Europe End Game

So the EU has taken the first steps towards fiscal union. Economists, ever ignorant of actual history, are repeating a mantra that currency unions and fiscal unions must go together and if they don’t a currency union is doomed. So the stock markets are happy and the can has apparently been kicked again.

To a degree, this can kicking is significant. As long as the periphery countries engage in actual serious austerity, then it is highly likely that the ECB will monetize bonds right around significant rollover dates and actual default of the insolvent can be pushed back. And since this perma-austerity means that Europe is now going to head into a deep recession/depression, it is likely that the price manifestations of monetary inflation won’t appear. Why stock markets think this is good news is baffling. It is good news for debt markets and for the euro currency (short-term) — but not for equities.

What this can kicking does do is really change the politics. Greece is now basically irrelevant. They will agree on some default – when default is deemed to be non-contagious. Greek bonds are probably a good speculation here. They are already pricing in a large default – and the profit would arise from this taking a bit longer than people think. Once they default, Greece is again irrelevant.

Italy is now being run by ECB and Goldman Sachs. The technocrats will wear out their welcome – and, most likely, screw things up. But for now, Italy was weary of bunga-bunga Berlusconi and is glad to be rid of him. Short-term, Italian bond rollovers will be “taken care of” (read monetized to some degree) and very short-term Italian debt (less than two years) may be OK – in small doses. If/when Italy defaults; the Italian equity market is really really cheap already. The only thing it isn’t pricing in is perma-austerity and the nationalization of banks. But still – I’m in wait/watch mode.

France is now the AAA country on the chopping block. If they lose that – via having to nationalize a bank probably – then all bets are off for everything. Avoid French banks via any channel – via French equity indices, French government debt, US money market funds, companies with callable loans, etc. When the ratings agencies do move on this, things may be different. But that is for the future. French elections (April 2012) also play a big short-term role. If Sarkozy is re-elected (35% chance); then things remain the same. If the Socialists are elected (55% chance), then the whole euro negotiation stuff rolls back to square one and, best case, we get to relive Groundhog Day (all the euro can-kicking since May 2010). Worst case, the markets say “enough” – and force the crisis endgame in a disorderly way. If Marine LePen is elected (10% chance); then watch out below because everything will become disorderly fast. IOW – there is no real positive outcome here — so this election uncertainty is likely to weigh on markets until April.

Spain actually looks OK here. They really don’t have much government debt – far less than the US. They do have a serious housing bubble that hasn’t burst yet and that could be a problem for large parts of the economy. But Spain also has very large financing exposure to Latin America and that can really be a positive for many companies (including banks). I kind of like the Spanish equity markets here – if I can avoid the Spanish banks/housing stuff.

Germany is in the catbird seat for now. Or so they think. Everyone else in Europe will have to undergo serious government austerity if they want bailout/fiscal transfers from Germany. And the morons in the US seem willing to bailout the eurozone if the Germans hesitate (which is bad news for the US – but not for Germany). However, Germany has relied on exporting to the rest of the eurozone for its economic health. That is going to disappear with austerity — and fast. German companies that export to the non-eurozone seem to be the best positioned for now. But if the US does bailout the eurozone via the IMF, then the DAX is the place to be. Germany will NOT pull out of the eurozone. At least not first. Any rumors to the contrary are complete and utter BS. It won’t happen – for a host of reasons.

The fiscal union pulls the UK into the political problem. The continent despises the Anglos and the institutions of the eurozone fiscal union seem like they will be the same institutions as the broader institutions of the EU. That presents a real problem for the UK. The eurozone could easily vote for increased taxes on things that mostly affect the UK (eg Tobin tax) and use that to fund their fiscal transfers. If that happens, the UK will have to seriously consider dropping out of the EU — which will in turn ignite trade wars and protectionism a la the 1930’s.

Likewise, the US is now to a lesser degree pulled into the problem via NATO. Eurozone “austerity” means that Euro defense spending will go from anemic to nonexistent. The US already carries NATO on its back anyway but these changes would make it obvious to even the moronic in the US. Unfortunately, “moronic” is what the powers-that-be ASPIRE to in the US – and no one except Ron Paul is talking about ending NATO subsidies or ending an alliance that has ceased to serve any actual function.

