Two perspectives on the “French lion in the grass”


Author Cam Hui

Posted: 30 July 2012

In this week’s essay, John Mauldin characterized France as the “lion in the grass”. He began with the comment that there are certainly lots of risks (lions) in Europe:

We can all see the lions, large and small, of Greece, Portugal, Ireland, Spain, Italy, and now Cypress and Malta. The fear of contagion is what keeps European leaders up at night, trying to figure out how to keep Spain afloat. Because if Spain sinks, the focus immediately turns to Italy.

The hidden risk is in France, Mauldin wrote:

But enough of the lions we can see. Don’t look now, but the lion that lies hidden in the grass is France. Yes, the France that is supposedly a big part of the solution to eurozone woes and Germany’s stalwart partner in guaranteeing all that debt. AAA France. Rated that way by the same people who turned the nuclear waste of subprime CDO squareds, composed 100% of the worst sort of BBB junk, into gold.

Now, the rating agencies are using the same alchemical Philosopher’s Stone to transmute French debt into … fool’s gold.

Today, investors are lending to the French state for five years for less than 1% and its 10-year yields are at all-time lows, presumably it has been lumped in with the likes of Germany as being a safe haven, the French fiscal outlook is dire. In particular, he pointed to an IMF study (actually, I believe that it was a BIS working paper called The future of public debt: prospects and implications). The study examined the debt to GDP path of various major industrialized countries and Mauldin observed that the French debt trajectory look the most like Greece.

BIS Public Debt to GDP projections

Yes, the country most like France is Greece. Yes, THAT Greece. The one that just defaulted. The one that everyone agrees is dysfunctional. Also notice that if Greece were to follow the suggested draconian path, it could stabilize its debt. And then notice that if France were to make the same level of draconian cuts, its debt-to-GDP ratio would merely rise to almost 200% within 25 years. Oops.

Two reactions
I have two reactions to that analysis. My inner investor says, wow that’s terrible. France is an accident waiting to happen. French debt costs will surely blow up and investors need to re-examine the credit risks of any debt paper that they consider. If French yields were to surge because of some event, then risk premiums will also blow sky high and that won’t be good at all for the risk-on trade, i.e. stocks, commodities, etc.

My inner trader tells me that, under the current circumstances, French real interest rates are negative and the France is actually making a profit by running these deficits. It has zero incentive given market conditions to rein in its deficits. In fact, it should be taking advantage of current conditions to extend the maturity of its debt structure in order to lock in low rates.

It’s important to be aware of the long-term risks of the French fiscal path, these kinds of things have a way of not mattering to the market until it matters. As a trader who is measured by the bottom line in his portfolio, he has to be aware of the risk but not hide in the bunker and act on this “lion in the grass” until the lions starts to move. You have to watch for the inflection point.

These differing viewpoints certainly put the Merkel/austerity vs. Hollande/stimulus debate into a fresh perspective.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.



None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

America has come to this?


Author Cam Hui

Posted: 03 Apr 2012

Despite my recent bullishness, I recognize that the United States has experienced a very anemic economic recovery. Here are a couple of anecdotal data points that show how difficult the recovery has been.

First, the Washington Post reported that senior citizens continue to bear the burden of student loans.

New research from the Federal Reserve Bank of New York shows that Americans 60 and older still owe about $36 billion in student loans, providing a rare window into the dynamics of student debt. More than 10 percent of those loans are delinquent. As a result, consumer advocates say, it is not uncommon for Social Security checks to be garnished or for debt collectors to harass borrowers in their 80s over student loans that are decades old.

Ouch! Imagine retiring with student loans!

The trailer park housing recovery
Next, FT Alphaville reported that the US housing recovery has been led by…mobile homes:

Whether and how that sanguine trend seeps into the single family home housing market remains to be seen, with ‘Shadow” inventory levels and an opaque foreclosure pipeline make this a tougher call. Not to mention the difference in demographics between the two buyer bases. And while mobile home sales volumes are up, prices for manufactured houses are still negative year on year. If nothing else, the contours of the current recovery in this narrow part of the housing market likely inform the likely path of eventual recovery for the industry as a whole.

Call this a recovery, but seniors are now retiring still owing money on their student loans and Americans are downsizing from houses to trailer parks…

America has come to this.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

We are all QEers now


Author Cam Hui

Posted: 27 Feb 2012

Richard Nixon famously said in 1971 that we are all Keynesians now. Within a decade, the unintended effects of Keynesian stimulus were plain to see for everyone as inflation raced upwards and out of control.

