long trend.

There does seem to be a feeling in the markets that current earnings levels are somehow illusory — a feeling which long predates fears of a double-dip recession. I’m not so sure about that: while earnings are surely cyclical, in the grand scheme of things corporations seem to be doing much better when it comes to earnings growth than individuals are, and I don’t see that trend reversing itself any time soon.

Even QE2 doesn’t seem to have helped on this front: while it boosted all asset classes, bonds seem to have been the primary recipients of the Fed’s flows, with stocks lagging behind.

So with the explicit proviso that I’m not going to try to explain this graph, I’ll tentatively put forward one hypothesis: that the dot-com bust of 2000-2002 had a much bigger effect on stock-market psychology than we might have thought. It made stock investors realize how fragile stocks really are, and concentrate on the risk that they could fall substantially in price. If you’re think that stocks are going to fall, then it almost doesn’t matter what their earnings yield is — you feel as though you should sell them at any price.

But frankly I don’t really believe it. There’s something more profound going on here; I just can’t put my finger on what it is.

Even without understanding what’s going on in this chart, though, it does seem to say quite clearly that now’s a good time to buy stocks, if only because the opportunity cost of not buying stocks is so enormous. Bonds and cash yield nothing: it’s really hard to see how they can be a better bet than stocks over the medium to long term. Which is not to say that stocks can’t fall, of course: they can. They can fall a lot. I’m not trying to time the market here. But the chart is striking, all the same.


Excuse me for being rude, but who cares. The relationship is irrational as the risks (deliberate plural usage here to denote varied interpretations of the work risk) basis of each is radically different. Maybe try to get closer by comparing the earnings yield to BBB (or take your pick) rated corporate bond yields. Has anybody ever heard of any investor questioning whether Apple or Fedex or BHP is better value than a 10 year t-bond based on the earnings yield?
Maybe the chart is telling you that!

Posted by MarkieMills | Report as abusive

Chart of the day, global equity market edition

Felix Salmon
Aug 11, 2011 10:42 UTC


I love this global equity snapshot from Bloomberg’s Michael McDonough. For one thing, it clearly shows how European bourses are in much worse shape than those in the U.S. First look at the green dots in the little 52-week sparklines: the American and European highs weren’t all that far away from each other, chronologically speaking. And then look at the red dots: every exchange in Europe is hitting new 52-week lows, usually quite dramatically. By contrast, the U.S. indices all have their red dots over to the left: we still haven’t even dropped back to where we were a year ago.

A similar tale is told in the percentage-change columns. News headlines, of course, concentrate on what’s happened on a daily basis, with U.S. stocks down more than 4% and European stocks trading up on the day. But take a step back and the bigger picture is rather different: the sea of red, marking stock markets down more than 20% from their 52-week highs, is almost entirely European. And the biggest loser of all, the Italian market, is down a whopping 35%. If the Dow fell that much from its 52-week high, it’d be at 8,331, with the S&P at 887.

The lessons here, then, are firstly that if you spend your time looking at intraday stock-market movements on a country-by-country basis, it’s easy to miss what’s really going on. I’m in the UK right now, where there are lots of headlines about the plunging stock market, but no indication that it’s up there with Canada as the best-performing stock market in the world.

And secondly, the Eurozone is in serious trouble. Instead of looking at the amount that the markets have fallen from their highs, try looking at the degree to which they’ve recovered from their lows. The Euro Stoxx 50 hit a low of 1,809 on March 9, 2009; it’s rallied 18% since then. By contrast, the S&P 500 is up 101% from its March 2009 low: even after Wednesday afternoon’s swoon, it’s still at more than twice the level it closed at on March 5 of that year.

Does this mean that U.S. stocks simply have that much further to fall, before they catch up with their European counterparts? I suppose that’s one way of looking at it. But more realistically, the worst-case scenario for the U.S. is a double-dip recession; the worst-case scenario for the Eurozone, by contrast, is downright existential. Even on an up day today, the French banks are still seeing their shares marked down ever further. The very solvency of the Eurozone banking system in general, and the French banking system in particular, seems to be in doubt. U.S. banks don’t have that kind of European sovereign exposure, so we have a significant advantage on that front.

It might seem a bit like schadenfreude to take solace in the fact that other countries are much worse off than we are. But as the current stock-market volatility continues, it’s worth keeping such things in perspective. Europe is a global economic powerhouse; it can’t suffer these kind of woes without infecting the rest of the world somehow. And the U.S., in the grand scheme of things, seems — still — remarkably insulated from what’s going on across the Atlantic.


