October....it has always been an interesting month for markets and it looks like this year's October is going the same direction. Markets have brought hope once again with a nice rebound over the last two weeks. Glad to finally see some reprieve and it certainly brings a lot less stress for work. The rally came on the back of optimism that the European leaders finally get it. They have finally gotten their act together and show more urgency with regards to solving the Eurozone crisis. Merkel and Sarkozy claimed that they have come to an agreement on to recapitalize the banks using the EFSF. I don't know whether you guys noticed, but they did not even give any details on what they intend to do. Also bear in mind how different their mindsets were, going into their meeting. Sarkozy was all for recapitalizing the banks while Merkel insisted that the EFSF should only be used as a last resort measure. So I really wonder where they will meet in terms of a compromise of what to do and to what extent.
Things are expected to be thrashed out on the 23rd of October when the Eurozone summit is held. Speculation is that they will be arguing for EFSF guarantees provided to around 25% of new bonds issued by troubled euro-zone governments such as Italy and Spain. The summit was meant to be held over this weekend but the they delayed it because it was obvious that the Eurozone leaders could not hammer out a deal on time. Lets hope they have more to offer given this delay. The G20 group of leaders have put more pressure over this weekend on the Eurozone leaders to do more during this summit so that should generate some positive sentiment tomorrow. There is however a danger of the summit disappointing the market since it has already started to price in plenty of positive news coming out of it.
Personally, I really do not think recapitalizing the banks is the solution to this crisis because this is a sovereign crisis and not a banking one. The only worry is for liquidity to freeze up and bring us to a repeat of 2008. The underlying problem is the sovereigns and this problem is not going to go away. We are facing a structural problem and it is going to take a great deal more to stop it from getting worse. I am glad that they are finally doing something for the banks to prevent any from going under or causing a widespread panic. But should things get any worse for Italy, Spain etc, fear will resurface. I do not know about you but I am getting nervous as Italian yields are pushing higher once again, getting close to 6% once again. This shows that fears are starting to show in the sovereign debt market.
There is also talk of increasing the amount of haircut on the Greek bonds which private investors have to take. This is once again a sore point because in July, there was already a proposal to take an haircut of 21% on the Greek debt holdings. At the beginning, most private investors and banks were pretty receptive towards this proposal but now there are talks of revising the level of haircuts to 60%. Do not think private investors are going to take to that too well. Not that they have any choice on the matter. The biggest issue I have with this development is how the other peripheral countries that have debt issues react to this proposal. If you realize that the bank has just given your friend a discount on his debt, wouldn't that you ask for one yourself? That is my worry. I believe that the deeper the haircut given, the higher the chance of moral hazard and unhappiness amongst the highly indebted countries.
The IMF has also brought up the suggestion that their funds be expanded to deal better with the current economic crisis but the Americans and Germans have rejected this proposal. Not surprising because they have too much problems and obligations on their own. Contributing more money to the IMF is not going to sound too appetizing for them. In my view, bullets are starting to become a rare commodity for these countries and they have to be rationed. This is not a good sign. Now there is talk about expanding the EFSF in terms of size and how they may use it to provide up to 20% insurance on sovereign debt. How much will that mean? Is it possible for the Germans to pump much more into the the EFSF? Especially after the trouble they had in contributing their initial share to the EFSF, what are the chances for them to inject significant amounts into the facility? The German citizens are not going to be too happy about it.
Last year when the stock market advanced after its summer correction various bond spreads began to contract to signal credit risk was easing. Credit risk began to pick up again in the middle of this year just as the stock market was peaking. Please note, however, that while the S&P 500 has been in a trading range since August, each rally we've experienced has not been confirmed by easing credit spreads, leading to a subsequent failure to breakout of the trading range in each case.
Since the S&P 500 peak this summer, we have just witnessed one of the largest uninterrupted rallies, and since we have seen virtually no improvement in credit spreads, I think this rally is highly suspect and investors should remain cautious.In addition to bond market credit spreads not confirming the stock market, neither are bank overnight lending rates which continue to rise even in the face of a sharply rising stock market. Back in June 2010 overnight lending rates peaked as credit risk began to stabilize and then in July and August overnight lending rates plummeted and global financial risks began to subside. This time around overnight lending rates for European and U.S. banks continue to climb and show no sign of stabilization. My inclination is that if the credit and interbank markets do not start following the direction of the stock market rally, I would be highly skeptical of this rally.
Would also like to throw in my view on the Occupy Wall Street movement which hit a new high by the coordinated movement across the world this weekend. This is really the era of the social network. There is no chance this could have happened 10 years ago. I bet the Chinese central govt is glad they barred Facebook access in China. What this movement shows is the growing discontent of the common folk in the street and their resentment towards the powerful and rich. Have you read the demands of the protesters? You should. Interesting read. Do not underestimate the effects of these protests because they could have long reaching consequences, so keep a close eye on it's progress.
Thats all I got for this week, it is going to be an interesting week ahead but do thread carefully as the markets seem to be pricing too much expectation of an European resolution. I seriously doubt it because betting on humans to put aside their self interests for the greater good is something that is not in our nature.
Have a great week ahead.
Best,
SVI
Subscribe to:
Post Comments (Atom)
Posts
No comments:
Post a Comment