Tuesday 27 April 2010

It is all playing nicely as expected in my post from the 10th of April...

Sovereign debt is now High Yield and Emerging Market is Investment Grade.

I had a thought today following S&P cutting the Greek debt from BBB+ to junk, BB+.

I had a discussion on ratings and perception today:
"GM had S&P's highest investment-grade rating, AAA, from 1954 to 1981. S&P rated Ford AAA from 1971 to 1980."
I remember watching Toyata's rating increase to AAA (although they recently lost it...)while GM moved from AAA to junk.

Same thing is happening now. Sovereigns debt in some Western countries are getting hammered while you can expect ratings from emerging markets to improve in the next couple of years.

In my previous article I was highlighting the upcoming rise of the VIX:


Today Bloomberg is indicating the following:

VIX Jumps Most Since January on Greece Downgrade; VStoxx Gains

"The VIX, as the Chicago Board Options Exchange Volatility Index is known, surged 21 percent to 21.19 at 12:40 p.m. New York time. The index measures the cost of using options as insurance against declines in the Standard & Poor’s 500 Index, which tumbled 1.9 percent. Europe’s VStoxx Index, a gauge of options on the Dow Jones Euro Stoxx 50 Index, climbed 17 percent to 28.56."


Looks like I was right and I am sure people who bought ATM call option on the VIX had a very good day today.

Also I highlighted previously about the Greek tragedy and the high correlation between the country's ratings and the fate of its banks, given that banks are a leveraged play on the economy, it is no suprise that Banks stocks have taken a beating today.

Alpha Bank ADR is down 9.30% today.
Given most of them are privately owned, it is difficult to gauge how they have impacted by today's market move, but given their rating correlation to the country's rating, they will also be seriously downgraded to junk status.

The cost of insuring Greece's sovereign debt against default for five years rose 87 basis points to an all time high of 798 basis points today as per CMA DataVision.
The annual cost of insuring 10 million USD of Greek sovereign debt for 5 years has risen by 87,000 USD to 798,000 USD from Monday's closing level.

Please find the link to the very useful CMA DataVision website which enables you to track CDS levels for sovereign. CDS are a very good indicator for risk monitoring as well as VIX.


Greece 5 year in Euros is currently at around 787.36 bps and the Cumulative probability of Default stands at 46.01 %. The yield on two-year Greek bonds bungee jumped to 15.35% from 13.16% on Monday...

Portugal is already targeted in the contagion list following the Greek troubles...with the current CDS 5 year at 335 bps.

As per Bloomberg:

"While Portugal’s public debt of 77 percent of gross domestic product is on a par with that of France, the burden including corporate and household debt exceeds that of Greece and Italy, at 236 percent of GDP. The savings rate is the fourth-lowest among 27 members of the Organization of Economic Cooperation and Development, according to the Paris-based group’s data."


So much for the V recovery expected by the equities market...

Once again Credit Markets are indicating trouble ahead, as they did back in 2007, following the beginning of the subprime debacle.

As per David Rosenberg's latest review on current economic troubles:

"But Mr. Market at some point will have to confront the future. The time gap between recessions is shortening now — we went 10 years from 1990 to 2000, then 5 years from 2002 to 2007 and the next recession, following this pattern, is likely going to occur within the next 2-3 years. And, unlike the start of the last recession when the government had so many arrows in its quiver, there are none today to help lift the economy again."


To reiterate what David Rosenberg, David Goldman pointed out on various occasions (please see shortcuts to their research on this blog), which I agree with, there will be no real recovery until small businesses start creating jobs and given current credit constraints in the market, it doesn't seem to be happening at the moment.

Thursday 22 April 2010

The results of QE will be an increase in inflation down the line...

The results of QE will be an increase in inflation down the line.

I mentioned this in my post on the 1st of March 2010 in relation to my analysis of the effect of Quantitative Easing in the UK.

16th of February I noticed inflation was creeping up at 3.5 % in the UK.

CPI is now at 3.5% as of yesterday, from 3% in March.

