April 2010
Merkel fiddled while Greece burned*
(*The Random House definition of the phrase “Nero fiddled while Rome burned” is: heedless and irresponsible behaviour in the midst of a crisis.)
Well, this is getting interesting, and Greece is finally starting to garner the headlines it deserves. Now the yield on Greek bonds with 2 year maturities has risen to just short of 20% (UK 2 year bonds yield around 1.4%), indicating that the market is now anticipating a restructuring of Greek debt. Whether this happens or not is still uncertain but this afternoon we hear that the German government will seek parliamentary approval for aid to Greece of up to €8.4 Bln in 2010, and for an unspecified amount for 2011 and 2012, according to a draft bill. However what is clear is that the EU/IMF “rescue package” of €45 Bln, if ever implemented, is not enough as it does not begin to cover the refinancing needed over the next two years and was only supposed to be three years in duration, creating another refinancing issue. However, IMF Managing Director Dominique Strauss-Kahn has been cited on German TV saying that the cost of saving Greece could be as much as €120 billion. If so it asks some very awkward questions about the Eurozone and whether these funds will be genuinely forthcoming in light of the fiscal position of other EU nations.
Put simply, if you look at the most optimistic Greek government figures on debt and deficit reduction they don’t compute without depression. Something has to give and within the legal confines of the EU it is hard to see what. In the meantime a crisis meeting has been pencilled in for May 10th (conveniently after the German regional elections) but the way things are developing this may be far too late, and is representative of an EU response which almost perfectly defines “heedless and irresponsible behaviour in the midst of a crisis”. Hopefully the stories emerging that we will see an agreement reached this weekend will prove to be correct, although we remain sceptical.
Some Good News
The exposure to Greek debt across the EU banking system is perhaps not quite as bad as thought. France in particular looked very dicey; however reviews of the figures indicate that much of the exposure is actually a result of the two major French banks having subsidiaries in Greece, while German exposure looks manageable in the short term. This at least reduces the risk of a systemic crisis like Lehman’s. However, should other dominoes fall this may change.
And in the US
There are some hopeful indications that the US recovery is becoming self sustaining with April consumer confidence figures beating expectations on the upside, with the number coming in at 57.9, up from 52.3 in March.
This pleased us, and briefly we felt good. Then we looked at a chart, which looks back to the levels since the mid sixties, and, well, were a little depressed to see that 57 is lower than most recessionary bottoms (apart from last years), while boom times go up to 140. It's all about the level.
(Apologies for not including the chart, apparently Bloomberg charts don't want to work with this blog!)
On the upside this low level means that we are unlikely to see the US Fed take a tightening stance this evening (our time), which should keep equity markets reasonably happy as many strategists see the beginning of fed tightening as a key indicator to take profits and reduce equity exposure.
However even after yesterday’s sharp downward movements in share prices, with so much uncertainty around, stock markets continue to look complacent compared with bond markets. Indeed the whole Greek debacle appears to be taking investors’ minds off exactly what it shouldn’t: namely the true implications of fiscal tightening in the developed world. With the high debt growth model of the last decade dead, how can we expect to see robust growth as government spending is cut to the tune of several percentage points of GDP, per annum, across the developed world? Still, that is enough worry for today so we will return to this shortly, perhaps after Thursday’s debate.
UK GDP disappoints, Greece throws in the towel
This morning we found out how much the UK economy grew during the first quarter of 2010. Analysts’ consensus had been around 0.4%; however, on the day the figure came in at a disappointing 0.2%. Oddly enough rather than being disappointed the market rallied on the back of this news. We assume this is because it had already decided that if the figure were to be too low it would be a false signal and would be revised up anyway (evidence, if any more were needed, that the theory of efficient markets is nonsense. If you expect the figure to be too low and the market to rally in expectation of revisions, the market should rally before any data is released. Still, best not to let logic get in the way of a good theory).
Anyway the market is probably correct; the first release is always based on a limited data set that is extrapolated out, with most of the hard data coming from the beginning of the period, which in this case was marked by the chaos of a real winter. Politically the read across is interesting. If taken at face value, after all the stimulus that’s been thrown at the economy, it continues to beg the question of why DC doesn’t just point at GB and shout “he’s bankrupting us”, whilst also allowing GB to argue that stimulus can’t be removed as the economy is still too weak. On the positive side industrial output is up but this cannot disguise that overall GDP remains more than 5% below its peak in 2008.
Greece
After prevaricating for weeks the Greek government has finally admitted defeat and formally asked for the joint EU/IMF rescue package to be rolled out. If implemented (not a guarantee as court action against it is almost guaranteed within Germany) this at least buys some time as it funds Greece for a year. This had to happen after Greek 2 year bonds were pushed to a yield of 10%, imposing a crippling rate of interest. Already this news has had a positive impact on the US market, with the newswires continuing to take a panglossian view of the world, but so many questions remain unanswered.