Wow, 666? A 5% dividend from KO, 6% from PG or JNJ?

I’m salivating… I thought we were in a market environment that promised *LOW* returns, not record-breaking dividend yields!

This isn’t 2001, or even 2008. Most of the big companies have real profits, and most of those profits are generated outside the US.

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Chart of the day: America’s small tax revenues

Felix Salmon
Jul 31, 2011 19:31 UTC


This chart comes from Barrie McKenna’s great article on US tax rates, and pretty much speaks for itself. While the rest of the developed world has seen its tax rate rise as it got richer, the US stands out as the one country where tax rates have been going down. In the OECD, only Chile and Mexico have lower tax burdens, and neither of them have been decreasing: both have relied very much on state-owned commodity wealth to stand in for tax revenue.

As McKenna reports,

The total tax burden on Americans, as a percentage of gross domestic product, stood at 24 per cent in 2009 – lower than it was in 1965 and still falling. That compares to 31.1 per cent in Canada, 34.3 per cent in Britain, 42 per cent in France, 37 per cent in Germany and 43.5 per cent in Italy. The Japanese, Australians and South Koreans all pay significantly more.

The United States is the only major country without a national value-added tax and its sales taxes are lowest in the OECD. Likewise, U.S. fuel and sin taxes are at the bottom among rich countries. And generous tax breaks mean many businesses and individuals pay few taxes, placing a heavy burden on a relatively narrow tax base…

Bill Frenzel, a former Republican congressman and now a scholar at the Brookings Institution in Washington, agrees no budget fix is possible without tax hikes…

Americans, he said, will never accept the kind of tax levels that exist in most other countries.

“The U.S. has always been a low-tax country,” he explained. “And we like it that way.”

This raises two questions. The first is why America’s taxes are so much lower than anybody else’s. Its system of government, after all, is a pretty standard democracy, so it’s not exactly baked in to the Constitution. The second question is why Americans don’t actually appreciate how low taxes are here. It’s a standard talking point in US politics that taxes are too high, and must be lowered; Republicans are adamant that even modest tax hikes, to levels still well below the rest of the developed world, would be economically devastating.

Right now a deal seems to be getting done in Washington which reduces the deficit by means solely of spending cuts, with no tax hikes at all. That makes no sense: just as it’s right that people should pay a higher tax rate as they get richer, the same is true of countries as well. Instead, the US seems to think that it can work as an advanced democracy while maintaining a tax rate more commonly associated with tinpot basketcases. Up until now, it’s managed to do that by borrowing the difference. But if it wants to try to cut spending to a level commensurate with its tiny tax base, it’ll soon learn how economically disastrous that can be.

(Via Kedrosky)


In Singapore corporate taxes are 13% +-… in California between Fed and state a poor small business will pay ~ 43% above $100K…so we have compare with them if we want to create jobs and compete. Who cares if in Italy or Japan they pay more taxes… their economy is not growing.

We need growth strategies, no subsidies or QEs.

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Adventures with yield curves, debt-ceiling edition

Felix Salmon
Jul 30, 2011 10:03 UTC

Bill Dowd emails to ask about short-term Treasury yields, which finally seem to have noticed the debt ceiling debate in recent days:

When treasury yields are discussed in the media, everyone seems to default to talking about 10-year bonds. The yields on those remain well below 3%, and indeed have fallen a bit today. On the other hand, yields on 1-, 3-, and 6-month bonds have increased considerably today, with the yield on the 1 month bond exceeding 17bp (up nearly 50% today). It seems to me that there’s no concern among investors about America’s long-term debt, just about its ability to get its act together in the short term. Of the three maturities I noted above, 1-month bonds are the highest. It seems as though investors are pricing in the possibility that payments might be delayed.

I put together a little chart from this page, which isn’t a thing of beauty; for one thing, in order to show changes at the short end of the yield curve, I had to switch the y axis to a logarithmic scale.


What you’re seeing here is, indeed, a sharp rise at the very short (1-month) end of the yield curve. And all the way out to one year, yields on Friday are significantly higher than they have been for a long time.

Still, a couple of points are worth making. For one thing, a yield of 0.16% is still minuscule, and doesn’t imply any real credit or payment risk. The fact that the yield curve is now inverted between 1 month and 3 months is interesting, but it’s basically an indication that the markets are now paying attention. The dog has pricked up its ears; it has yet to actually do anything.

