Sell the rumor, Buy the news?

And another thing on the euro

Finishing the week, finishing the quarter

• German retail sales down. Interesting in light of the fact that US sales are up while incomes are down (yes, lower savings rate - AGAIN). What does it mean? Consumers will be tapped out faster without HELOCs.

Austria to Ireland: Good night, and Good luck

I was wrong: I thought it would be Germany who would be the one to hit a breaking point; however, it turns out that Austria beat them to the punch:

News reports indicate that Austria is refusing to release its 190 mln euro share of the EU bailout for Greece because it has not met its budget commitments.  The Fin Min Proell says that after reviewing the latest data, there is “no reason, from Austria’s point of view” to allow the December tranche to be paid.

Read more: http://www.creditwritedowns.com/2010/11/breaking-austria-balks-at-greece-emu-bedeviled-by-more-than-ireland.html#ixzz15SRFgvfm

Of course Austria is getting wary – they see that it’s a bottomless pit: first comes Greece, then comes Ireland, next comes Spain…at which point no one will be left to securitize the bailout that Austria will need. Time to bring the forces back home, draw defensible fiscal borders, and let each country fend for itself. And there’s the problem with the euro. Call it a problem of the commons (as each country’s incentive is to take on as much debt as possible and then default first) or a moral hazard or whatever you want. In the US, the shared federal government, shared services (like the army), a common currency, and an integrated legal system give each state a stake in upholding the stability and integrity of the union. No such stake exists in Europe.

Europe revisited

It’s back – although, for some of us it was never out of sight: Europe is in trouble.

Greece is facing gdp growth rate of -3.5% and is now officially beyond low double digit unemployment (and rising).

Spain, in the meantime, is facing another liquidity crunch.

And the only thing saving the credit markets from freezing up is a quickly eroding common fund that is going to face some huge losses in the very near term. (See article here.)

The Hard Trade or Greece Redux

In November 2009, amid fears that the dollar would crumble and with calls from central banks around the world to diversify assets, I discussed “the hard trade” of buying the US dollar against both the euro and yen – now, I stand by that investment. Since then, the currency markets continue to be a main focus for signals of stabilization, relative returns, etc. Greece and Portugal were just canaries in our global coalmine, and I have often written about them (pessimistically).

I continue to view Greece as a canary for the euro and the structure of the European union, but today I want to explore a new direction. The question I find myself asking is: when will Greece become a value play, if at all? 2-year Greek bonds are yielding roughly 13%. Is that enough to compensate for the risk of default? When everything looks so obvious, I often have to stop myself from buying into the mania – and that is where I am with Greece. Yes, the situation continues to worsen. Yes, the rioting in the streets looks bad on TV. I anticipate continued capital flight from the country. And yet…shouldn’t all this information already be priced in to the markets? Mind you, I’m not calling a bottom, or trying to catch a falling knife; rather, I’m exploring whether and when there will be potential in the space.

(Source: StockCharts.com)

Maybe the fall is not completely done…

Maybe I’m a bit early…

Maybe there’s no easy way to play it…

Or maybe…

There isn’t a Greece ETF trading in the US (although they appear so quickly, who knows if there will be one by the time I finish writing?). However, there are a few ADRs that look interesting, such as National Bank of Greece (NBG) and Hellenic Telecommunications Organization SA (OTE). Both stocks have recently been shunned by investors and reporting requirements are limited, but let’s at least recognize that there is some contrarian potential here:

(Source: StockCharts.com)

(Source: StockCharts.com)

With recent significant spikes in volume, it’s difficult to imagine that there are sellers left, or people who haven’t heard the news and already taken their stand. Going long anything Greek certainly seems difficult these days, but the hard trade is often the best.

(Disclosure: I have no position in neither NBG nor OTE, but I have exposure to short euro and yen positions. This is in no way a recommendation to buy or sell any security! These positions are subject to change at any time.)

While you were talking about GS, Portugal happened

First, read this article from the NY Times.

LONDON — Next target: Portugal.

Speculators have begun to zero in on another small member of Europe’s troubled monetary zone, highlighting the same economic flaw that brought Greece to the verge of insolvency: a chronically low savings rate that forces a reliance on the now-diminishing appetite of foreign investors to finance persistent deficits.

Guess what – when governments told you that Greece was contained, they were wrong.

Guess what else – the stability of the euro is temporary.

Guess what else – the Greek bailout won’t help the euro long term.

Guess one last time what else – even after we all pass the Greek and Portuguese mishmash, Spain is coming up with the same issues.

This is not the time to buy dips, but rather, it’s the time to wait for serious undervaluation in any position. The real money and returns are made in the waiting.