Today, as the world holds its breath for the results of the ECB’s LTRO2 auction later in the week, we are all Quantitative Easers. The Bank of Japan, Federal Reserve, the European Central Bank and Bank of England have all embraced quantitative easing, or money printing. Recently, both the BoE and BoJ have announced further rounds of quantitative easing.

In the short run, there are clear benefits to the US federal government of the Fed’s ZIRP and quantitative easing. In 2011, the US paid $454 billion in interest payments under ZIRP and, despite skyrocketing debt, interest expect was less than it was in parts of the 1990’s.

Moreover, L Randall Wray points out that the Federal Reserve holds assets equal to one-fifth of GDP. What’s more, an astounding 50% of its assets have maturities of 10 years or more.

Governments of the developed world are trapped by their central bankers dual policies of ZIRP and QE. If central bankers were to raise rates, interest costs would spiral out of control and overwhelm budgets. Just read Reinhart and Rogoff to see what happens next.

This has resulted in a binary investment environment of risk on, when central bankers are engaged in QE, and risk off, when they are not. The endgame will either inflation or debt default – and I don’t know what the result will be.

For investors, this means becoming more tactical in understanding the risk on/risk off backdrop and participating in the trend of the day. Right now, central bankers are engaged in another round of QE around the world. Despite what you may think of the ultimate costs of such policies, the right thing for an investor to do is to party and worry about the consequences later.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

China saves the world


Author Cam Hui

Posted: 18 Feb 2011

When my Asset Inflation-Deflation Trend Model flashed an asset inflation signal on February 6, 2012 to buy high beta and high octane inflation hedge and emerging market stocks, the major risk to the bullish forecast was a Chinese hard landing. One of the key indicators that I was watching at the time was the Shanghai Composite, which had been in a well-defined downtrend.

All that has changed. Since I wrote those words in early February, the Shanghai Composite has managed to stage a rally through the downtrend, signaling that China’s hard landing scenario is becoming less likely.

Indeed, Reuters reported the PBoC indicated that it is prepared to ease policy gradually in order to keep inflation in check:

In its monetary policy implemention report for the fourth quarter of 2011, the central bank said it will use a mix of policy tools, including interest rates, to maintain reasonable credit growth while keeping a lid on inflation.

Next door in Hong Kong, the Hang Seng Index has already rallied through its downtrend line and the 200-day moving average at about the same time, which is another signal of global healing and recovery.

Now that both the Shanghai Composite and Hang Seng Index have rallied through their respective downtrend lines and the fundamentals are becoming more positive, it seems that China is in the process of confirming the global bull move in risky assets. In fact, it’s saving the world as it indicated that it would continue to buy euro denominated debt, which it said it would do once the Europeans got their act together (and it is in the Chinese self-interest as Europe is a major export market).

These developments confirm my recent observations that we are seeing a intermediate term bull market in stocks and risky asssets.

So party on and let’s rock ‘n roll!

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

 

The ECB’s non-party: What does it mean?


Author Cam Hui

Posted: 22 Dec 2011 12:08 AM PST

What happened? The ECB throws a party but no one shows up?

The size of ECB’s LTRO was far ahead of expectations at €489 billion (see my previous discussion here). That should have been bullish, right? Instead:

  • The EURUSD exchange rate fell
  • Yields for Spanish and Italian debt rose across the yield curve
  • Shares of key troubled banks (SocGen, Credit Agricole, Comerzbank, Intesa and Unicredit) are mostly down on the day
  • European stocks retreat and US stocks retreated but rallied to finish the day roughly flat

Why?

There are a number of plausible explanations for the market reaction, but they could amount to little more than rationalizations. First, the EBA effectively nixed the carry trade by requiring banks to mark-to-market, so much of that €489 billion amounted to liquidity injections into the eurozone banking system. If the banks need that much liquidity, what could they be hiding? Or does this just show that the European banking system is just getting by on ECB life support?

Ambrose Evans-Prichard wrote that the size of yesterday’s LTRO wasn’t enough:

Roughly €300bn of today’s eagerly awaited LTRO tender is recycled old money from earlier support operations. The new money is €200bn. This alone is not going to shore up the sovereign states of southern Europe as they grind deeper into recession/depression.

