How Bad Is Europe?

[bmichaud]

How about this for a macro wakeup call....

 

http://pragcap.com/credit-update-chandrasekhar-limit

[biaggio]

http://www.cnbc.com/id/44452871/

 

A Greece bankruptcy would actually be a good thing because "it's time for people to acknowledge reality," well-known investor Jim Rogers told CNBC Friday.

 

Rogers said that if Greece defaults, some other countries will default too—Italy, Spain, Ireland and a few others.

 

If this happens "the euro will go down a far amount. But I would buy all the euro I could at that point because then that would mean that Europe is going to have a very strong, sound currency," he explained. "People can not lie about their finances anyone, people have to run a tight ship."

 

"It would be a lot of pain between now and then, but boy if that happened in the next month or so, buy all the euros you can," Rogers said.

 

Rogers went on to say he was long the U.S. dollar. “The only reason I’m long…is because everybody in the world, including me, has been terribly pessimistic. And whenever that happens you should take the other side of the trade.”

 

 

 

[MrB]

Ditto on the dollar. If all of the above comes to fruition then the dollar will run and in the absence of a meaningful QE3 it will even outperform gold in the short to medium term. However, it is still a case of pick your poison!

[MrB]

Furthermore...

http://www.bloomberg.com/news/2011-09-10/g-7-ends-without-objection-to-yen-action.html

 

 

[tombgrt]

The strength in the EUR/USD pair the last couple of months is/was ridiculous given the structural disadvantages Europe has in comparison with the US. There is no way to tell what a fair value would be, but downside for holding USD instead of EUR seems limited.

 

In their sunday edition, Der Spiegel writes that Wolfgang Schaüble is preparing for a Greek default. Of course it will happen, the question is wether they will be able to contain spreading and a general panic.

 

Would love to switch some USD to industrial companies like SIE if they keep the stock and currency beating up for a while.

 

I am down 5.5% for the year, 1.5% more than 2/3 months ago. I can afford being fully invested.  Anyway, we'll see how it all turns out. Interesting times!

[Myth465]

Finally a step in the right direction - Towards a decision....

 

http://www.smh.com.au/business/world-business/germany-signals-possible-greek-default-20110912-1k4n6.html

 

Monday should be quiet interesting.

[Parsad]

Parsad,

And then...?

How should they deal with Portugal, Spain and Italy?

 

Greece is a whole different ball of wax.  I think the other three nations are manageable if their governments do institute strict measures to control spending and liabilities...not unlike Ireland.  But what that means is a long deleveraging process, contraction of their economies, higher taxes, reduced services and possibly a stagflationary type of environment for a period of time.  It also means protests, pain, political suicide and not saving face.  Finally having to make hard choices!  Cheers!

[Myth465]

Parsad,

And then...?

How should they deal with Portugal, Spain and Italy?

 

Greece is a whole different ball of wax.  I think the other three nations are manageable if their governments do institute strict measures to control spending and liabilities...not unlike Ireland.  But what that means is a long deleveraging process, contraction of their economies, higher taxes, reduced services and possibly a stagflationary type of environment for a period of time.  It also means protests, pain, political suicide and not saving face.  Finally having to make hard choices!  Cheers!

 

The question is whats in it for them.....

 

I see what Germany wants (control, they want to prevent devaluations to gain competitiveness and a single currency for ease of transactions) and what they are willing to give (not much). Without low bond rates, I dont see what the South gets out of this. Politicians will prefer to weaken currency vs. austerity.... I know I would...

[Viking]

Governments will not make the final necessary changes (as they will be VERY unpopular) until they feel they have a gun to their head. The markets are focussed on Greece at present and it is pretty apparent that default is coming. After Greece is savaged, and similar to 2008, markets will then focus on the next weak link (pick one... Ireland, Portugal perhaps Spain). Bond yields will spike and another will likely default. And then they will relentlessly move on to the next weak victim like a pack of hyenas tooking for the next kill.

 

What made 2008 very scary was that it played out for so long and one domino knocked over the next domino and so forth. It was not predictable HOW bad things were going to happen or even WHICH companies would be the losers or the survivors. At a marco level it was clear that bad things were likely going to happen.