Secondly, and this isn’t very obvious on the chart, we’re seeing an even bigger drop in long rates than we are an increase in short rates. The yield on the one-month bill rose 6bp from 0.10% to 0.16% on Friday; the yield on the 10-year bond dropped by 16bp from 2.98% to 2.82%.

And thirdly, the yield curve is only inverted between one and three months. From 3 months on in, its still got a nice upward gradient to it. If there’s worry here at all it’s about possible payments problems over the next month; there’s no indication of concern about a debt downgrade coming in the next six months to a year.

The next big debt maturity comes at the end of August, and it makes sense that if you’re only getting 0.16% yield in any case, you might as well just hold cash instead of very short-dated bills. But even cash has to be on deposit somewhere, and that somewhere is a place with non-zero credit risk. (Unless you’re a bank, in which case you can hold cash on deposit at the Fed.)

I’m getting really rather worried about the debt ceiling. This is now the second consecutive last possible weekend to get something done, and it frankly looks as though the August 2 deadline is all but certain to be missed. Meanwhile, the White House is pouring cold water on the idea that we might get saved by the 14th Amendment.

People like Tom Davis are drawing parallels to the TARP vote, which is understandable, but also dangerous:

“He’s going to have to pass it with Democratic votes. That’s going to be a tough decision, but he doesn’t have any choice at that point, particularly if the markets are reacting,” said Tom Davis, a former House Republican leader from Virginia. “That’s the position they’ve got themselves in.”

But, he added: “The stakes are much higher here. If interest rates start spiking up, it’s going to cost us a lot more than anything you could save. They’re playing brinkmanship with our credit rating. That’s not very smart.”

Mr. Davis recalled his vote in late September 2008 for the $700 billion Troubled Asset Relief Program that President George W. Bush sought to rescue a financial system near collapse. “I hated TARP, but no one had a better alternative,” he said.

But most of his Republican colleagues opposed the rescue measure and helped defeat it, sending the stock markets tumbling even as the vote was taking place. That reaction forced the Republicans to retreat, and days later a bailout bill carried on a second try.

The problem here is that this is much more serious than the TARP vote. With TARP, a no vote sent the stock market down, and then a yes vote largely rectified the damage done. The debt ceiling doesn’t work that way — a failure to get it raised will have enormous long-term consequences, much more serious than a twitch in the stock market, which couldn’t be rectified by a subsequent change of mind by Congress. Even in the worst-case scenario, the debt ceiling is going to get raised somehow, sooner or later.

And this I think is what we’re really seeing in the yield curve. Never mind twitches at the very short end — look at the speed with which long-term rates are going down. That’s a sign of pessimism about long-term U.S. growth — an indication that Congressional failure to raise the debt ceiling will hobble the economy for the next decade. Thanks, guys.

Update: In the comments, GRRR puts Treasury’s yield information together in another way, by having two different y-axes. I like this:



You need to mention prices and not yields. Someone could reasonably think that going from 0.08% to 0.16% is a doubling of yield! However, the price difference on $1000 nominal 1-month bond from 0.08% to 0.16% is 7 CENTS. Think about if you have $1000 in your pocket, of various denomination bills and coins. Do you notice $0.07 lost? There may be some arbitrage/interest rate hedge trade that could yield some profit using massive leverage, but I dont’ see any practical importance in 1-month yields moving from .08% to .16%.

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The microeconomics of restaurant letter grades

Felix Salmon
Jul 28, 2011 14:27 UTC


Many congratulations to the WSJ for putting this chart together; it says much more than the thousand-word accompanying article does. New York City restaurants are periodically graded by inspectors, and then given a grade based on how many violation points they have. And the chart demonstrates, more than any set of anecdotes ever could, that inspectors are trying very hard to give the restaurants the highest letter grade they can.

Now that’s not what the restaurants think, of course. And indeed the fiscal incentives run the other way: restaurants which get B or C grades get fined, and “the amount collected in fines has skyrocketed,” the WSJ reports, “to $42.4 million in the fiscal year that ended last month, from $32.7 million in the previous fiscal year.” (Does a 30% increase really count as “skyrocketed”? I’m not sure about that.)

One theory in the story doesn’t ring true to me at all: Columbia University statistician Roger Vaughan speculates “that restaurant owners learn, after the inspection, about the criteria they are graded on and what the thresholds of the grading system are, and do enough improvements so that at the next inspection they are able to move their scores below 14 violation points or below 28.” But restaurant inspections are much less predictable than that — it’s simply not possible to fine-tune the cleanliness of your kitchen to within a point or two.