He wrote that European banks need to shore up their Tier 1 capital base to the tune of “€2.5 trillion adjustment according to the BIS’s Global Stability Board”. In addition, “Eurozone sovereigns must raise €1.6 trillion in 2012, and banks must raise another €700bn.”

The LTRO was a liquidity injection operation that took a Lehman-like event off the table. Maybe the markets are now finally focusing on what typically matters, such as earnings, growth, interest rates, etc. and it didn’t like what it saw? Indeed, Christine Lagarde of the IMF warned emerging market economies to prepare for a downtrun in Europe.

A glass half-full
Putting on my technician’s hat, I would say it doesn’t matter what the explanation or rationalization is. The market’s inability to rally on good news, namely €489 billion in QE from the ECB, has to be interpreted bearishly.

When I look at the one-year charts of most markets, I see the charts mostly forming triangles indicating indecision. The direction of the next break will likely determine the next intermediate term move. This chart of ACWI representing the All-World Index is a typical example.

Going around the world, a similar pattern can be found in the US stock market:

..the UK market:

…and the European market:

A bearish tilt
There are clues of which way the market might break. Much the evidence points to a bearish break. For example, commodities are in a downtrend. If there was a triangle, they experienced a downward break in early or mid December:

Similarly, the yield on 10-year US Treasury note shows a similar pattern of a downtrend and break downward in early to mid December:

The commodity sensitive Canadian market is also not behaving well.

The Chinese market, as represented by the Shanghai Composite, has broken down decisively and is in a well-defined downtrend.

In sympathy, Hong Kong experienced a downside break in its triangle in the last week.

India isn’t behaving well either.

The South Korean KOSPI experienced a downside break recently, but that could excused because it could be viewed as a special case of a market reaction to geopolitical tensions.

Bullish data points are few
To be sure, the picture isn’t entirely bearish and there are a couple of bullish data points. The Brazilian market rallied above a downtrend line in October.

The Australian All-Ords Index is showing a similar pattern of broken downtrend and sideways consolidation.

Both Australia and Brazil are major supplier of resources to China. So these chart patterns must be regarded as somewhat supportive that a hard landing may not be in the cards for the Middle Kingdom.

However, the weight of the evidence suggests that while the trend breaks have not shown up definitively, the bias for the next intermediate term move is to the downside.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Pandora’s Box


Greece’s Prime Minister Papandreou shocked the world, the European Union, his country, his own party and his finance minister today by upping the stakes with a referendum on the austerity measures needed for financing the country’s debt burden. It is high stakes brinkmanship whereby a loss would mean financial ruin for the country as it leaves the Eurozone or strengthens his party’s hand. This will, no doubt, raise the German ire already at a breaking point and stresses the entire negotiations. He has cleverly not set a date for the referendum as I would guess to extract further concessions from the Troika as they all look into the abyss…

The ancillary effect is that if it goes through and the Greek voters get a say on whether to accept austerity measures and stay in the union – what of the Italians, the Spaniards , the Portuguese voters.  Won’t they want a say as well?? According to a recent poll, nearly 60 percent of Greeks have a negative view of the rescue deal suggesting that voters will say no.

The tangent this course of action puts this process of negotiation in a downward spiral. It usurps the power of the democratically elected leaders and slows the process down considerably. The political contagion will be fast and violent – Papandreou has opened Pandora’s box.

4.48 vs 6.06


The widely anticipated move by the European policy makers was well received by the global equity markets.  Although the 50% voluntary haircut in Greek debt and levering the EFSF four to five times for around a trillion euro fund to backstop the potential contagion was cheered by the equity markets, once again the droll credit/bond analysts have not bought it.  The European and US markets rallied hard on the news with the Dow Jones rallying 4.48% in the last few days. However the bond markets were unmoved and in fact yields rose a little for Italy – one of the profligate issuers of debt in Europe. One could argue that most of the debt is borrowed internally unlike say Greece and the country does have a robust manufacturing industrial base unlike Greece. But that being said, on Friday, they paid the most for their 10 year debt since joining the Euro in 1999 reflecting a yield of 6.06%. This is up from 5.84% only last week. The PIIGS threshold yield was approximately 7% where that pushed them into problem territory. The problem with Italy is that it is the #3 issuer of debt ceded only the US and Japan.  So there is a global push and pull right now between the equity and credit bulls and bears. The question is if this is such a good plan then why are yields rising – they should be falling.

Bottom line: given that the bond market dwarfs the equity market, I remain unmoved and I am selling into this rally.

Italy is too big to fail, too big to bail…

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