[Packer16]

I agree with you Myth (what does Greece and the South get out of this)?  I think once Greece defaults and devalues or goes out of the Euro the temptation for others in the South (Spain, Portugal and possibly Italy) to do the same will just be too tempting.  Why put your country through all the pain to support some German and French banks/exporters?  The losers here will be Germany as their exports to the other Euro countries will collapse.  I do not think the export levels were real as the banks were financing export purchases with money that was too cheap.  Sort of like the dot com/telecom buuble.

 

 

Packer

[Munger]

Good insights from Maudlin this week -- long but for those interested in Europe, worth a read...no easy choices ahead for Europe.  Not that easy for Greece or Germany or any other country to just leave the Euro.  Buckle up.

 

 

 

 

“I am sure the Euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created.”

- Romano Prodi, EU Commission President, December 2001

Prodi and the other leaders who forged the euro knew what they were doing. They knew a crisis would develop, as Milton Friedman and many others had predicted. They accepted that as the price of European unity. But now the payment is coming due, and it is far larger than they probably thought.

This week we turn our eyes first to Europe and then the US, and ask about the possibility of a yet another credit crisis along the lines of late 2008. I then outline a few steps you might want to consider now rather than waiting until the middle of a crisis. It is possible we can avoid one but, as I admit, whether we do (and the extent of such a crisis) depends on the political leaders of the developed world (the US, Europe, and Japan) making the difficult choices and doing what is necessary. And in either case, there are some areas of investing you clearly want to avoid. Finally, I turn to that watering-hole favorite, the weather, and offer you a window into the coming seasons. Can we catch a break here? There is a lot to cover, so we will jump right in.

 

The Consequences of Austerity

 

The markets are pricing in an almost 100% certainty of a Greek default (OK, actually 91%), and the rumors in trading circles of a default this weekend by Greece are rampant. Bloomberg (and everyone else) reported that Germany is making contingency plans for the default. Of course, Greece has issued three denials today that I can count. I am reminded of that splendid quote from the British ’80s sitcom, Yes, Prime Minister: “Never believe anything until it’s been officially denied.”

Germany is assuming a 50% loss for their banks and insurance companies. Sean Egan (head of very reliable bond-analyst firm Egan-Jones) thinks the ultimate haircut will be closer to 90%. And that is just for Greece. More on the contagion factor below.

“The existence of a ‘Plan B’ underscores German concerns that Greece’s failure to stick to budget-cutting targets threatens European efforts to tame the debt crisis rattling the euro. German lawmakers stepped up their criticism of Greece this week, threatening to withhold aid unless it meets the terms of its austerity package, after an international mission to Athens suspended its report on the country’s progress.

“ ‘Greece is “on a knife’s edge,”’ German Finance Minister Wolfgang Schaeuble told lawmakers at a closed-door meeting in Berlin on Sept. 7, a report in parliament’s bulletin showed yesterday. If the government can’t meet the aid terms, ‘it’s up to Greece to figure out how to get financing without the euro zone’s help,’ he later said in a speech to parliament.

“Schaeuble travelled to a meeting of central bankers and finance ministers from the Group of Seven nations in Marseille, France, today as they face calls to boost growth amid increasing threats from Europe’s debt crisis and a slowing global recovery.” (Bloomberg: see http://www.bloomberg.com/news/2011-09-09/germany-said-to-prepare-plan-to-aid-country-s-banks-should-greece-default.html)

(There is an over/under betting pool in Europe on whether Schaeuble remains as Finance Minister much longer after this weekend’s G-7 meeting, given his clear disagreement with Merkel. I think I take the under. Merkel is tough. Or maybe he decides to play nice. His press doesn’t make him sound like that type, though. They are playing high-level hardball in Germany.)