Another Vaughan theory doesn’t compel me much either — that restaurant inspectors just don’t want the extra work involved in re-grading restaurants, something which happens to everybody getting a B or a C. The inspectors are salaried, and inspect a fixed number of restaurants: the grades they give out don’t affect that.

Which leaves the hypothesis that “pressure from restaurant groups” is driving the inspectors to give higher grades where it matters. That wouldn’t be the first time, of course, that a regulator was captured by the industry it was meant to be regulating. But of course neither restaurants nor inspectors would ever admit to such a thing, so it’s hard to nail down — until you generate a chart like the one above.

My feeling is that there could be a couple of other factors in play. Firstly, NYC restaurant inspections are harsh, and the inspectors know it. And I remember from my schooldays that the toughest and strictest teachers — the ones we were all most afraid of — were often the ones who ended up giving out the highest grades at the end of the year; something similar might be going on here.

And on top of that is the fact that a simple add-up-the-points heuristic is not always going to be the best way of judging the final grade a restaurant should get. The chart says to me that a restaurant inspection is a somewhat iterative process: you add up the points, you see where the letter grade is, you then compare that letter grade to the letter grade you feel that the restaurant as a whole deserves, and if there’s a difference, you shave off some points here or there. And the inspectors nearly always err on the side of generosity: they’ll shave off points to get you an A or a B, but they won’t be extra-tough to get you a B or a C.

This is no great scandal. Restaurants lose business if they don’t have an A rating, and getting a B or a C costs real money in fines, as well. Given what the public will think when they see a B or a C rating, it’s good that the restaurant inspector takes a minute to ask if that rating is really deserved.

Bad ratings are serious punishment, which shouldn’t just be handed out by an unfeeling computer. Judging, perforce, involves the exercise of judgment. What this chart really shows is that restaurant inspectors are human. Which is something I’m frankly quite grateful for.


If you want to see inspection results on your iPhone/iPad/iTouch, check out Grade Pending in the App Store. Free, and works even when you don’t have Internet access (in the subway, for example). http://tinyurl.com/gpend

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The curious Greek bond price chart

Felix Salmon
Jul 26, 2011 15:29 UTC


Many thanks to Van Tsui and Scott Barber for putting this chart together for me. We’re all used to seeing yield curves — charts which show the yield, for any given credit, at various points along the maturity spectrum. This chart is different: it’s a price curve. It just shows the price at which Greek bonds are trading, plotted according to their maturity.

And it’s really odd.

To understand just how odd this chart is, it’s important to realize that in the Greek bond exchange, there’s only one menu of options for anybody holding a Greek bond. It doesn’t matter if your bond is maturing in six months or if it’s maturing in 26 years, the instruments you’re given the choice of swapping into are all exactly the same.

The way that the bond exchange has been structured, the new Greek bonds are all going to trade at roughly the same price, at least in the first instance. If they didn’t, then everybody would simply pile into the most valuable instrument. We won’t know exactly what price they’ll be trading at until they start changing hands, of course, but I’ve marked a range between 62 and 75 cents on the dollar in the chart. At 62 cents on the dollar the bonds would be trading at an exit yield of 13%; at 75 cents on the dollar they would be trading at an exit yield of 9%. Chances are, when the bonds start trading, they’ll be somewhere in that range.

For the bonds which are trading at or near that range, the exchange makes sense. You swap one bond for another bond worth pretty much the same amount, and Greece gets a bailout at the same time. Net-net, you’re better off.

But for bonds trading significantly above 75 cents on the dollar, there’s a lot of reason to stay out of the exchange. We’re talking the bonds maturing in the next year or two here — for them, you’d be much better off holding them to maturity, or even just selling them on the secondary market.

Odder still are the bonds trading at very low prices, below 40 cents on the dollar, or, in some cases, below even 10 cents on the dollar. What on earth are they doing down there?

All of those bonds can be tendered into the exchange for new bonds which are likely to be worth at least 60 cents on the dollar: it’s free money. Just buy a long-dated low-coupon Greek bond, tender it into the exchange, sell your new bond, and double your money. Why hasn’t that price difference been arbitraged away? And, more generally, why aren’t the blue dots all arrayed in a nice straight line at roughly the level the market expects the new bonds to trade at?