In sum, I do suspect that this can-kicking does “work” in the sense that it delays/hides the sovereign debt crisis and removes it from the headlines for awhile. Markets still need to price in a serious deep perma-recession in Europe – but that is a different dynamic. I think volatility is likely to drop a bit going forward. But equity markets will not be rising from here. An ugly slow steady grind-down in the first half of 2012 is the most likely scenario IMO. If the austerity actually works – and Europeans reduce government spending/entitlements and allow for semi-free markets again; then Europe is going to be a far far far better buy at the trough than the US is. We in the US have not even begun to face those problems and our longer-term outlook is currently just as bad as Europe.

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International Equity Valuations

Not really interested in any longs right now but did want to see whether any markets have declined to actual “good value” levels. Countries are grouped with similar “risk” countries

True blue-chip countries — None.

AA rank countries:

Country P/S P/B P/CF ROE % Financials
Switzerland 1.5 2.18 10.72 15.1 18.8%
Sweden 1.19 1.33 10.97 14.6 27.9%
Finland .66 1.39 7.9 11.7 13.8%
Norway 1.27 1.63 9.38 11.4 13.3%
Canada 2.01 1.06 12.05 5.2 27.3%

A rank countries

Country P/S P/B P/CF ROE % Financials
Japan .56 .93 3.79 5.3 17.8%
Germany .63 1.34 6.82 12.3 15.4%
France .78 1.28 6.34 10.2 14.9%
Denmark 1.25 1.66 7.02 11.4 14.7%
Netherlands .83 1.33 10.71 11.3 17.9%
Austria .92 1.07 4.04 6.5 39.6%
Singapore 1.92 1.66 -22.2 12.8 46.8%
Hong Kong 2.36 1.52 386.3 13.9 47.0%
Taiwan .89 1.85 8.37 11.9 16.7%
Chile 1.91 2.5 19.94 14.7 18.6%
US 1.20 1.89 6.78 27.5 14.5%

Near Junk countries

Country P/S P/B P/CF ROE % Financials
UK 1.13 1.8 13.21 12.0 18.0%
Belgium .97 1.2 3.7 8.6 23.8%
Spain 1.37 1.26 3.09 14.9 37.8%
Italy .41 .55 9.31 5.44 33.2%
Australia 1.9 1.78 13.68 11.3 37.9%
New Zealand 1.24 1.55 8.2 6.6 12.7%
S Korea .47 1.21 6.27 12.9 14.5%
Czech Rep 2.15 1.95 6.8 18.3 20.0%
Israel 1.58 1.83 8.5 14.3 19.2%
Poland 1.15 1.52 15.35 11.1 37.8%
S Africa 1.36 2.00 11.65 12.5 25.3%
Malaysia 2.24 2.17 46.2 12.5 24.9%
Brazil 1.09 .95 22.04 15.2 24.4%
Mexico 1.82 2.63 10.43 13.9 8.5%

Included the % financials because that’s the sector of every economy that is most tied together and correlated with other countries. There’s some value already in some countries – but still a lot of potential downside in most. Given the total debt level in many of these countries, it’s hard to make a case that any returns will flow thru all that debt and to equity holders. What is most interesting is the fraud in the US re “earnings” – via the unsustainable outlier ROE. The US is now equivalent to – maybe worse than – China or Russia or other insider kleptocracies.

Weekend Update

Equity markets: My long-side trade earlier this week failed because it was one day early and I didn’t have the stomach for the downside volatility which was the first move. Short-term, equity markets are still neutral – with a slight upward bias absent headline news. That “absence of news” could last for the rest of the summer. But the volatility is going to remain. Equities are still not pricing in an economic slowdown – much less another deleveraging/crisis cycle. But they are heavily oversold. That said – half of the “oversold”ness has already been corrected – simply by going nowhere for a few days. So any new equity investment has to lean bullish rather than simply leaning towards an oversold scalp. And intermediate-term – I am more bearish than I was this time last week.