Anyone reading my letter for the last three years cannot be surprised that Greece will default. It is elementary school arithmetic. The Greek debt-to-GDP is currently at 140%. It will be close to 180% by year’s end (assuming someone gives them the money). The deficit is north of 15%. They simply cannot afford to make the interest payments. True market (not Eurozone-subsidized) interest rates on Greek short-term debt are close to 100%, as I read the press. Their long-term debt simply cannot be refinanced without Eurozone bailouts.

Was anyone surprised that the Greeks announced a state fiscal deficit of €15.5 billion for the first six months of 2011, vs. €12.5 billion during the same period last year? What else would you expect from increased austerity? If you reduce GDP by as much as Greece attempted to do, OF COURSE you get less GDP and thus lower tax revenues. You can’t do it at 5% a year, as I have pointed out time and time again. These are the consequences of allowing debt to get too high. It is the Endgame.

[Quick sidebar: If (when) the US goes into recession, have you thought about what the result will be? A recession of course means lower GDP, which will mean higher unemployment. That will increase costs due to increased unemployment and other government aid, and of course lower revenues as tax receipts (revenues) go down. Given the projections and path we are currently on, that means even higher deficits than we have now. If Obama has his plan enacted, and if we go into a recession, we will see record-level deficits. Certainly over $1.5 trillion, and depending on the level of the recession, we could scare $2 trillion. Think the Tea Party will like that? Governments have less control than they think over these things. Ask Greece or any other country in a debt crisis how well they predicted their budgets.]

The Greeks were off by over 25%. And they are being asked to further cut their deficit by 4% or so every year for the next 3-4 years. That guarantees a full-blown depression. And it also means lower revenues and higher deficits, even at the reduced budget levels, which means they get further away from their goal, no matter how fast they run. They are now in a debt death spiral. There is no way out, short of Europe simply bailing them out for nothing, which is not likely.

Europe is going to deal with this Greek crisis. The problem is that this is the beginning of a string of crises and not the end. They do not appear, at least in public, to want to deal with the systemic problem of too much debt in all the peripheral countries.

Without ECB support, the interest rates that Italy and Spain would be paying would not be sustainable. I can see a path for Italy (not a pretty one, but a path nonetheless) but Spain is more difficult, given the weakness of its banks and massive private debt. These are economies that matter.

How do they get out of this without a debt crisis on the scale of 2008? By coming to grips with the problem. Germany is apparently doing that this weekend, by preparing to use the money it was going to pour into Greece to shore up its own banks. That is a much better plan. But as a well-researched report (by Stephane Deo, Paul Donovan, and Larry Hathaway in the London office – kudos, guys!) from UBS shows, solving the problem will be very costly. The next few paragraphs are from their introduction.

 

Euro Break-Up – The Consequences

 

“The Euro should not exist (like this)

“Under the current structure and with the current membership, the Euro does not work. Either the current structure will have to change, or the current membership will have to change.

 

“Fiscal confederation, not break-up

“Our base case with an overwhelming probability is that the Euro moves slowly (and painfully) towards some kind of fiscal integration. The risk case, of break-up, is considerably more costly and close to zero probability. Countries cannot be expelled, but sovereign states could choose to secede. However, popular discussion of the break-up option considerably underestimates the consequences of such a move.

 

“The economic cost (part 1)

“The cost of a weak country leaving the Euro is significant. Consequences include sovereign default, corporate default, collapse of the banking system and collapse of international trade. There is little prospect of devaluation offering much assistance. We estimate that a weak Euro country leaving the Euro would incur a cost of around €9,500 to €11,500 per person in the exiting country during the first year. That cost would then probably amount to €3,000 to €4,000 per person per year over subsequent years. That equates to a range of 40% to 50% of GDP in the first year.

 

“The economic cost (part 2)

“Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalization of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around €6,000 to €8,000 for every German adult and child in the first year, and a range of €3,500 to €4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year. In comparison, the cost of bailing out Greece, Ireland and Portugal entirely in the wake of the default of those countries would be a little over €1,000 per person, in a single hit.

 

“The political cost

“The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the Euro would incur political costs. Europe’s ‘soft power’ influence internationally would cease (as the concept of ‘Europe’ as an integrated polity becomes meaningless). It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.”

