Read the market reaction, not the Summit statement


Author Cam Hui

Posted: 29 June 2012

As we approach yet another crucial European summit, the bargaining is becoming more intense. While the Merkel quote of “I don’t see total debt liability as long as I live” got the headlines, there is no doubt a lot of jockeying behind the scenes. Various proposals are being floated, including a package of “banking union, a fiscal union and further steps towards political union”, and intense pressure is being put on the Germans to yield.

The forecasts are all over the map. While the consensus is that Germany will have to eventually bend on the issue of eurobonds, though not necessarily at this summit, others like Ray Dalio (via Zero Hedge) say, “Don’t count on it!”

While I am not expecting the Germans to change the lines of their national anthem to Europa, Europa über alles, nor do I expect an admission of failure this summit. Most likely, we will see the typical European fudge, or an announcement of “we have a secret plan to have a plan.”

While I am mildly interested in the summit statement, I am much more interested in the market reaction. If I am right and we get a “we have a plan to have a plan” kind of announcement, will the market rally or sell off? Gauging the market to news gives me much more important clues as to whether the bulls or bears are in control of this market.

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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Are Eurobonds the Solution?


Author Larry Berman

Posted: 30 May 2012 re-posted from etfcm

Last week Italian Prime Minister Mario Monti suggested that Eurobonds might be the solution that would help calm the financial markets and that German Chancellor Angela Merkel was opening up to the idea. From our point of view, Merkel will be open to anything that gets her elected again next year, much like Obama and Romney will say just about anything to get elected this year.

The political theatre is about to heat up in the US and Germany in the coming months and Main Street will learn, like they did last summer, just how bad things are when the US likely gets downgraded again in early 2013 in absence of a credible plan to significantly reduce the deficit and debt.

But Germany is not the stalwart that Europe believes it is, they are neck-deep in toxic debt too. German Bund yields are falling faster than US Treasuries these days as money is being scared out of the weaker peripheral countries and the stronger ones like Germany are going to have to foot the bill.

Watch German bund yields closely as a signal that investors are sensing that Eurobonds are coming. When Bund yields start to rise, investors are showing concern that Germany may not be able to carry the debt burden of the entire EU. If so, it will be another really big band-aid for a while, but as we have written here many times in the past year, throwing more debt at a debt problem is not a solution. For Monti and Italy, it would be a great help, but will stop well short of fixing the problem. As we have seen in Greece and elsewhere, severe austerity is not being tolerated as an entire generation has been weaned on the government dole which simply needs to stop.

In the US, the political theatre heats up after the Republican convention in late August, after which attention may turn back to see the US is fiscally bankrupt. In the mean time, corporate earnings and outlooks are ever so slightly on the decay…stay tuned.

Poor starving children in China…


Author Cam Hui

Posted: 28 May 2012

It is said that American parents used to admonish their children to eat their dinner because “there are poor starving children in China.”* In a recent interview with the Guardian, IMF chief Christine Lagarde invoked the poor starving children metaphor when speaking about Greece [emphasis added]:

So when she studies the Greek balance sheet and demands measures she knows may mean women won’t have access to a midwife when they give birth, and patients won’t get life-saving drugs, and the elderly will die alone for lack of care – does she block all of that out and just look at the sums?

“No, I think more of the little kids from a school in a little village in Niger who get teaching two hours a day, sharing one chair for three of them, and who are very keen to get an education. I have them in my mind all the time. Because I think they need even more help than the people in Athens.” She breaks off for a pointedly meaningful pause, before leaning forward.

“Do you know what? As far as Athens is concerned, I also think about all those people who are trying to escape tax all the time. All these people in Greece who are trying to escape tax.”

Even more than she thinks about all those now struggling to survive without jobs or public services? “I think of them equally. And I think they should also help themselves collectively.” How? “By all paying their tax. Yeah.”

In summary, Lagarde is admonishing the Greeks to get on with eating their vegetables. This seems to be a clever piece of negotiating on her part as a way of pushing two parties towards a middle ground, becuase last week, the WSJ reported that she was pushing Germany to accept eurobonds:

International Monetary Fund head Christine Lagarde Tuesday called on euro-zone governments to accept more common liability for each other’s debts, saying that the region urgently needs to take further steps to contain the crisis.

“We consider that more needs to be done, particularly by way of fiscal liability-sharing, and there are multiple ways to do that,” Lagarde told a press conference in London to mark the completion of a regular review of U.K. finances.

I wrote last week (see A Canadian’s roadmap to Greek struggles) that to expect Europe to show both a carrot and a stick to the Greeks. Lagarde offered them a carrot last week in the form of tacit support for eurobonds. Now she is showing them a stick.

* I can still recall the Doonesbury cartoon from the 1970’s of the Chinese parent admonishing his son to eat his jellied duck web because there are poor starving children in West Virginia.