Credit markets: Like last week, these are the key markets. But these generally deteriorated a bit this week. In Europe, Italy/Spain yields fell (presumably because of ECB buying) while Germany/France yields rose. Interbank/overnight/TED spreads are still widening – but are not a problem yet. The ECB may have succeeded in buying a bit of time – but at the cost of directly revealing to Germans what the cost is going to be for them. Ultimately, any credit crisis from Europe is going to be indicated by a)debt auction timing from the four key eurozone sovereigns, b)spreads between the four, c)a banking collapse because of those spreads, and d)indications from Germany as to which way they (the taxpayers not the govt) are leaning re a longer-term fix. I suspect fiscal/transfer union may become the ultimate fix here but that is gonna be a tough sell to Germans who don’t work in banking/exports.

In the US, riskier credit bounced a bit. But the financial sector did not and the first post-AAA 30 year Treasury auction did not go well. And none of it has priced in another deleveraging/default cycle. Treasury funding could become a problem – but the bad news cycle on that is almost certainly over for a few months.

Currencies: The downgrade last week did not affect the dollar as much as it could have. The swissie was the worst performing currency after they intervened. So much for a post-downgrade safe haven. Followed by the two commodity currencies (C$ and A$). Gold was the best performer followed by the yen. The dollar and euro are now lashed together via swap lines. The safe haven trade is still the operative one which doesn’t bode well for equities or commodities. And since the dollar is not going to be downgraded again this week – and since gold/yen are, like the swissie, at/near their breaking points for intervention – I expect the dollar/euro links to weaken a bit and for the dollar to resume its role as safe haven. There simply is no alternative right now and until there is one – the dollar is both the reserve currency and the safe haven currency. Period.

Precious metals: All four performed better than currencies – in order gold (because of the gap up over last weekend), platinum, then a gap to silver, palladium. Going forward, I think the forces that are driving them and the price volatility that results are going to provide for good trades. Longer-term, they will all outperform currencies so offer good risk-reward v cash. Cash however still has the optionality value. All will get some safe haven demand. Gold/silver are the two most vulnerable to deleveraging in the very crowded Western “paper precious” market – and that WILL create big fast price swings. Silver/palladium are the two most vulnerable to poor economic outlooks. Gold/platinum have the lowest-risk downside – but gold’s potential downside is $300 lower than platinum’s – and both will likely respond first to whatever the central bank “trickle-down” (aka QE/bailout) response is to this deflation run. Platinum/palladium have the best response to either short-term supply shocks (S Africa strikes) or longer-term physical supply/demand bottlenecks. In a word – there is opportunity here, and if one is wrong about the shorter-term trade then its ok because the longer-term picture is good. But this applies mainly to the metal/physical itself — not to the miners or options or futures or ETF’s or anything else.

G7 and ECB Intervention

Not a surprise.

The ECB announced on Sunday that they would buy Spanish and Italian and other periphery bonds. The hope being that Asia will help bail out European banks which hold that debt. Kick the can. Kick the can.

The G7 Finance Ministers and Central Bank Governors also met over the weekend and released a statement before the Asia open.

We are committed to addressing the tensions stemming from the current challenges on our fiscal deficits, debt and growth, and welcome the decisive actions taken in the US and Europe. The US has adopted reforms that will deliver substantial deficit reduction over the medium term. In Europe, the Euro area Summit decided on July 21 a comprehensive package to tackle the situation in Greece and other countries facing financial tensions, notably through the flexibilisation of the EFSF. Translation — FU S&P. You are all now criminals with international arrest warrants charged with peeing in the punchbowl.

No change in fundamentals warrants the recent financial tensions faced by Spain and Italy. Translation — WTF do you people think you are? We have told you what to think for decades. And now you are disobeying us?

We welcome the additional policy measures announced by Italy and Spain to strengthen fiscal discipline and underpin the recovery in economic activity and job creation. The Euro Area Leaders have stated clearly that the involvement of the private sector in Greece is an extraordinary measure due to unique circumstances that will not be applied to any other member states of the euro area. Translation — The water is safe for you private investors to buy non-Greek debt. You won’t get screwed. We promise. Scout’s honor.