 

 

Welcome to the Hotel California

Welcome to the Hotel California

Such a lovely place

Such a lovely face

They livin’ it up at the Hotel California

What a nice surprise, bring your alibis

 

Last thing I remember, I was running for the door

I had to find the passage back to the place I was before

“Relax,” said the night man, “We are programmed to receive.

You can check out any time you like, but you can never leave!”

- The Eagles, 1977

You can disagree with the UBS analysis in various particulars, but what it shows is that there is no free lunch. It is not a matter of pain or no pain, but of how much pain and how is it shared. And to make it more difficult, breaking up may cost more than to stay and suffer, for both weak and strong countries. There are no easy choices, no simple answers. Like the Hotel California, you can check in but you can’t leave! There are simply no provisions for doing so, or even for expelling a member.

The costs of leaving for Greece would be horrendous. But then so are the costs of staying. Choose wisely. Quoting again from the UBS report:

“… the only way for a country to leave the EMU in a legal manner is to negotiate an amendment of the treaty that creates an opt-out clause. Having negotiated the right to exit, the Member State could then, and only then, exercise its newly granted right. While this superficially seems a viable exit process, there are in fact some major obstacles.

“Negotiating an exit is likely to take an extended period of time. Bear in mind the exiting country is not negotiating with the Euro area, but with the entire European Union. All of the legislation and treaties governing the Euro are European Union treaties (and, indeed, form the constitution of the European Union). Several of the 27 countries that make up the European Union require referenda to be held on treaty changes, and several others may choose to hold a referendum. While enduring the protracted process of negotiation, which may be vetoed by any single government or electorate, the potential secessionist will experience most or all of the problems we highlight in the next section (bank runs, sovereign default, corporate default, and what may be euphemistically termed ‘civil unrest’).”

Leaving abruptly would result in a lengthy bank holiday and massive lawsuits and require the willingness to simply thumb your nose in the face of any European court, as contracts of all sorts would have to be voided. The Greek government would have to “conveniently” pass a law that would require all Greek businesses to pay back euro contracts in the “new drachma,” giving cover to their businesses, who simply could not find the euros to repay. But then, what about business going forward?

Medical supplies? Food? – the basics? You have to find hard currencies for what you don’t produce in the country. Greece is not energy self-sufficient, importing more than 70% of its energy needs. They have a massive trade deficit, which would almost disappear, as who outside of Greece would want the “new drachma?” Banking? Parts for boats and business equipment? The list goes on and on. Commerce would slump dramatically, transportation would suffer, and unemployment would skyrocket.

If Germany were to leave, its export-driven economy would be hit very hard. It is likely that the “new mark” would appreciate in value, much like the Swiss Franc, making exports from Germany even more costly. Not to mention potential trade barriers and the serious (and probably lengthy) recession that many of their export and remaining Eurozone trade partners would be thrown into. And German banks, which have loaned money in euros, would have depreciating assets and would need massive government support. (Just as they do now!)

Can a crisis be avoided? Yes. But that does not mean there will be no pain. We can avoid a debt debacle in the US, but doing so will mean reducing debt every year for 5-6 years in the teeth of a slow-growth economy and high unemployment. It will require enormous political will and mean many people will be unemployed longer and companies will be lost.

Ray Dalio and his brilliant economics team at Bridgewater have done a series of reports on a plan for Europe. Basically, it involves deciding which institutions must be saved (and at what cost) and letting the rest simply go their own way. If they are bankrupt, then so be it. Use the capital of Europe to save the important institutions (not shareholders or bondholders). Will they do it? Maybe.

The extraordinarily insightful and brilliant John Hussman recently wrote on a similar theme. He is a must-read for me. Quoting:

“The global economy is at a crossroad that demands a decision – whom will our leaders defend? One choice is to defend bondholders – existing owners of mismanaged banks, unserviceable peripheral European debt, and lenders who misallocated capital by reaching for yield and fees by making mortgage loans to anyone with a pulse. Defending bondholders will require forced austerity in government spending of already depressed economies, continued monetary distortions, and the use of public funds to recapitalize poor stewards of capital. It will do nothing for job creation, foreclosure reduction, or economic recovery.

