Why I am buying the pain in Spain


Author Cam Hui

Posted: 19 Apr 2012

A couple fights and the neighbors hear every word. To outsiders, it sounds like the relationship is in shambles and on the verge of collapse. Insiders know that the couple have a long history together are deeply committed to the marriage.

That’s the story of the eurozone. An underlying assumption in my last post about buying Spain when the pain is at its worse is an underlying belief in mean-reversion. That is to say, the EU will not throw a major member state to the wolves.

Not a marriage of convenience
Martin Wolf of the FT wrote a must-read article entitled “Why the eurozone may yet survive” reinforcing this idea. He said that “the centrifugal economic forces are all too painfully clear”, but outsiders don’t understand that the eurozone and the EU isn’t just a marriage of financial and political convenience, but there is a serious political will holding the European experiment together [emphasis added]:

The principal political force is the commitment to the ideal of an integrated Europe, along with the huge investment of the elite in that project. This enormously important motivation is often underestimated by outsiders. While the eurozone is not a country, it is much more than a currency union. For Germany, much the most important member, the eurozone is the capstone of a process of integration with its neighbours that has helped bring stability and prosperity after the disasters of the first half of the 20th century. The stakes for important member countries are huge.

Thus, the big idea that brings members together is that of their place within Europe and the world. The political elites of member states and much of their population continue to believe in the postwar agenda, if not as passionately as before. In more narrowly economic terms, few believe that currency flexibility would help. Many continue to believe that devaluations would merely generate higher inflation.

If this were a mere marriage of convenience, a messy divorce would seem probable. But it is far more than such a marriage, even if it will remain far less than a federal union. Outsiders should not underestimate the strength of the will behind it.

I wrote about this theme on July 1, 2011 (see The European Experiment in context):

After the Second World War, Western Europe surveyed the wreckage and collectively decided “never again”. In the 200 years preceding that war, Europe had been wracked by conflict (WW II, WW I, Franco-Prussian War, Napoleonic Wars) and the main source of conflict was between France and Germany, or the Germanic states before their unification. When Western Europe said “never again”, they devised a solution that bound the French and the Germans so tightly that the devastation of war on the European Continent would be stifled, hopefully forever. That solution was the EC, which became the EEC and now the EU.

Politically, they have largely succeeded. Today, if Angela Merkel mobilized the Bundeswehr and told the troops, “We are going to war against the French”, the men would all laugh and go home. Compare that result to the cost of the Battle of Verdun of 300K dead and another 500K+ wounded and you will start to understand why the EU was formed.

I agreed with Wolf that the euro is not just a marriage of convenience:

To say that the euro is at an end as a common currency is overly simplistic analysis. In many ways, the EU was paid by blood – just remember the price paid at Stalingrad, Verdun and Napoleon’s retreat from Moscow, just as some examples.

The way ahead
Today, the European Elites have a Grand Plan to save the eurozone. No doubt the Grand Plan will get diluted in the normal back-and-forth negotiations and a Grand Plan 2.0 will emerge. The marriage will survive. Martin Wolf expressed a similar opinion when he wrote:

The most likely outcome – though far from a certainty – is compromise between Germanic ideas and a messy European reality. The support for countries in difficulty will grow. German inflation will rise and its external surpluses fall. Adjustment will occur. The marriage will be far too miserable. But it can endure.

For investors, the survival of the European Experiment and the eurozone means that the eurocrats will eventually take steps to take tail-risk off the table, just as the ECB did with LTRO. That’s why I believe in buying Spanish equities and banks at the point of maximum pain in anticipation of a rebound.

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.

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Europe takes one step back?


