Election fever hits the markets
We’re not talking about the U.S. presidential vote, though that does cast another layer of uncertainty over the outlook. Rather, investors are focused on even shorter-horizon events, as evidenced by this jam-packed electoral worry list from Marc Chandler, currency strategist at Brown Brothers Harriman:
This weekend’s first round of the French presidential election kicks of the quarter that will include:
* Greek national elections, where polls warn that the current coalition government may not be returned, increasing the uncertainty.
* Italian municipal elections which will be, at least in part, a referendum on Monti, who has seen his support wane since the labor reform was unveiled.
* Two German state elections, which may see the FDP further marginalized, making a grand coalition next year more likely.
* Irish referendum on the fiscal compact. Due to qualified majority procedures, an Irish rejection would not prevent the adoption of the fiscal compact, but would jeopardize Irish access to the ESM, should it be needed.
* After the second round of the French presidential election in early May, there is the parliamentary election in June.
The going gets tougher for Italy and Spain
One trillion euros is a lot of money. And as we have previously noted on this blog it did a lot for stock markets early this year but not much for the real economy.
But recent bond auctions in the euro zone suggest the impact of two rounds of cheap 3-year ECB funding on the region’s struggling bond market may also be fading.
Italian three-year borrowing costs surged more than a full percentage point at an auction to 3.89 percent – its highest since mid-January.
Nick Stamenkovic, strategist at RIA Capital Markets says:
Clearly it shows investor appetite for Italian bonds even at the short end has diminished recently as the effects of the two LTROs (long-term refinancing operations) from the ECB dissipate.
That was not the only patchy bond sale recently. Italy’s one-year borrowing costs doubled at a sale of short-term bills on Wednesday and, just last week, Spain had to pay dearer to borrow through medium-term bonds.
The new jitters in the market have partly been fueled by Spain’s fiscal conundrum: austerity aimed at reducing its budget deficit risks choking off the very growth that is needed to repair the country’s fiscal position.
When the euro shorts take off
Currency speculators boosted bets against the euro to a record high in the latest week of data (to end December 27) and built up the biggest long dollar position since mid-2010, according to the Commodity Futures Trading Commission. Here — courtesy of Reuters’ graphics whiz Scott Barber, is what happens to the euro when shorts build up:
The question is how many more weeks to go before a serious correction in equities?
from Global Investing:
Phew! Emerging from euro fog
Holding your breath for instant and comprehensive European Union policies solutions has never been terribly wise. And, as the past three months of summit-ology around the euro sovereign debt crisis attests, you'd be just a little blue in the face waiting for the 'big bazooka'. And, no doubt, there will still be elements of this latest plan knocking around a year or more from now. Yet, the history of euro decision making also shows that Europe tends to deliver some sort of solution eventually and it typically has the firepower if not the automatic will to prevent systemic collapse. And here's where most global investors stand following the "framework" euro stabilisation agreement reached late on Wednesday. It had the basic ingredients, even if the precise recipe still needs to be nailed down. The headline, box-ticking numbers -- a 50% Greek debt writedown, agreement to leverage the euro rescue fund to more than a trillion euros and provisions for bank recapitalisation of more than 100 billion euros -- were broadly what was called for, if not the "shock and awe" some demanded. Financial markets, who had fretted about the "tail risk" of a dysfunctional euro zone meltdown by yearend, have breathed a sigh of relief and equity and risk markets rose on Thursday. European bank stocks gained almost 6%, world equity indices and euro climbed to their highest in almost two months in an audible "Phew!".
Credit Suisse economists gave a qualified but positive spin to the deal in a note to clients this morning:
It would be clearly premature to declare the euro crisis as fully resolved. Nevertheless, it is our impression that EU leaders have made significant progress on all fronts. This suggests that the rebound in risk assets that has been underway in recent days may well continue for some time.
So what exactly have investors and been doing while waiting for the fog to clear in Brussels? The truth on most benchmark prices and indices is "not very much" -- at least not since world markets got the collywobbles in early August about US downgrades and debt ceilings, euro sovereign debt angst and double dip recession. Yet, since the European stocks nadir in late September prodded the Franco-German alliance into more serious action, there has been some impressive market gains of between 10 and 20% across most equity sectors and national indices. More broadly, after a year of intense political and financial turmoil across the globe, developed market equities are only down about 4% year-to-date -- a 10 point outperformance on emerging markets, for example.