For some further readings, click here for an article from BusinessWeek.

Geopolitics – Are they priced in?

The stock market as a discounting mechanism has definitely been implying that things in the world are getting less risky. But are they? Earlier today, as ship off the coast of South Korea, in disputed waters sank. No one know for sure what’s happened yet, but it’s a good opportunity to posture some scenarios. If North Korea did fire on South Korea (http://www.cnn.com/2010/WORLD/asiapcf/03/26/south.korea.ship.sinking/index.html?hpt=T2) would the market go down? If tensions with Iran, or Israel, or Russia, or any of the “-stans” heat up, would the market feel comfortable that it had already anticipated these moves? There are so many cross currents at this juncture that it often feels difficult to keep track.

We tend to go back to valuations, so we already feel that the market is overvalued as we’ve outlined before. However, I’d like to posit that part of what makes the market overvalued is that it is specifically NOT assigning any uncertainty to the world stage, when in reality, it should. Aside from the protectionist talk all around (CNY reval for example, Russia/nat gas/Europe, Germany threatening Greece, etc.) there is additional risk from the political front that is more difficult to quantify and therefore to take into account, but it doesn’t make it any less real.

We’ll write more about it this weekend.

Connecting the dots

There are so many things happening in the past few days, that it’s been hard to make sense of how they’re all related – but they are, and the signals are not good. In the end, we have to go back to valuations and relationships.

Equity markets are overvalued. No matter what valuation methodology I look to, the market looks overvalued by 30-50%. CAPE, Q-ratio, dividend yields, whatever. They all point to the same thing. I could be early. P/E ratios could expand from their current low 20′s. In 2000 they expanded to the 40′s. But the end result will be the same. Then there is the top-down approach. Stocks preform well coming from price instability toward price stability. Price instability can be either inflation OR deflation. Both are unstable. In the early 1980′s with rampant inflation (instability) we moved towards stability and stocks were able to perform well. We have now built a base of stability, which unfortunately means we will move towards instability. The longer we stay in this stable environment (ironically), the greater the danger that the developing fingers of instability will crack. P/E expansion cannot happen in this environment, so it won’t.

Treasury yields are heading higher. It doesn’t matter whether we move towards deflation or inflation. The worlds central banks are on a path of competitive devaluation and long-dated Treasury yields will have to rise (homegrown inflation and foreign countries no longer willing/able to finance our debts). Even in a deflationary environment, we will face higher rates. Economic books will have to be re-written, just as they were after the stagflation of the 1970′s. Bill Gross’s current piece is a must read, but I just want to highlight 2 paragraphs:

…In the U.S. in addition to the 10% of GDP deficits and a growing stock of outstanding debt, an investor must be concerned with future unfunded entitlement commitments which portfolio managers almost always neglect, viewing them as so far off in the future that they don’t matter. Yet should it concern an investor in 30-year Treasuries that the Congressional Budget Office estimates that the present value of unfunded future social insurance expenditures (Social Security and Medicare primarily) was $46 trillion as of 2009, a sum four times its current outstanding debt? Of course it should, and that may be a primary reason why 30-year bonds yield 4.6% whereas 2-year debt with the same guarantee yields less than 1%.

The trend promises to get worse, not better. The imminent passage of health care reform represents a continuing litany of entitlement legislation that will add, not subtract, to future deficits and unfunded liabilities. No investment vigilante worth their salt or outrageous annual bonus would dare argue that current legislation is a deficit reducer as asserted by Democrats and in fact the Congressional Budget Office. Common sense alone would suggest that extending health care benefits to 30 million people will cost a lot of money and that it is being “paid for” in the current bill with standard smoke, and all too familiar mirrors that have characterized such entitlement legislation for decades. An article by an ex-CBO director in The New York Times this past Sunday affirms these suspicions. “Fantasy in, fantasy out,” writes Douglas Holtz-Eakin who held the CBO Chair from 2003–2005. Front-end loaded revenues and back-end loaded expenses promote the fiction that a program that will cost $950 billion over the next 10 years actually reduces the deficit by $138 billion. After all the details are analyzed, Mr. Holtz-Eakin’s numbers affirm a vigilante’s suspicion – it will add $562 billion to the deficit over the next decade. Long-term bondholders beware.

Click here to access the full article.