“The alternative is to defend the public by focusing on the reduction of unserviceable debt burdens by restructuring mortgages and peripheral sovereign debt, recognizing that most financial institutions have more than enough shareholder capital and debt to their own bondholders to absorb losses without hurting customers or counterparties – but also recognizing that properly restructuring debt will wipe out many existing holders of mismanaged financials and will require a transfer of ownership and recapitalization by better stewards. That alternative also requires fiscal policy that couples the willingness to accept larger deficits in the near term with significant changes in the trajectory of long-term spending.

“In game theory, there is a concept known as ‘Nash equilibrium’ (following the work of John Nash). The key feature is that the strategy of each player is optimal, given the strategy chosen by the other players. For example, ‘I drive on the right / you drive on the right’ is a Nash equilibrium, and so is ‘I drive on the left / you drive on the left.’ Other choices are fatal.

“Presently, the global economy is in a low-level Nash equilibrium where consumers are reluctant to spend because corporations are reluctant to hire; while corporations are reluctant to hire because consumers are reluctant to spend. Unfortunately, simply offering consumers some tax relief, or trying to create hiring incentives in a vacuum, will not change this equilibrium because it does not address the underlying problem. Consumers are reluctant to spend because they continue to be overburdened by debt, with a significant proportion of mortgages underwater, fiscal policy that leans toward austerity, and monetary policy that distorts financial markets in a way that encourages further misallocation of capital while at the same time starving savers of any interest earnings at all.

“We cannot simply shift to a high-level equilibrium (consumers spend because employers hire, employers hire because consumers spend) until the balance sheet problem is addressed. This requires debt restructuring and mortgage restructuring. While there are certainly strategies (such as property appreciation rights) that can coordinate restructuring without public subsidies, large-scale restructuring will not be painless, and may result in market turbulence and self-serving cries from the financial sector about ‘global financial meltdown.’ But keep in mind that the global equity markets can lose $4-8 trillion of market value during a normal bear market. To believe that bondholders simply cannot be allowed to sustain losses is an absurdity. Debt restructuring is the best remaining option to treat a spreading cancer. Other choices are fatal.”

See ( http://hussmanfunds.com/wmc/wmc110905.htm for the rest of the article.)

You think the world’s central banks and main institutions are not worried? They are pulling back from bank debt in Europe, as are US money-market funds. (Note: I would check and see what your money-market funds are holding – how much European bank debt and to whom? While they are reportedly reducing their exposure, there is some $1.2 trillion still in euro-area institutions that have PIIGS exposure.)

Look at the following graph from the St. Louis Fed. It is the amount of deposits at the US Fed from foreign official and international accounts, at rates that are next to nothing. It is higher now than in 2008. What do they know that you don’t?

[Myth465]

Damn thats a long read that I will get to soon enough.

 

Read it all, a very scary article. Thanks for it, definitely shows there are no free lunches.

 

Thanks again for the article, I sold some things in the morning at a nice gain to quoted prices now...

 

-----

 

The most interesting thing that I came across was someone who stated that if Greece left the EU and devalued, they would receive a huge windfall in tourist revenue. I know I went to Croatia (still expensive) instead of Greece due to the Euro. What happens to Italy and Spain when tourists flock to Greece, or when politicians see that the masses are no longer in the squares there.

 

Greece, Spain, and Italy have never been competitive. From what I have read, they simple devalue when things get out of wack. The poor dont travel or hold international assets, and the elites just convert currency over as needed to save in safe currency. Expecting Greece, Spain, or Italy to reshape their public sector, tax regimes, and cut salaries 20% - 30%, and endure a decade of slow to no growth is a foolish expectation in my opinion.  Easier to print.

 

European vacationing will definitely pickup if this doesnt end in a stronger more intertwined euro. I think Germany is making a slight miscalculation. Strong currencies and exporter of machine tools dont work well together. They will end up with the Duestchmark and will be priced out of the export game if they dont give up anything. They want to codify rules that I dont think the Southern countries can abide by. Its like the US asking Louisiana not to be towards the bottom of the list in education or road maintenance.