Author Cam Hui

Posted: 29 Mar 2012

The story of Europe has been the story of two steps forward and one step back. Here are the two steps forward/

Since the eurozone crisis, the ECB has taken steps with its LTRO programs to stabilize the banking and financial system. Moreover, I wrote that Mario Draghi, on behalf of the eurocrats, outlined the Grand Plan as a way to fix the long-term problems within the eurozone. The Grand Plan consisted of two steps, which sound like pages taken from the Maggie Thatcher playbook:

  • Austerity in the form of “good austerity”, defined as lower taxes and less government spending; and
  • Structural reform, which is the European version of the China taking steps to smash the iron rice bowl, which translates to union busting and going after all of the entrenched interests of the old with their lifetime jobs and gold-plated pensions at the expense of the young jobless.

The one step back happens when Europe dilutes these grandiose object. In the wake of the German and Dutch failure to hit austerity targets, a step backward is inevitable.

Time for Grand Plan 2.0
Most recently, the OECD warned that the eurozone debt crisis is far from over. The organization indicated more work needed to be done, i.e. Grand Plan, and market confidence is fragile. At about the same time, Willem Buiter at Citigroup issued a warning on Spain:

Spain is likely, in our view, to be pushed into a troika (EC, ECB, IMF) programme of some kind during 2012, possibly by losing access to market funding on affordable terms, but more likely by the ECB making a programme for the Spanish sovereign a condition for continued willingness to fund the Spanish banks, which are currently the main buyers of newly issued Spanish sovereign debt. The existing and likely near future EFSF/ESM and IMF financial facilities are unlikely to be sufficient to both fund the Spanish sovereign fully and leave enough financial ammunition in reserve to deal with possible sovereign financial emergencies in Italy or in the ‘soft-core’ of the euro area. The Spanish sovereign would therefore likely continue to fund itself at least partly in the markets even if it comes under a programme. To ensure market access by the Spanish sovereign, the same combination of cheap ECB funding for periphery banks and financial repression of periphery banks by their national authorities that has been effective in lowering sovereign yields since the first LTRO is likely to be required.

Buiter did concede that the government is taking steps to implement structural reforms:

It did use this period to pass several important pieces of structural reform legislation. Among these were labour market reforms aimed at reducing severance pay in the long-term contract sector (while introducing or raising it in the flexible contract sector); reforms aimed at reducing the scope and incidence of industry-wide collective bargaining and replacing it with something closer to firm-level or establishment-level contracting; the imposition of an additional €50bn provisioning requirement on the banks; and laws aimed at strengthening central government control over the finances of the lower-tier authorities (autonomous regions and municipalities).

…though he was uncertain as to their implementation:

Passing legislation and implementing it are not the same thing, however, as we know from the Greek experience. In addition, both structural reform and a medium-term programme of fiscal austerity based on a politically acceptable formula for fiscal burden sharing look necessary to restore Spain to fiscal sustainability. The new government’s decision to wait 100 days to introduce its first budget, in the pursuit of electoral gain, did little to boost Spain’s standing in global markets.

Spain is a too-big-to-fail country within the eurozone. Market angst is starting to rise over the willingness of the Spanish government and the Spanish people to bear the pain of austerity.

Will Spain fall and bring down the eurozone in another crisis? I doubt it. This is the back-and-forth of the Theatre of Europe, but some form of Grand Plan 2.0 compromise will likely emerge. I agree with Gayle Allard at the IE Business School in Madrid who says to not count Spain out in a crisis:

[Allard] said Spain’s biggest problem is investors’ lack of faith in the population’s willingness to withstand austerity. “They don’t see the Spanish people in that way, they don’t understand how a country can put up with it,” she said.

“Having watched Spain through previous crisis, they are a pretty surprising country. They get behind things, hard things,” Allard said. “I don’t think this is ever going to look like Greece and that’s something the markets don’t understand.”

Italy does structural reform
Over in Italy, FT recently reported that Mario Monti clashed with the unions over structural reforms “that would give companies more flexibility to fire workers for economic reasons” and he is winning because of weakened opposition:

[W]ith the [labor union] CGIL considerably weaker than a decade ago and with the main political parties in no position to offer a coherent alternative to the present government, political commentators doubt Mr Monti’s technocrats risk being driven from office.