We reaffirmed our shared interest in a strong and stable international financial system, and our support for market-determined exchange rates. Excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. Translation — We are making plans to centrally-plan currency interventions while uttering soothing words about market-determined exchange rates. When the centrally-planned intervention doesn’t work, we will blame it on the disorderly market since we told you all to behave but you aren’t listening and obeying.

Weekend Update – part2

Now for indicators:

Equity markets:
Short-term – Slightly bearish
Intermediate-term – Very bearish

Markets may be extremely oversold – as in historically oversold – but show no indication of a bottom yet. The tiny number of individual equities that are showing early signs of reversal/strength are – exclusively – either the bearish ETF’s (where technical analysis generally doesn’t work because it triggers too late), bond/safe haven proxy ETF’s, or penny stocks. Sidelines for me.

Credit/bond markets:
Are showing early signs of stress. Riskier, lower priority, and longer-term are being sold relative to higher rated, short-term, or higher priority. Not signs of stability or bottoming or EOTWAWKI priced in. Credit is a leading indicator. This is not a correction for equities. Credit is where the first buy opportunities will pop up. In particular, this is where to get out of the dollar after the current dollar-inflow panic stabilizes/subsides.

International equities:
Nothing looks good here. On an intermediate-term basis though, this is where to focus equity buying when this panic runs its course.

Precious Metals:
Gold is looking OK here. That said, I suspect that going forward, it is too late to buy/add for short-term play here. Safe-haven demand is likely to be met/exceeded by ETF holdings sold to meet margin calls elsewhere. India is not going to be the physical demand savior at these prices. Silver is looking bearish. The inflation play is dead for now. And the SLV ETF is far too crowded with day-traders and speculators. Platinum is looking VERY good. Chinese are buying it hand-over-fist – for jewelry and long-term physical investment – now that platinum is roughly the same price as gold. The platinum/gold ratio of 1:1 is now where it was in the depths of 2008 and before that in the 1990’s (when China was far poorer). At these prices, auto industry demand does not matter. If platinum takes 5% of the gold jewelry market, that will equal auto industry demand. So, the most likely scenario is that it tracks gold for the short-term with far better upside/downside risk when things settle down. Palladium will follow platinum but with a bit more short-term downside risk and a bit more long-term upside.

Commodities:
Fuhgeddaboutit. Agriculturals are the best buy here and there is no hurry. Metals and oil are hugely subject to dishoarding of stockpiles – ie what was demand over the last 2 years can turn around in an instant and become supply.

Currencies:
Uggh. The swissie is the only major safe-haven currency that has not successfully debased. It is extremely overbought and Europe is clearly panicking into it. But the SNB has just announced its version of QE so as/if either the panic subsides or peaks, the swissie will plummet. Shorter-term, at current levels, the swissie is riskier than the dollar. I think the price is now too high for “recognized safe-havenness”. Way too early for commodity currencies – but a mix of second-tier “safe havens” – pound? swedish krone?

Weekend Update

A huge “newsy” week last week helped throw global markets into a serious tailspin. The two biggest are questions re what the ECB can do re Italy and the debt ceiling and downgrade kerfuffle for the US. The latter in fact exacerbates the problems of the former since it throws a risk premia spotlight on France and UK (the two weakest remaining AAA sovereign).

Links:
Impact of the Downgrade — Dead on analysis. The downgrade will exacerbate political schisms in the US as both sides will choose to blame the other (or shoot the S&P messenger) instead of dealing with the problem. The downgrade has more impact on European/global financials than it does on US financials because of the dollar’s reserve status. Trade ideas (assuming no major coordinated PR/actual move by ECB/G7): Long safe havens (Gold, CHF, global big-caps with rock-solid balance sheets and dividends) — this current decline is the last decline for awhile where the dollar will be a safe haven compared to most – you do not want to be in dollars when it ends; long Treasuries (shorter-term) and Euro-periphery debt (on yield spikes). Short euro, short “infrastructure”/commodities (coal, steel, shipping, copper, A$), short bunds, short financials.