Rates at some point will have to be hiked which will increase seriously the risk for a double dip recession. Not only banks balance sheets have been impaired but individuals balance sheets as well. Unemployment is as well on the rise as expected, as we move towards a stagflation a la "70s" style, as I previously commented on my blog.

It is all playing out.

Saturday 10 April 2010

A run up to the second leg down...and no this time it is not different.

Back in December I highlighted that the theme for 2010 will be sovereign risk and I was also indicating the headwinds facing Greece in particular and the PIIGS in general. Yet the rally runs unabated in the equity market and credit spreads are tightening still, although major structural issues have barely been addressed.

In a previous post as well I encouraged readers of this blog to track the CRB index as I was expecting commodities to surge higher as the "recovery" (which should be rebranded inflation) is gathering pace.

Gold is trading at record level again and oil is also trading much higher. The surge of Oil will have some consequences on the GDP growth. It will start to be a drag before becoming a threat.

At the same time VIX has dropped significantly.

At these levels, VIX is getting my attention and a long dated ATM call option is looking more and more attractive as I expect a volatility spike in the very near future, this summer most likely.

And by the way 42 banks have failed in the US this year so far according to the latest count on the FDIC list of failed banks:


What are the structural issues that needs to be fixed and what are the current threats:

-"Too big to fail" is not acceptable for banks.
Hedge funds can fail and it happens (this what capitalism is all about) and apart from LTCM it hasn't been disruptive to the markets. Banks are not hedge funds and should not be allowed to act like ones using deposit money.

Glass-Steagall act should either be re-enacted or a reduction in leverage should be enforced. The taxpayers and goverments cannot afford bailing out the financial system anymore and in many parts of the world, it is seriously crippled. In Ireland for instance, the situation for Anglo Irish Bank isn't great to say the least and they need additional injection of capital directly from the government to shore up their core capital and tier one ratio which has been seriously impaired by the hits they have taken on their loans. The level of their NPL (Non Performing Loans = really bad property loans...)is staggering: 11 billions of Euros, of which 4.2 Billions of Euros have already been provided. AIB’s equity core tier 1 at the end of 2009 was 5 per cent, excluding the 3.5 billion euros of preference share investment done by the Irish government previously!

Ireland’s “bad bank” — the National Asset Management Agency (NAMA) is initially removing 16 billion euros of bad loans from three of the five Irish participating banks to purge their balance sheet.
An estimated 80 billions Euros of bad loans will eventually be transferred by September
The Irish taxpayers will be picking up the tab for the next 7 to 10 years it will take to clean up the mess...

-OTC products in general and CDS in particular: they should be cleared on exchanges -period. It would reduce counterparty risk as well as adding liquidity and transparency.

-Senator's Chris Dodd proposed bills at the US Congress for the FED are purely and simply dangerous and seriously threatening the already impaired independance of the FED.


-Greece, the tip of the Iceberg.
1999 rating of Greece before joining the Euro: BBB+
9th of April 2010: Greece rating according to Fitch is now BBB-
The end of the game is approaching fast, similar to Lehman's situtation prior to its demise, Greece is experiencing massive capital flight from its banks, 10 billions euros have already been pulled out of Greek banks. Unsecured consumer borrowings for Greek banks has increased from 10% in 2003 to more than 20% today as a percentage of household disposable income (this figure is 23% in the US). Although Greek banks, have better tier one ratios than their Irish counterparts, the capital flight they are experiencing is fast and furious and doesn't bode well for their funding needs. Always remember that the banking industry is a leveraged play intensively correlated to the economy it is operating in and given the GDP contraction Greece has experienced and the state of the public finances, their fate is linked. Before Fitch's downgrade on Greece, National Bank, EFG Eurobank and Alpha Bank's ratings where BBB neg according to Fitch. You can expect Greek banks to be downgraded as well.
It is truly a Greek tragedy.

-United Kingdom upcoming elections: Conservatives need a clear majority, markets would react negatively to a hung parliament which could slow down much needed spending cuts and hurt even more the GBP. Soros is now talking about devaluation being an option for the UK government recently at a conference organised in Cambridge. It could be effective in reducing the debt burden, boosting exports in the short term but inflationary in the long term which would mean rates hikes down the line.
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