And the clearing of the euro fog now allows investors to start looking beyond the Brussels cauldron and review how the rest of the world is shaping up. What they find, surprisingly for those drowning in disaster commentaries, is‘not all that bad – especially, but not exclusively in the United States. There's been a string of more positive economic data releases throughout October and these have continued through the back end of last week and early this week. The bellwether Philadelphia Fed industrial index rose to its highest in six months; U.S. durable goods orders (excluding volatile aircraft orders) rose at their fastest pace in six months in September; U.S. new home sales rose at their fastest in five months; business surveys show Chinese manufacturing is back expanding again in October for the first time in three months; U.S. power firms are reporting a pickup in industrial activity in H2, Ford has increased fourth quarter forecast for North American vehicle production. The U.S. Q3 earnings season hasn’t been half bad either – with a third of the S&P500 reported, some 70 percent beat forecasts and the main strength was in the industrial world. What’s more for markets, seasonal equity flows are typically in an updraft for the rest of the year, all things being equal. Fund managers already started rebuilding equity positions in September.
European business and consumer sentiment surveys have continued to push lower through the policy logjam, unsurprisingly, even if real data contradicts some of that anecdotal ‘evidence’. And this may well translate into the wider investment theme as the euro crisis ebbs. Europe may agree to adapt grudgingly to solve its immediate problem but tyhen pay the price in economic growth because it’s less worse than the alternative of financial chaos.
On the more immediate horizon, there may be groans from those hoping to escape summit mania as G20 leaders are set to meet in Cannes next Thursday and Friday -- with a hoped-for endorsement of the euro plan and a specific interest in the EFSF/IMF/SPV idea that seems to be courting sovereign wealth funds from China and other emerging giants from the BRICs to use a special conduit to buy euro sovereign bonds. ECB rate cuts too may be firmly back in the frame on Thursday as Mario Draghi takes the helm of the central bank for the first time. The Federal Reserve's Open Market Committee gives us its latest decision on Wednesday. US payrolls looms large on Friday, with a heavy European earnings sked including Barclays, BMW, ING, BNPP, Unilever, CS, ArcelorMittal, RBS, Commerzbank, and many more.
Are CDS markets the euro zone’s iceberg?
In an unfortunate turn of phrase at the height of his country’s current debt crisis, Greek Finance Minister George Papaconstantinou on Monday compared his government’s Herculean task in slashing deficits and debts as akin to changing the course of the Titanic. Sadly, we all know where the great “unsinkable” ended up almost a century ago and I’m sure, given the chance, Mr Papaconstantinou would have chosen another metaphor. But if the Greek economy (or perhaps the euro zone at large?) is to be cast as the Titanic, then what is its potential iceberg?
For some euro politicians, look no further than the sovereign Credit Default Swaps market. France’s finance chief Christine Lagarde said as much last week when she questioned “the validity, solidity of CDSs on sovereign risk” and warned speculators to be careful as regulators took a “second look” at the market and European governments closed ranks. Lagarde, of course, is not alone. You can be sure CDS are being examined long and hard by Spanish intelligence services investigating the “murky manoeuvres” in the debt markets. But what is the exact charge against CDS?
CDS are ways to buy or sell insurance on the risk of debt defaults without needing to own the underlying bonds in the first place. It’s a way of hedging your debts, if you like, without having to go through the often more complicated game of selling securities short (or selling borrowed paper). In essence, it allows you to take a bet on default without having to go to the trouble of owning the bonds you’re insuring against. Some critics, not unreasonably, would view this as the epitome of the casino capitalism that has elicited so much public outrage over the past three years . The fear is this market has become the tail wagging the dog.
About 10-years old, CDS were for years seen as a valuable bellwether of sentiment on corporate default risk. But its opacity as an over-the-counter market came in for heavy criticism during the credit crunch, mainly because it allowed speculators with no interest in the underlying securities to sow panic in the real marketplace, particularly in banking stocks, and offered them the power to precipitate the very crises they were betting on. There were also cases, most notably in attempts by Kazakhstan’s then biggest bank BTA to restructure its debts, where conflicts of interest were alleged. Some bondholders acting as creditors stood to gain more from forcing the bank default because they were substantial CDS holders too. What’s more, Commerzbank points out, many even doubt the sense of sovereign CDS markets at all because it’s far from clear who would pay out in the event of default. Insurer AIG was certainly unable to pay when the financial industry went south in 2008.
One defence of CDS is they merely allow a liquid market to anticipate future credit rating moves rather than outright defaults per se and, as such, are important not in their absolute but in their relative rankings of credit. Greek CDS prices last week indicating a one-in-three chance of default, for example, were wildly at odds with a consensus view such an outcome was highly unlikely. Yet, Commerzbank said that even the acceptance of sovereign CDS as a useful market signal still exposed some odd anomalies, such as German CDS trading cheaper than the US when the US and not Germany had control of its own printing presses.