I suspect that what’s going on here is that we’re seeing artifacts of an extremely illiquid market. Over the past year or so, as the Greek fiscal crisis got steadily worse, mark-to-market bond investors sold their bonds to banks, who were willing to pay a premium for them, partly because they were eligible to be used as collateral at the ECB. And the banks are holding on to their Greek bonds now, promising to tender them into the exchange. As a result, there’s no real liquid market in Greek bonds any more, and the prices seen in this chart aren’t available to any old bond investor looking for a quick flip.

Embedded in that mechanism is an implied quid pro quo. The banks will make a lot of money, at least on a mark-to-market basis, by tendering their long-dated Greek debt. In return for that profit, they will tender their short-dated Greek debt as well, even though doing so doesn’t make a lot of rational sense.

This helps explain why the official description of the bond exchange splits the par bond into two seemingly identical parts: a “Par Bond Exchange” where bondholders get a new 30-year bond with a step-up coupon rising from 4% to 5%; and a “Par Bond offered at par value as a Committed Financing Facility,” where bondholders roll maturing bonds into exactly the same thing.

Why make a distinction between the Par Bond Exchange and the Par Bond offered at par value, when both involve swapping your old bonds for the same new 30-year bond? Because the second one, the Committed Financing Facility, can be spun by the banks as them putting new money into the deal. And in a certain sense they are: they’re voluntarily giving up the extra money they could get by holding or selling their short-dated Greek debt.

All of this is in one sense much more complicated than it needs to be. Why construct a hidden and implicit quid pro quo, when you could do a normal bond exchange instead, and swap existing debt into new debt of similar or slightly higher value? Greek bonds, as the chart clearly shows, are worth anywhere from 10 cents on the dollar to 110 cents on the dollar: why should they all be swapped into the same thing?

On the other hand, this is at heart an old-fashioned London Club debt restructuring, as opposed to an Argentina- or Ecuador-style bond exchange. Bondholders look at their holdings on an instrument-by-instrument basis, while bankers are more prone to thinking about their exposure to any given credit as one big risk to be restructured.

So this exchange might well work, insofar as Greece’s debt is overwhelmingly held by banks. But don’t think of it as a template for future restructurings.


“Embedded in that mechanism is an implied quid pro quo. The banks will make a lot of money, at least on a mark-to-market basis, by tendering their long-dated Greek debt. ”
Except most of these bonds aren’t marked to market by the banks. In many countries, even where they are held as available for sale, they don’t take any capital hit/gain from MTM. So they’re going to take a hit from realising the par loss.

Posted by GingerYellow | Report as abusive

Chart of the day: Techs vs industrials

Felix Salmon
Jul 22, 2011 15:18 UTC


Thanks to Larry Summers for suggesting that I take a look at this chart. It wasn’t particularly easy to find, but it’s quite striking all the same. (And thanks very much to Roy Strom and Van Tsui, here at Thomson Reuters for putting it together.)

What we’re looking at here is a ratio of ratios: it’s the price/earnings ratio of the companies in the MSCI USA IT index, which covers technology companies, divided by the price/earnings ratio of the companies in the MSCI USA Industrials index. (For earnings, we’re using 12-month forward earnings — but we’re not really looking at the p/e ratios themselves here, just the ratio between the two ratios.)

Summers is absolutely right: this ratio is currently at an all-time low. The TR data goes back to 1994, so this chart encompasses 17 years, but I suspect you’d need to go back a lot further to find the last time this ratio was trading this low.

Importantly, the ratio is trading at less than 1: the market is saying that earnings at technology companies, which historically exhibit high growth, are worth less than earnings at established industrial companies.

Now this might be an artifact of the specific indices I’m using here: according to another chart sent to me by John Coogan, the ratio is still at an all-time low, but is above 1. Still, the fact is that the market clearly isn’t giving technology earnings the premium they’ve historically commanded.

Why might that be? Frankly I don’t really know. Maybe it’s a function of industrial earnings rebounding less quickly than earnings in the tech sector more generally. Maybe it’s largely an Apple thing. But there’s definitely an indication here that either industrial earnings are too expensive, or technology earnings are too cheap right now. Or both.


I believe the gap can at least be partly explained by the fact that execs in the tech sector spend so much time going to hipster conferences (SXSW!) and otherwise acting like cliquey high-school kids, while their counterparts in the industrial sector are at the office making sure their companies are actually selling stuff at a profit. And no, I’m not kidding.

Posted by ErikD | Report as abusive