For instance, we discovered yesterday that Greece’s deficit was worse than stated after the figures were re-examined, as were Ireland’s, which had a whopping 14.3% deficit last year. This begs the question that with a number of other EU states on the verge of needing rescue, how can these nations contribute to the Greek rescue package? Furthermore, as discussed in a previous entry, by dragging all the states in together we have seen yields on German Bunds increase as the markets start to price in higher risks.
Worse still, after all the grubby allegations surrounding Goldman Sachs, commentary this morning indicates some Greek banks and other market counterparties were buying Greek debt aggressively prior to the announcement of the rescue plan, indicating that some may have been tipped off and given time to front run the market. Just rumours at the moment but they may have legs.
In the end most of the fundamental issues discussed in the past have not gone away. Although this step may buy time it feels a bit like a very slow motion version of the desperate attempts of the UK government in 1992 as it tried to stave off the inevitable departure from the ERM and the devaluation of the pound.
And just to make sure we don’t feel too clever watching from the UK, a leading fund manager yesterday announced he had crunched some figures and reckoned that without massive government cuts and radical steps (going further than DC’s idea of increasing the retirement age by a year) the UK will have to begin defaulting on its pension, health and welfare commitments within two decades. Sobering stuff!
And finally....
A little boy wanted £100 badly and prayed for two weeks but nothing happened.
Then he decided to write GOD a letter requesting the £100.
When the postal authorities received the letter addressed to GOD, UK, they decided to send it to Gordon Brown.
The PM was so impressed, touched, and in total agreement, that he instructed his secretary to send the little boy a £5 note.
Gordon thought this would appear to be a lot of money to a little boy.
The little boy was delighted with the £5 and sat down to write a thank you note to GOD, which read:
Dear GOD,
Thank you very much for sending the money, however, I noticed that for some reason you had to send it through Parliament and, as usual, that lot deducted £95!
Stagflation, Greece (again) and a thought from Roosevelt
While I write, a note has come from a major Wall Street office discussing the negative action today on European Bourses. The big negatives: Credit Default Swaps (bond insurance, see earlier blogs for details) on Greek and Portuguese debt blowing out due to growing default worries and an undersubscribed German sovereign bond issue as global appetite falls for all European debt on contagion fears. More on that below, but first the UK.
A busy week for economic data releases, with yesterday’s inflation data coming in above expectations for both CPI and RPI. While today’s unemployment figures were not bad the big test comes at the end of the week when we get the first estimates of 2010 Q1 growth figures. Despite the bad weather there is hope we can post some decent growth (long overdue after such a sharp contraction) however some remain doubtful. If the figures come in on the low side this could point towards the risk of stagflation (stagnant growth with high-ish inflation) which is difficult to deal with as it is tough to raise interest rates to counter inflation when this will kill off anaemic growth. Thankfully if you strip out autos and fuel from the figures they look less bad, although still far from perfect.
Frankly whoever wins the next election has some impossible choices to make (they’re all lying by the way, or worse, staggeringly ignorant) but stagflation is a gate crasher we really don’t need. Let’s see what Friday brings. Stay posted.
Greece
We continue to be amazed at how little attention this is now getting, with everyone apparently assuming there is a rescue in place, even when the Greek government is wriggling like mad to avoid accepting rescue package MK3 (or is it 4?). All the while protests grow within Greece about the austerity cuts that haven’t even been made yet. Mmmm.
If a bail-out goes ahead (still far from certain) it can only buy time (at great cost both financially and to EU political harmony) and as Wolfgang Munchau wrote in the FT on Monday: ”The bail-out prevents a default this year, but makes no difference whatsoever to the likelihood of a subsequent default. Just do the maths”. But nobody is paying attention to this, or the implications. A research note found me yesterday, ironically from the New York office of a major German Bank, anticipating that a restructuring was inevitable and more likely than a simple bail-out. It argued well that an organised 50% “hair-cut” was likely and slowly being priced in by markets. While a very credible outlook it still leaves massive question marks about the state of the Euro, the downgrading of other European debt and most importantly European banks.
It is well known that European banks have been far slower than US banks in recognising bad debts and many are thought to be technically insolvent, but it is European banks who will suffer further massive losses if any default/restructuring takes place, which it almost certainly will. Worse the research also indicated that a similar Portuguese debt restructuring was also inevitable and again it is European banks with the most exposure. Yesterday’s IMF report on Global Financial Stability (235 pages of joy for financial geeks) points to slowly reducing bad debts globally, with the caveat those sovereign debt problems could upset the applecart.
And this brings us back to the UK unfortunately as we face a future with no easy answer to our own problems and the fear of a hung parliament starting to weigh heavily on many, indeed the head of a respected economics house said to me yesterday “we are in danger of having the IMF at our door if we aren’t careful”.