Then we get to currencies. Competitive devaluations, entitlement programs, protectionism, tariffs, quantitative easing, and the rest of the games central banks and governments play are long-term inflationary on a global scale. However, on a relative basis, which the currency markets are, funny things are happening. The euro is getting hit from all sides, so the eurozone countries have to talk about its stability, even though they are probably secretly happy that the currency is depreciating. Good effect, bad reason. That puts pressure on the US, since a strengthening dollar is deflationary. Meanwhile, the Chinese are holding the yuan steady, but are getting pressure to revalue it upwards. The US is hoping that by getting the Chinese to revalue the yuan (and thereby devalue the dollar) they’ll get a bit of inflation pressure and maybe some uptick in exports. Slim chance. If anything, the Chinese recognize the US position and might devalue the yuan in a bold economic strategy to bolster their own position on the world economic stage. So the dollar is strengthening, even as no one really wants to hold longer term Treasuries. So where do you park billions of dollars when you don’t want to go out on the curve? The shorter the better, which leads us to one of the steepest yield curves in history, with funny inversions happening on the short end as money moves around and attempts to hedge other short end positions.

I can’t just leave the euro there. I continue to think it’s completely flawed. Worries over Greece have (finally) started to materialize. The initial pressure on the euro abated for a while, which I just couldn’t understand, since the problems were never about Greece (a small Euro member), but about Greece’s larger brethren. So now Portugal is in the crosshairs. (Read about the Fitch downgrade here.) We shorted the Euro and Yen in mid-November of 2009 (bought EUO and YCS – admittedly not the best implementation vehicles), but we were early.

That leads us to the yen. I must admit, I don’t get it. I’m short the yen, but I’ve been wrong for the past few months. It’s continued strength seems counter-intuitive (at best). The only explanation I have is that there is still some domestic support (which will end as the aging population uses it’s savings) and support from China and Europe who are uncomfortable with their own currencies. Otherwise, the Japanese might just be manipulating all the numbers. Either way, it’s will all end poorly for the yen, and I don’t think it will be long.

We haven’t even begun talking about commodities (bullish on some, negative on others), real estate (negative across the board; even more negative on Chinese real estate), and US Banks (still negative; think CRE).

Going into a long weekend: Dubai back in focus

Is this what we have in store for Greece? Who wants to go into a long weekend with exposure?

The price of credit default swaps on Dubai government debt jumped to 630 basis points on Friday, up from 592 on Thursday, Markit data show. These CDS prices were last above the 630-point mark on Nov. 27, when they traded at 634 basis points.

http://www.marketwatch.com/story/dubai-debt-concern-grows-2010-02-12

Notes from underground – Yra Harris

Bloomberg reports: Greece/Ireland may leave Euro

How long will Germany want to hold up and finance the Euro? It was fine for a few years, but there’s a limit to everything. Herein lies the underlying problem with the Euro: it requires one to sacrifice national interests for the benefit of monetary stability; it’s a pegged currency – which never works! Politicians, who are beholden to local populations, would want to print money when the economy goes down, but that isn’t possible when you’re currency is pegged. In the end, the peg always ends in pain and a revaluation occurs. In this case, either Greece has to leave the Euro completely (makes one question the currency anyway) or Greece will have to be revalued. I don’t even know if the Euro charter has any mechanism to deal with sovereign spreads this wide. Why did no one think of this at the time, you ask? People did, but no one wanted to listen as the idea of having a balance to US supremacy, and visions of pan-European cooperation went wild. Ironically, how much stronger would the Euro be now had they accepted Turkey? Turkey is thanking its lucky stars for unanswered prayers, as it will end up coming out of this period significantly stronger in the geopolitical world.

http://www.bloomberg.com/apps/news?pid=20601102&sid=a3SIOdqSGOtE

Notes from underground – Yra Harris

Weak links

Greece, obvious. Dubai, of course. Earlier we wrote about Austria and Spain. The WSJ is saying Russia…http://online.wsj.com/article/SB10001424052748703558004574584003569052862.html?mod=WSJ_hps_LEFTWhatsNews. I guess there are a lot of options to choose from.

Greece in the news, but it’s just one part of the picture

Readers of our newsletter won’t be surprised to learn that the world cares about Greece (and Dubai) – still.

From The Big Picture:  Yesterday no one cared about Greece, today they do

From the FT:  Fitch strips Greece of A-grade credit rating

As I mentioned, my view is that this is a big net negative for the Euro, and may thwart Bernanke’s reinflation plans as USD gets squeezed up. I also have a feeling that Dubai and Greece aren’t the only ones. Smaller countries in the eurozone may also be in trouble, which will place added pressure on Austria (which has built it’s recent economy on lending to emerging Europe). In my mind, Austria and Spain are the big ones to watch. If they hold, the euro will have a fighting chance. If they go down like Greece and Germany needs to finance increasingly large neighbors, we’re going to see the euro crack.