Opinion polls indicate strong public support for Mr Monti in general, although a majority of Italians opposes changing Article 18 which protects workers in the courts from wrongful dismissals for economic reasons. Under the proposed changes, employees would receive compensation but not reintegration back into their workplace.

Monti is also following the Grand Plan script of structural reforms which pit the young unemployed against their elders, who have secure jobs:

With nearly a third of young people unemployed, Mr Monti also wants to end Italy’s two-tier labour market that protects older workers on indefinite contracts but provides little or no security for mostly new hires on short-term contracts.

The politicians are indeed following through with painful structural reforms. In the meantime, there is doubt from the markets that they can implement them even if the legislation is passed. In a typical EU-style compromise, some of the legislation will get watered down, but I believe that the pendulum is swinging back and the momentum toward structural reform is inevitable.

For now, the message for investors is be prepared for some downside volatility out of Europe. But also know that it is likely a temporary hiccup out of which Grand Plan 2.0 will emerge.

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 optimistic view of Europe


Author Cam Hui

Posted: 3 Mar 2012

Forget about the alligators. Let’s talk about draining the swamp. There is a way out of this quagmire for Europe. Ken Rogoff, in an interview with Der Spiegel, believes that political integration (or a “United States of Europe”) is closer than anyone expects:

SPIEGEL: Do you honestly believe that the countries in the euro zone can bring themselves to hand over that much more power to Brussels?

Rogoff: The terrible thing is that few countries in Europe seem genuinely prepared for that. Those politicians who know what is needed keep quiet, fearing opposition from the voters. But the pressure of this crisis will create a momentum whose scope and impact we cannot yet imagine. At the end of the day, the United States of Europe may well come about a lot quicker than many would have thought.

SPIEGEL: With all respect to your optimism, the Europeans are unlikely to play along with that. The popular opinion in most member states is that Europe has far too much power, not too little.

Rogoff: Europe is in an interim stage, quite similar to that in late 18th century America. The ratification of the United States constitution in 1788 was preceded by 12 years of a loose confederation, which sometimes worked but usually didn’t. Europe is in a similar situation today. States are like people, it is difficult to sustain a stable half-marriage; either you go for it or you forget it.

Much of the latest eurozone crisis stems from the fact that there was economic integration without political integration. Rogoff believes that the European elite within the Community will take this latest crisis to push for greater integration.

This is all part of the Grand Plan that I wrote about before. Mario Draghi, in an interview with the WSJ, said that the steps include:

  1. Austerity, defined as lower government expenditures and lower taxes; followed by
  2. Structural reform, defined as the elimination of the European social model.

In the meantime, the ECB stand ready to provide the necessary tonic (such as LTRO) to smooth the transition as long as the eurozone was moving in the right direction. Greater European integration, as per Rogoff, would be one of those steps.

The optimist in me says that if the Europeans manage to pull this off, it will result in a new Renaissance for the EU and the global economy. The World Bank warned this week that China may be at risk of a middle-income trap as the supply cheap labor, which was the primary source of competitive advantage, diminishes. Were Chinese growth were to slow and the slack were to be taken up by a surge in Europe in the next decade, it would be a source of welcome global rebalancing.

Key risks
The caveat, of course, is that everything has to go right. For example, Bruce Krasting pointed out that some hospitals in the PIGS countries have not paid their drug bills for up to three years and the outstanding bills amount to €12-15 billion. Stories like these suggest that there are liabilities out there beyond sovereign debt as represented by the bond market that the market isn’t very aware of. How much and can the Powers That Be skirt these potholes as they come up? I don’t know.

The greatest political challenge to the Grand Plan of austerity, structural reform and political integration is the discontent on the Street. Consider this chart of European youth unemployment. Note how it is going up everywhere except for Germany.