Case for Going Global – Stronger than Ever Another dead on (longer term) analysis with a couple aha’s! for me. G7 govt bonds are pricing in slow/no growth; “emerging” govt bonds are pricing in 6-9% growth. ie – G7 is expensive, EM is cheap — on pure yield/price. EM’s have 2x more foreign exchange reserves than the entire G7 combined – and far lower govt debt. EM’s are undercapitalized (aha! – inflation there is more a consequence of “hot money” inflows relative to a small existing capital stock – iow – their inflationary pressures will drop as their GDP grows). G7 countries are all in for decades of deflationary pressure and capital exodus. EM equity markets still have lower PE’s – so they are pricing in slow growth. Trade flows are increasingly among EM’s themselves – and that will accelerate. Big disconnect/opportunity. Volatility is here to stay – because capital productivity increases (which precede GDP increases) in EM’s won’t be smooth and because G7 relative decline will also be herky-jerky. Trades: Long EM bonds, short G7 bonds. Long capital surplus countries (mostly Asia). Long commodities. Long EM equities – esp mass consumer and infrastructure – not traditional exporters. Long/watch solid financials focused on allocating capital to EM’s — ie with no legacy balance sheet in G7.

That latter link is intermediate-term. Shorter-term, the trade is still risk-off – and for EM’s that can mean “hot money inflows” turn on a dime into “hot money outflows”. But these are the opportunities to buy the dip.

My own thoughts. Any conflict between “hyperinflationists” and “deflationists” is over for awhile. The hyperinflation scenario is dead. Deflationists have won. Non-G7 will be dealing with inflationary surges – but those pressures will diminish over time. G-7 is solidly in deflation — until such time as existing debt is repudiated. Which is emphatically NOT happening any time soon. Yes – prices of non-asset “stuff” will increase in G7 and squeeze the snot out of consumers (esp the poor and the middle class and the young). But that is NOT hyperinflation or money printing.

Ugly Ugly

Equity markets worldwide dumped 4-8%. Commodity markets dumped. Junk bonds fell 2-3%. Investment grade and sovereign bonds rose a bit. Gold skyrocketed – and then fell (probably the beginning of margin calls). The TED spread is still low at 26 bps – but rising fast. Given zero interest rates for short-term debt – the risk of a global liquidity crunch or flash crash will rise sharply if it hits 40 bps. Still however a long way from a 2008 level liquidity crunch (100-400 bps). S&P500 VIX is at 31.6 – so now in parabolic panic mode. The swissie and the dollar were the only safe havens today – and both are now in full QE mode to debase themselves.

Technically, markets are still ugly. Oversold but no indication that any tradeable bottom has been reached. The S&P500 just hit “correction” mode today (10% off peak). European markets are in full bear market mode. I really don’t see how the massive numbers of serious problems can just be dismissed/ignored by US equity investors as part of a normal “correction”. More pain is due.

On an intermediate term basis, the technicals are as ugly as I have seen since 2008. On a short-term basis, markets are heavily oversold but zero zero indication of any buyers out there. Given the selling today, any short-term bounce is likely 3+ days away. And the risk of a crash is very high. My guess is that the markets will drop until a new globally coordinated QE to debase fiat money is hinted at. Right now, the most oversold/bearish/negative sentiment sector is industrials. That could change – but if it doesn’t and there is a bounce, that is the one that will likely bounce hardest.

Asia is now dumping. Gold is steady. Rumor is that Italy had bank runs today – so unless the ECB intervenes successfully – tomorrow – the euro experiment will end by next week.

Anyone who is using leverage or who has debt or anything is about to discover how painful that is in a deleveraging deflationary cycle.