And finally...not a joke but some thoughts from FDR, taken from his famous “the only thing we have to fear is fear itself” inauguration speech in 1933:
“Only a foolish optimist can deny the dark realities of the moment...The rulers of the exchange of mankind’s goods have failed through their own stubbornness and their own incompetence...Faced by failure of credit they have proposed only the lending of more money...They know only the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish.”
Crisis Averted.For the moment.
A Greek rescue or simply tragedy delayed. The markets gave a tentative thumbs up to the weekend announcement of a rescue package, although as predicted the word fudge is writ large across the details.
In short the rescue package underpins Greek debt at 5% by offering a lifeline of EU and IMF funds at that rate, although confusion reigns about who stumps up first. If it is the IMF how happy can members be if they can't see any realistic plan for deficit reduction, while devaluation or debt restructuring is off the table. Meanwhile if EU funds are used first there are already rumblings of legal action in Germany as this plan seems to ignore the "no bail out clause" of the constitution. And to be fair you can see why.
As Jennifer Hughes points out in today's FT if there is now an implicit guarantee behind all EU soveriegn debt then you should buy Spanish, Italian and Portuguese debt as it is very cheap. But you should sell German & French debt as it is far too expensive as underpinning the rest of the Eurozone undermines its financial position. You may recall from the last entry this is a problem because both Germany and France have significant deficits (and what is more with a much shorter maturity profile than our own) so this adds a significant burden to them, particularly if they are shouldering the lions share of bailout costs and coping with subdued growth.
In short don't yet count on the bailout working. As we have said before we are playing a new game and the outlook is far from certain, largely because we still don't know the rules.
And finally....
A City bond trader has set up a charity page to raise £100m for Greece. As he says:
"Greece is in a deep financial crisis. Donating here will go a long way to helping these poor people who have lived beyond their means for the last 10 years and are now struggling to pay their bills. Please think of them as they avoid their taxes and then blame evil speculators rather than face up to the fact that lying about their national statistics was probably more of a factor. Please donate in pounds as all euro payments will soon be subject to a 50pc haircut.”
Donations include £15 from someone calling themselves Angela Merkel with the touching comment “Greek swine”.
A certain Anthony Chisnall has promised £10 but only if they stop smashing all their crockery. Mr Turkey said he would donate £10 in return for an island.
Even the British Museum is reported on the site to have stumped up a tenner along with the message: “Have you lost your marbles.”
Sleep Walking into a disaster, or a rescue this weekend?
While the Greek debt crisis continues to garner some headlines there appears to be a growing complacency among commentators (and more worryingly the markets) that all will be right in the end and life can go on as normal.
Well sorry to upset the applecart but that view is utter balderdash as it is becoming increasingly clear that this is a game-changer and whether the ultimate denouement is postponed by fudge for a few years, or comes crashing upon us over the coming weeks, it will not be pleasant and throws a harsh light on our own current situation.
The recent EU-IMF rescue that was heralded by EU politicians is clearly nothing of the sort. At German insistence it only provides funding for Greece at market rates. Well those rates have blown up to between 7% & 8%and if Greece actually reaches the point where it can't get market funding the rates are likely to have gone higher still. Bearing in mind Greece faces deflation to get its fiscal house in order, this could lead to crippling real rates of 10% or more, on debt that is already out of control. Hardly a rescue.
However the alternative to a rescue is inevitable default as not only does Greece have to issue plenty of fresh debt it has a significant amount of existing debt rolling over before the end of May. Some optimists have been saying that at current yields the new dollar issue of between $5-$10 Bln that the Greek Government is hawking across the US will whet the appetite of Emerging Market Debt (EMD) investors. Well although some may step up to the plate (with BCA Research recently suggesting Greek debt looked attractive at those yields) it is hard to see why when you look closely.
Speaking as an actual investor in the asset class one of the key attractions of EMD is not just its high income yield it is the fact that the underlying finances of many of these economies are very strong, completely unlike Greece. To highlight the point lets look at some debt to GDP predictions for 2011 (figures from the OECD and IMF): Japan 204%, Italy 130%, Greece 130%, Ireland 93%, Portugal 97%UK 94%, US 100%, France 88% and just so they don't feel too smug, Germany 85%. Compare these figures to the following regional averages: Asia 41%, Central Europe 29% and Latin America 35% (no really, and that is with Argentina in risk of default again, showing how strong the finances of other nations are). Why would you want Greek debt?
Intervention this weekend?