We have a map showing how to get out of the swamp. Can the European elites steer the EU out? I am not sure, but not all is lost. Just remember how Thatcher’s reforms revitalized Britain. Is the current situation on the Continent very much different from the UK in the early 1980’s?

I remain cautiously optimistic longer term. Consider the judgment of the markets. If Europe is in such trouble, then why has the EURUSD exchange rate been rallying?

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.

Greece is so…last year


Author Cam Hui

Posted: 08 Feb 2012

As Mr. Market waits for the will they or won’t they news on Greece, he is telling me that worrying about Greece is so…last year. Despite all of the angst about a possible Greek default, the Greek stock market has been rallying and outperforming the Euro STOXX 50 in the past few weeks.

Worries in the eurozone has shifted to Portugal, whose stocks have been dramatically underperforming.

All is not lost for the bulls. The Portuguese market is staging a tactical rally and testing its downtrend line.

In addition, Portuguese 2 year yields, which had spiked above 20%, are now in retreat, perhaps indicating that Mr. Market is anticipating further relief from the ECB’s LTRO2 program.

That’s why I am relatively sanguine about the risk trade. If this is the worst that Mr. Market is worried about, it’s time to get long and stay long.

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.

A stark reminder of the north-south eurozone divide


Author Cam Hui

Posted: 05 Jan 2012 12:05 AM PST

The FT had an interesting article highlighting the north-south divide in the eurozone:

The starkly contrasting economic trajectories of countries inside the eurozone were highlighted on Tuesday as Germany reported unemployment at 20-year lows while Spanish jobless figures rose for the fifth consecutive month.

Moreover, there is an interactive graphic in the article showing the different unemployment rates by country.

While the latest eurozone seasonally adjustment unemployment rate is 10.3%, compared to 10.1% a year ago, there are vast gaps in unemployment rates between member states. Most notable are Germany at 5.5% (vs. 6.8% a year ago), the Netherlands at 4.8% (vs. 4.4%) and Austria at 4.1% (vs. 4.2%). The underperforming PIIGS are suffering vastly higher unemployment, with Greece at 18.3% (vs. 13.9%), Ireland at 14.3% (vs. 14.2%), Portugal 12.9% (vs. 12.3%), Spain at an astounding 22.8% (vs. 20.5%) and Italy an outperformer at 8.5% (vs. 8.4%). As a point of reference, the unemployment in France, which is the other major partner in the eurozone leadership, stands at 9.8% (vs. 9.7%).

How badly will austerity bite?
Please note that these unemployment figures are dated October 2011, before the full brunt of many announced austerity programs have been felt. As the effects of these cutbacks start to wind their way through these economies, will unemployment go up or down?

How long before the elites are faced with a political backlash?

The Guardian reported that the new Greek government is fed up with new demands and playing a game of brinkmanship again [emphasis added]:

Greece was promised a second emergency bailout worth €130bn (£108bn) in October after it became clear that the first rescue package, agreed in May 2010, was not enough to stabilise its debts.

But talks about this second deal, including a writedown for Greece’s private-sector lenders, are still continuing. Kapsis told Greek television: “This famous loan agreement must be signed, otherwise we are outside the markets, out of the euro and things will become much worse.”

Reports have emerged since the weekend that the troika could demand fresh austerity measures from Athens in exchange for a new loan to ensure that it meets its targets for reducing the deficit. But Kapsis also said imposing more cuts on a recession-hit nation could be very difficult.

They have threatened to leave the euro within three months unless they get relief:

The Greek government has stepped up the pressure on its eurozone paymasters by warning that unless a new bailout for the recession-hit country is agreed within the next three months it will be forced out of the single currency.

No doubt much of this rhetoric is typical of the posturing that goes on in negotiations, but as austerity programs begin to bite all over Europe, investors will start to worry about and price in the tail-risk of social upheaval and political instability.

The ECB’s LTRO program of unlimited liquidity has bought the politicians some time. Don’t be too surprised if that window of time may be shorter than expected.

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.

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