Barclays Capital have burrowed deeper with a note called “Sovereign CDS: Cat or Canary?” They concluded that both CDS exposures and volumes are just fractions of the cash bond markets for the likes of Greece, Spain, Ireland, Italy and Portugal — only between 2% and 10% on exposures and 1% to 12% on volumes, with Portugal showing the highest CDS to cash bond ratios. And although there was a correlation between CDS volumes and widening cash bond spreads, this was unsurprising and showed no cause and effect.
However, Barclays did point out the CDS market appeared skewed toward fear and volatility. “CDS activity drops quite a bit when spreads tighten. This would suggest that the CDS market tends to be dominated by players who are looking to buy protection,” it said, adding that this was even more likely in markets like Greece where the absence of centrally-cleared cash repo markets makes many players reluctant to “short” the cash market.
from Global Investing:
It’s the exit, stupid
Anyone wondering what ghoul is most haunting investors at the moment could see it clearly on Tuesday -- it is the exit strategy from the past few years' central bank liquidity-fest.
Germany came out with a quite positive business sentiment indicator, relief was still there that Greece had managed to sell some debt a day before, and Britain formally left recession -- albeit in a limp kind of way.
But what was the main global market mover? It was China implementing a previously announced clampdown on lending.
Doesn't bode well for when the euro zone stops lending banks low-interest money, Britain stops buyng gilts and the Federal Reserve raises interest rates.
Britain heading for rude awakening?
There is a divisive election ahead for Britain, the threat of a ratings downgrade on its sovereign debt and a deficit that has ballooned into the largest by percentage of any major economy. UK stocks, bonds and sterling, however, are trundling along as if all were well. What gives?
For a fuller discussion on the issue click here, but the gist is that all three asset classes are being support by factors that may be masking the danger of a broad reversal. UK equities have been driven higher by the improving global economy, bonds held up by the Bank of England’s huge buying programme and sterling by valuation and the distress of others.
But with the Bank of England’s buying spree due to end soon and the possibility that UK voters won’t give a clear victory to either the Conservatives or Labour, meaning political stalemate, is this set to change?
Royal Bank of Canada does not go as far as saying it will. But it says it is clear that not enough attention is being paid the prospect of politics grinding to a halt and failing to solve the fiscal problem
Many sacred cows will have to be sacrificed in the years ahead, and this will require effective leadership, imagination, and courage. But the danger is that because of the political situation, the country is instead left with weak government, temporary expedients, and initiatives that are the lowest common denominator of long and exhausting negotiation.
Britain is not yet headed back to the 1970s, in our view, but such economic and political recidivism cannot be ruled out. Policy makers and money managers would do well to consult their history books and be alert to the errors and failings of 35 years ago
Graphics: Markets since Lehman’s fall
Junk Bonds
Credit markets today have healed after the entire U.S. junk bond market traded at distressed debt levels suggesting a substantial risk of default. Those bond prices have since recovered and now offer investors returns of 40 percent to lead major asset classes.
Rising Stocks
The U.S. stock market too has recovered lost ground, with financial stocks leading the charge. The S&P 500 Index has rallied for most of this year. The Dow Jones industrial average <.DJI> now trades around 9,300 — up sharply from a 2009 closing low at 6,547.05, but down only about 15 percent from its close at 10,917.51 on the day of Lehman’s bankruptcy filing.
Financial Shares
Financial shares have led the charge, including gains by Goldman Sachs, Citigroup, JPMorgan Chase and Bank of America.
Live Blogging G20
Finance ministers from the G20 are meeting in London on Friday and Saturday to discuss the next steps in battling the world’s worst economic and financial crisis since the Great Depression.
Reuters correspondents from around the world will be at the event, taking you behind the scenes and and providing unprecedented coverage through this live blog.
Vote here on Japan’s economy and its election
Britain’s Association of Investment Companies has UK investors who run Japanese equity funds whether they think the general election on Sunday will have a positive impact on the country, which is slowly emerging from recession.
Their answers can be found here, but the consensus was that the Democratic Party of Japan would defeat the ruling Liberal Democrat Party and that this would result in more consumer friendly policy or economic revival through higher living standards.
Managers were more divided on how long-lived any positive impact on stock market would be.
Our unscientific mini-poll below gives you the chance to vote on the issue — but as ever your comments are also welcome.