 

-----

 

Here are Krugman's thoughts. This might be a good week for cash, or a good week to not look at stock quotes if you are tapped out...

 

http://economistsview.typepad.com/economistsview/2011/09/paul-krugman-an-impeccable-disaster.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+EconomistsView+%28Economist%27s+View+%28EconomistsView%29%29

[MrB]

Prasad,

“Greece is a whole different ball of wax”

Based on what? What are the main facts that sets Greece apart from PIS?

Myth,

“I dont see what the South gets out of this”

Money! The Greek government is running a deficit. If Greece does not get € 8Bn at the end of this month then it cannot pay its bills. If it defaults then the biggest losers will be the Greek banks>Greek financial system>Greek economy and finally the average Greek. The same goes for the other countries.

 

In general it is also a case of the devil you know. Currently the main issue being played up as the critical issue, is Greece and folks e.g. Germany, can gauge potential costs with a reasonable amount of certainty. However, they do not know what waits for them beyond the Greek default door. If you study historical defaults (IMF data) then you will find that western nations had Debt/GDP ratios of 55% BEFORE it defaulted. That ratio was 85% for the Euro area at the end 2010 according to official data, which means in reality it is probably higher. Which countries came in below the 55%? Poland, Finland, Latvia, Norway, Denmark, Slovakia, Sweden, Czech Republic, Lithuania, Slovenia, Romania, Luxembourg, Bulgaria and Estonia.

 

I acknowledge that one cannot use one ratio in isolation, but it serves the purpose of making the point that Greece is not the main problem and considering that its GDP makes up 1.7% of the EU and its debt 2.8% of EU debt it does not deserve the airtime it is getting.

So it begs the question, why is it getting all this airtime? From the list of countries mentioned above you will note that all the main commentators in the current debate is absent from that list. So this looks more like a case of let’s focus on the other guy’s problem in order to shift it away from my problems. The big boys all know this. They know Greece is not the real problem and that they ALL have a problem and they are in effect trying to deleverage slowly, but they are losing control.

 

This ultimately just serves to prove the point yet again that the main danger with debt is that it takes your flexibility away. Excess reserves are like shock absorbers in a car. If you take reserves out and add debt you are taking out the shock absorbers, which you might fail to notice while cruising on the QEW or the M25 or the I95. However, never ever go “off-roading”!

 

Don’t underestimate the incentive to save Greece. Not only in light of the above, but also considering the point that Myth just made, which is the incentive that Germany has to keep it together because it is an export nation that currently enjoys the benefit of a weak currency. Personally I think that is the pivotal point for Germany and Germany is arguably the most important player to watch in this debate.

 

So, the probability of Greece not defaulting might be low, but it is not Zero. Greek govies anyone?

 

 

 

 

[Packer16]

I think the main issue is that what you are asking Greeks, Spanish and Portugese citizens to do is to change thier culture and attitudes about $ or give up thier economic soverignty to Germany.  Some of the cliams of the article appear extreme on the surface.  I am not sure how much I believe the costs to leave the Euro 50% to 60% of GDP.  How is that calculated and what are key assumptions.  Is the 50% to 60% in euro terms or local currency terms?  Also the assumption about having to negotiate to leave and getting EU approval is silly.  If Greece wanted to leave tommorow, they could and would not have to ask premission (they have political soveignty already). 

 

Packer

[Santayana]

Greek 1yr yield up to 139% this morning!

[locutusoftexas]

I have several rules regarding Wall Street. One of them is, "If everyone on Wall Street is saying the same thing, it is either an error or a lie." This applies directly to the European situation and the contention and fear that it is a replay of the US collapse in 2008. The situations are only alike in that they involve debt. In this case, the total amount of Greek debt and the various bonds are known by Greece and the EU. Avoiding default simply requires paying the interest and principle on time. This will happen. In 2008, we had a huge amount of misrated debt instruments, insured only in name and secured by personal debt in the form of the thousands of mortgages -- a morass which could be tracked and analyzed only through the expenditure of great amounts of time and effort. In addition a large percentage of the mortgages were undergoing default in one form or another. In other words, nothing was transparent, except that the underlying assets were collapsing, and, in fact, the rating process appeared, let's say, dubious from a legal standpoint.