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.

Draghi, the last domino falls


Author Cam Hui

Posted: 25 May 2012

As expected, the Latin quarter of the eurozone ganged up on Germany on the issue of eurobonds, but Angela Merkel stood fast. But Germany is becoming increasingly isolated. The WSJ report that Christine Lagarde of the IMF came out in support of the concept of eurobonds:

International Monetary Fund head Christine Lagarde Tuesday called on euro-zone governments to accept more common liability for each other’s debts, saying that the region urgently needs to take further steps to contain the crisis.

“We consider that more needs to be done, particularly by way of fiscal liability-sharing, and there are multiple ways to do that,” Lagarde told a press conference in London to mark the completion of a regular review of U.K. finances.

So did the OECD:

Her comments came an hour after the Organization for Economic Cooperation and Development had, for the first time, endorsed joint bond issuance in its latest Economic Outlook

Angela Merkel’s staunchest ally has been Mario Draghi of the European Central Bank. Up until now, Draghi had been relatively silent on the Greek crisis. He spoke yesterday at at the Sapienza University in Rome and addressed the latest eurozone crisis in an unusually frank manner [emphasis added]:

We are living at a critical juncture in the history of the Union. The sovereign debt crisis has exposed serious weaknesses in the institutional framework; in this context, the difficulties in finding common solutions are having a negative impact on market valuations. The extraordinary measures taken by the ECB have gained us time; they have preserved the functioning of monetary policy.

But we have now reached a point where European integration, in order to survive, needs a bold leap of political imagination. It is in this sense that I have referred to the need for a “growth compact” alongside the well-known “fiscal compact”.

He went on to explain what he meant by a “growth compact”, namely closer economic integration:

A growth compact rests on three pillars and the most important one, from a structural viewpoint, is political: the economic and financial crisis has challenged the myopic belief that monetary union could remain just that, and not evolve into something closer, more binding, into an arrangement whereby national sovereignty on economic policy is replaced by the Community ruling. If the governments of the Member States of the euro define jointly and irrevocably their vision of what the political and economic construct that supports the single currency will be and what the conditions to reach that goal together should be. This is the most effective answer to the question everyone is asking: “Where will the euro be in ten years’ time?”.

Hmm, sounds sort of like an endorsement of eurobonds to me.

He went on to talk about “structural reforms”, which I wrote about extensively in the past (see Mario Draghi reveals the Grand Plan). It means, in effect, structural reforms at the micro-economic level so that it’s easier to fire people. It also means internal devaluation by the peripheral countries:

The second pillar is that of structural reforms, especially, but not only, in the product and labour markets. The completion of the single market and the strengthening of competition are crucial for growth and employment. Labour market reforms that combine flexibility and mobility with a sense of fairness and social inclusion are essential.

Growth and fairness are closely connected: without growth, and the events of recent months also reflect this, the temptation to “circle our wagons” gains strength, and solidarity weakens. Without fairness, the economy breaks up into multiple interest groups, no common good emerges as a result of social and economic interaction, and there are negative effects on the capacity to grow. Recent Italian history has no shortage of examples.

By fairness, he refers partly to the high level of youth unemployment compared to the entrenched older generation with their job security and gold-plated pension plans:

In the European Union, between 2007 and 2011 the unemployment rate rose by 5.8 percentage points among the 15-24 year olds, by 3.5 points among the 25-34 year olds and by 1.8 points in the 35-64 age range. Qualitatively, the profile is similar almost everywhere; the clear exception is Germany, where the unemployment rate among 15 to 24 year olds in the first quarter of 2012 was 8%; in Italy it was 34.2%, in Spain 50.7% and the euro area average was 21.9%. These trends reflect a fundamental question: they confirm the particular vulnerability of this essential part of our workforce. The unequal sharing of the “cost of flexibility”, only affecting young people, an eternal flexibility with no hope of stabilisation, leads among other things to companies not investing in young people, whose skills and talents often decline in jobs with low added value. The underuse of their resources reduces growth in various ways: it makes the creation of start-ups less likely – and they are on average more innovative than others – it causes a decline in skills in the long run, slowing down the assimilation of new technology and acting as a brake on efficient production processes. In addition to undermining society’s sense of fairness, it is a waste that we cannot afford.

In addition, Draghi endorsed the idea of pan-European infrastructure bonds:

The third pillar is the revival of public investment: the use of public resources to push forward investment in infrastructure and human capital, research and innovation at national and European levels. (The proposed strengthening of the EIB and the reprogramming of Union structural funds in favour of less-developed areas go in this direction).

An endorsement of closer economic integration? A advocate for pan-European infrastructure bonds, which is the first step in the slippery slope to eurobonds?

It sounds like Merkel is losing her last ally in Mario Draghi. Expect the Germans to bend sooner than 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.

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.

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