With things so difficult one UBS analyst says "external intervention may be unavoidable and could happen very soon as the situation is untenable. We think an intervention over the weekend is a distinct possibility". But at what rate and what terms? In an effort to save the Eurozone Germany may bow to pressure and allow financing at 4-4.5% and stave off collapse (ignoring the legal action some Germans are preparing to stop any such move) but this will only delay the inevitable as Greece will not do an Ireland and make the necessary cuts (We would take the just announced 40% deficit cut for the first quarter with a handful of salt. This is the nation that massaged its GDP figures by including the economic impact of money-laundering and prostitution to help gain entry to the Euro). What is more Greek banks are already facing massive difficulties as their rich have withdrawn up to €10Bln since the start of the year (remember this is a country where only 6 people admit to earning €1m+ per annum) and are already receiving government support.
In the short term it is probable that a further fudge will be found but recent talk from Trichet that "default is not an issue for Greece" sounds like talk we heard before the sub-prime collapse, Bear Stearns, Lehman Brothers, AIG, RBS, HBOS and others. Talk is cheap, the fundamentals look horrid and the risks massive, although we will perhaps delve further into the specifics another time.
The stock market? It's up again.
Very Quick First Quarter Summary
With relentless determination time has brought us to the end of another quarter and as I write the sun is finally making an impression outside and the world feels an alright place to be and with the equity markets continuing on at a positive pace perhaps that feeling is right.
Except there is a gnawing feeling in my head (no not a hangover, it was herbal tea last night) that just will not buy into the spring like mood, so as we move forward into the second quarter let us have a very brief look at the evidence that confronts us (and news of one worried hedge fund manager).
Positives
Growth has returned, UK Q4 GDP figures have been revised up (although at some expense to earlier quarters), while the US put in useful growth in both Q3 and Q4. The Eurozone was mixed and largely flat after a positive Q3, although final revisions to are out next week.
Growth has rebounded strongly in Emerging economies, with China continuing to surprise on the upside.
Manufacturing indicators in the Western world are generally moving into positive territory and there are signs that unemployment may be flattening out.
On the back of this risk markets have been strong, with equities regaining ground to pre-crisis levels, corporate bond spreads normalising and commodity prices are generally up.
Negatives
In light of the extent of the retracement the re-bound in growth and manufacturing is hardly stellar (and weaker than previous upturns) and may be largely inventory re-build. If the consumer (and indicators are mixed here) does not come back strongly this may reverse.
Market valuations are no longer cheap and vulnerable to disappointments.
There appear to be growing macro risks, from Greek debt (the recent EU/IMF solution was yet another massive fudge, leaving even the FT’s very pro-European Wolfgang Munchau very worried) while growing protectionism from a newly emboldened Democratic party in the US looks problematic.
Reining in fiscal deficits poses a real risk of double dip recessions, with a natural knock on to asset valuations, while surprisingly strong recovery would lead to monetary tightening with similar possible consequences.
Conclusion
It all looks finely balanced and we suggest that we all maintain that as a mantra. There are reasons to take risk and reasons to keep the powder dry.
One worrying news titbit is the Jupiter’s Phillip Gibbs (who famously had no financials and high cash in his “Financials Fund”, just prior to Lehman Brothers) has moved the cash position in his hedge fund to over 50% as he fears the markets are underestimating the sovereign debt risks. He is not always right and his performance is volatile but it is a point worthy of note.
Finally we hope everyone has a good break over the next few days and again we remind ourselves of the value of the important things in life.
And finally, finally...
After every flight, Qantas pilots fill out a form, called a "gripe sheet," which tells mechanics about problems with the aircraft.
The mechanics correct the problems, document their repairs on the form, and
then pilots review the gripe sheets before the next flight...
Never let it be said that ground crews lack a sense of humour. Here are some actual maintenance complaints submitted by Qantas' pilots (marked with a P) and the solutions recorded (marked with an S) by maintenance engineers.
P: Left inside main tire almost needs replacement.
S: Almost replaced left inside main tire.
P: Test flight OK, except auto-land very rough.
S: Auto-land not installed on this aircraft.
P: Something loose in cockpit.
S: Something tightened in cockpit.
P: Dead bugs on windshield.
S: Live bugs on back-order.
P: Autopilot in altitude-hold mode produces a 200 feet per minute descent.
S: Cannot reproduce problem on ground.
P: Evidence of leak on right main landing gear.
S: Evidence removed.
P: DME volume unbelievably loud.
S: DME volume set to more believable level.
P: Friction locks cause throttle levers to stick.
S: That's what friction locks are for.
P: IFF inoperative in OFF mode.
S: IFF always inoperative in OFF mode.
P: Suspected crack in windshield.
S: Suspect you're right.
P: Number 3 engine missing.
S: Engine found on right wing after brief search.
P: Aircraft handles funny.
S: Aircraft warned to straighten up, fly right, and be serious.
P: Target radar hums.
S: Reprogrammed target radar with lyrics.
P: Mouse in cockpit.
S: Cat installed.
P: Noise coming from under instrument panel. Sounds like a midget pounding on something with a hammer.
S: Took hammer away from midget.