 

Some large investors probably are betting on a Greek default and are being aided by the media in trying to force default by portrayal as a fait accompli. Sorry, this is nonsense and Europe does not have to accept these assertions or the desired cure (default, etc.) in contrast to what our banks and country did in 2008-9.

 

Just my opinion,

Tex

[S2S]

If Greece wanted to leave tommorow, they could and would not have to ask premission (they have political soveignty already). 

 

Packer

 

Withdrawal (voluntary or otherwise) of a country(ies) from the Eurozone makes for good talking point but comes with (some say insurmountable) practical challenges.

 

This UBS report does an excellent job of detailing the implicatoins (bank runs, domestic debt defaults, cessation of trades etc):

http://www.scribd.com/doc/64020390/xrm45126

[Parsad]

I have several rules regarding Wall Street. One of them is, "If everyone on Wall Street is saying the same thing, it is either an error or a lie." This applies directly to the European situation and the contention and fear that it is a replay of the US collapse in 2008. The situations are only alike in that they involve debt. In this case, the total amount of Greek debt and the various bonds are known by Greece and the EU. Avoiding default simply requires paying the interest and principle on time. This will happen. In 2008, we had a huge amount of misrated debt instruments, insured only in name and secured by personal debt in the form of the thousands of mortgages -- a morass which could be tracked and analyzed only through the expenditure of great amounts of time and effort. In addition a large percentage of the mortgages were undergoing default in one form or another. In other words, nothing was transparent, except that the underlying assets were collapsing, and, in fact, the rating process appeared, let's say, dubious from a legal standpoint.

 

I think you make some very good points here.  The risks and many of the counterparty liabilities were completely unknown in 2008.  Paulsen, Bernanke and Geithner found out about exposure, only as the losses mounted and the institutions had to seek assistance, thus the drastic action to have institutions merge.  Financial Institution exposure to any of the European soverign nations is known.  While there would be unheaval in any default, it would not be any different than Argentina in 2002 or Iceland in 2008.  Cheers!

[moore_capital54]

Today is the first day we became fully invested in equities since 2003. I am prepared to increase leverage from 0 to 20% as well. Either im wrong or equities are extremely cheap here.

[rranjan]

Today is the first day we became fully invested in equities since 2003. I am prepared to increase leverage from 0 to 20% as well. Either im wrong or equities are extremely cheap here.

 

Neither you are wrong nor equities in general are extremely cheap :)

 

I am sure you don't buy the whole market and there are many individual bargains present to be picked up.

 

[bmichaud]

Today is the first day we became fully invested in equities since 2003. I am prepared to increase leverage from 0 to 20% as well. Either im wrong or equities are extremely cheap here.

 

I'm not being a smart-ass, I'm legitimately curious how today compares to March 2009 for you guys. Do you think (I truly do not know) the risk/reward is better now than it was in March 2009? Since this is the first time you've been fully invested since 2003 I'm obviously assuming you were not at the March 2009 lows...

 

[moore_capital54]

We were only about 50% invested in March 2009 lows, and about 30% in really attractive preferred/fixed income situations but the difference in my view was that 2008/2009 was uncharted territories I personally did not know that central banks had the right or authority to backstop the system the way they did. It only started resonating towards the end of April and even then it was kind of a new element that we had to incorporate into how we viewed the market.

 

So today I view the market knowing that, central banks will always step in to support any systemic crises with the creation of new money ad infinitum. We can argue about whether that will in turn cause money supply to expand or not, I am not debating that point, because I feel comfortable buying some of these equities at 5-6% dividend yields and 3-4x EV/EBIT.

 

With that said, and in full disclosure, this view has not served us well, as of today we are down about 11% YTD in our equity portfolio, resource funds are still up over 10%.