We don’t need no steenkin safe haven

Well so much for the swissie and the yen as safe havens. The Swiss National Bank just announced their version of QE in order to halt-reverse the skyrocketing appreciation of the Swiss Franc. The Bank of Japan just announced an intervention to crush the yen. Brazil and Philippines — yeesh – safe havens?!? – just announced their versions of a currency war. Bank of New York just announced that they will charge 13 bps for all large cash deposits. The 3 mo T-bill is now yielding negative interest. Italy is now on the “bailout” list — markets all now shut down — but is too large to bail out. All markets are projectile vomiting – down multiple %.

Gold is up — big — but be very careful buying here. It is a dead bang certainty that CME will raise margins real real soon in order to wash paper longs out. Why the freak don’t they just raise margins to 100% and leave them there. The whole point of gold as an alternative currency is that it is UNLEVERAGED unlike all the other leveraged fast-money speculations out there. And that it therefore does not have to suffer from occasional deleveraging bank-based fiat currencies. Forget about gold mining stocks here — the risks of nationalization and confiscatory taxes worldwide are rising in line with the gold price. Central banks are now panic buying gold — and they will have no problem confiscating gold in the ground if they can’t get gold in the market. These stupid greedy fucks running the world are driving every single fucking economy in the world into a depression. It is time to pry their hands off the levers of power — cold dead hands if necessary.

With all the developed world sovereigns in, basically, various stages of bankruptcy; we could be nearing the Kondratieff winter credit crunch of all credit crunches. Right now, bond vigilantes are only focused on Eurozone – Italy, Spain, etc. But that could change in a nanosecond. All major nation public finances are crap and none are remotely capable of growing out of their debt load. The only thing preventing the emergence of true bond vigilantes – ie investors who are concerned with not only getting paid a reasonable rate of interest but also interested in getting their principal back — is that they have no safe “base” where they can withdraw to if necessary. Currency wars and trade wars are imminent.

Weekly Market Summary

I’m changing my summaries to weekly. It’s a bit less noisy than the daily indicator summary. And a weekly summary allows for a slightly different view and a better investment plan.

Short-term: Slightly negative
Intermediate-term: Neutral

Last week’s pullback turned out to be, generally, more healthy than indicative of something worse. That said, roughly 2/3 of equities still look like this is a false rally overall for them. Like last year, it looks like we are in summer noise mode and have established a trading range for the Memorial Day to Labor Day timeframe.

Currencies
Strongest currencies last week were the two safe-havens – yen and swissie. US$ isn’t a safe-haven until debt ceiling argument is resolved. Weakest currencies last week were euro, A$, and emerging currencies. The swissie is the only currency that is a bit overbought over the last month. It could be vulnerable to either a “risk on” move or a short-term resolution of the US$ “safe havenness”. No currencies are oversold. Longer-term, the barbell currency trade (A$ and swissie) that has performed well over the last year looks overbought – while the US$ looks oversold. Overall, currencies are not indicating a direction for other markets.

International
The healthiest looking equity markets look to be (in no order): Canada, Japan, HK, Singapore, Taiwan, Malaysia, and Mexico

Country Rankings

An assessment of country risk rankings over the foreseeable future. International investing is tougher than domestic simply because the context within which companies operate is not embedded in an investors mind as “normal”. What is “normal” is what we experience here in the US. That doesn’t mean other countries are either the same as here or the same as what the media/financial headlines might imply. Nor does this ranking imply that solid economies are actually growing or that investments there are attractively priced/valued. This is true out-of-the-blue risk – banking system collapse, currency collapse, sovereign default (via whatever method), revolution, etc.

Stable and solid investment environments (risks are lower than the US):
Norway
Sweden
Switzerland
Denmark
Japan
Canada
Hong Kong
Singapore
Taiwan
Chile

Solid environment except for euro currency risks (slightly better than US)
Germany
Finland
Netherlands
Austria

Marginal/borderline (multiple risks – I put the US in the higher end of this category)
France
New Zealand
Israel
Malaysia
Belgium
UK
Italy
Czech Republic
Poland
South Africa
South Korea
Australia
Brazil
Mexico
Peru
Spain

Every other big country is basically junk. I would need a huge discount to invest. However some are definitely on their way up and others on their way down. Not really worth trying to pick them though given what is happening in the major Western markets