 

But I just don't think I am wrong about this. I don't see any of the issues we are facing as more dangerous than a potential shut-down of the economic system which is what we faced in 2008. ECB Can play all the games they want, in the end they will print just as Ben will print and even China will print if it ever comes to it.

 

 

 

 

[bmichaud]

We were only about 50% invested in March 2009 lows, and about 30% in really attractive preferred/fixed income situations but the difference in my view was that 2008/2009 was uncharted territories I personally did not know that central banks had the right or authority to backstop the system the way they did. It only started resonating towards the end of April and even then it was kind of a new element that we had to incorporate to how we viewed the market.

 

So today I view the market knowing that, central banks will always step in to support any systemic crises with the creation of new money ad infinitum. We can argue about whether that will in turn cause money supply to expand or not, I am not debating that point, because I feel comfortable buying some of these equities at 5-6% dividend yields and 3-4x EV/EBIT.

 

With that said, and in full disclosure, this view has not served us well, as of today we are down about 11% YTD in our equity portfolio, resource funds are still up over 10%.

 

But I just don't think I am wrong about this. I don't see any of the issues we are facing as more dangerous than a potential shut-down of the economic system which is what we faced in 2008. ECB Can play all the games they want, in the end they will print just as Ben will print and even China will print if it ever comes to it.

 

What makes you confident that a backstop of the financial system will in turn backstop the economy? Even if the ECB prints money ad infinitum, Euro countries are being forced to run fiscal surpluses (do to the fact that they are effectively on the gold standard) thus the European private sector is being forced to run a DEFICIT in order to deleverage. With the Euro private sector being forced into rapid deleveraging, the Eurozone economy has no choice but to sink. It's a debt spiral that no amount of money printing can solve.

 

Declining Eurozone economic activity = lower S&P 500 earnings = lower valuations

[moore_capital54]

Bmichaud I am not sure if I answered your question. In short, I do believe that on  a risk-adjusted basis today at least for me is a safer environment to deploy capital into equities than march 2009, even though back then valuations may have been a bit cheaper (for 5 days maybe)

 

From a grahamian perspective all that matters is margin of safety. On that basis, yes securities were cheaper in march 2009 (again for maybe 2 weeks max during the capitulation phase) but I personally am comfortable with the risk adjustment I have made to account for the fundamental shift in the way markets work.

 

I find it crazy that nobody else has picked up on this.

 

Lets recap:

 

1600-1971 - Central Banks - Had to maintain reserves made up of percious metals which could not be increased at will. Impact on Equities - When things got bad equities could truly decline until demand returned due to fundamentals.

 

1971-2008 - Central Banks - Are now Fiat-Based, can print money at will, but do not do so, opting instead to increase or decrease interest rates, when markets declined, at most the central bank would decrease interest rates. - Impact on equity markets - When times were bad, an investor would have to wait for the cycle to run it's course. Very predictable cycles.

 

2008-2009- Central Banks throw out the rule books, print as much money as they need to sustain the system exchanging newly printed money for any asset so long as it stablizies system - Impact on Equities - Never before seen valuations, in the context of 1971-2009 remained that way for less than a few months, following which the surge of liquidity made equities extremely attractive.

 

So now in 2011, when I see some equities trading at March 2009 levels, (Think BP, CSCO etc) why would I not buy hand over fist? I have the cash to deploy, and my job is to invest it. Why wait? I am not a market timer. These exogenous events will correct themselves and if history is an indicator it will most likely be due to an artificial intervention by central banks.

[moore_capital54]

Bmichaud I don't agree with that. European equities are extremely attractive here, and if we go through the cycle you mention interest rates will be kept artificially low creating, at some point significant demand for equities.

 

I absolutely despise going into all these analysis as I am primarily a bottoms-up investor. But your last argument is effectively a gamble that equity values can decline more, after the STOXX 50 has already declined by 28% and the DAX is down 26%. I am not smart enough to know whether equities will decline further or today was the bottom. I just believe that buying stocks here will produce better returns than cash over time.

 

I am not satisfied with the quality of my posts today, due to a headache and absolutely no free-time, I apologize for the short-responses.