OMT – From OMG to MIA & Why It Drives Risk
Even A Risk on/Risk Off World Isn’t This Simple, Or Is it?
This is the S&P 500 since July. We’ve had earnings, elections, open ended QE, attacks on embassies, doubts about the viability of social media as a business, weak economic data out of China, bouts of strength with U.S. economic data, budgets, and stress tests, yet I would argue that the ECB has had the single biggest influence on the market.
While it is impossible to tell what drove the overall trend, let alone any given day, there is a strong case to be made that the ECB has played the biggest role in the “risk on” trade, and for that matter, even the recent “risk-off” trade. The moment Draghi said he was prepared to do “whatever it takes” the market rallied. The ECB press conference immediately after was a bit of a disappointment, but reading between the lines, and the odd use of “transmission” by two ECB members was a good sign that something was in the works.
OMT was announced, and while not the full and easy QE we get out of the U.S. Fed, it was fairly impressive. My initial reaction was to give it an A for Effort but C for Execution. It was the first clear sign that the ECB was looking to take new actions and was working hard to address market concerns. It would rely on the ESM to play a role and was a little short on details, but seemed good.
This was followed up by QE, Spanish budgets, any number of things that added to the view that central banks were watching out for the markets, but then something happened. Spain didn’t ask for the money, the last summit was a flop, and many countries seem to be backtracking on prior promises, rather than becoming more aggressive.
While I think the link between the ECB and the “risk on” trade is clearer than the case for arguing that the inability to start OMT has caused this recent “risk off” trade, I don’t think it is much of a stretch to say it played a major role.
Has “Mañana” finally arrived?
So for me, the biggest question for the market is when Spain will get a bailout and what will it look like? Sure the fiscal cliff is out there, but that isn’t until after the election. The election itself is out there, but I’m not even sure which candidate winning does what to the market. On the one side, Romney is seen more pro-business, but there is a growing concern that labeling China a currency manipulator and demanding a hawkish Fed may not be the best for markets.
So, I think Spain will finally ask for the money, and wouldn’t be surprised to see it happen in the next week.
A lot of “housekeeping” is out of the way. The fiction that passes as the Spanish budget is finished. The fiction that passes as bank stress tests has been completed. Regional elections are not only out of the way, but the demands being placed on the Spanish government by the regions is so high that it will need money. The unemployment rate hit 25%. I’m not sure why 1 in 4 people unemployed seems that much worse than 1 in 4.01 people, but maybe it’s because we can’t imagine a .01 person. ESM is up and running. Bankia’s disastrous quarter (I wonder how it compares to the “stress tests”) also helps pave the way for some capital injections.
Those all either help nudge Rajoy towards asking for money or given enough excuses to the ECB and IMF to be lenient on their conditionality. Those are all good. At the same time, only a complete financial moron wouldn’t be picking up on the signs that Europe is tiring of bailouts. Countries seem to be contradicting earlier pledges and can’t make up their mind on how to give Greece a chance, which is a relatively small problem compared to Spain. The longer Spain delays, the more risk that there is no program available by the time they ask.
So I expect Spain will act more quickly and we should hear something as early as this week. So that means I’m slightly bullish finally. A lot could go wrong, but it seems that all the moving parts are aligning themselves to attempt something sooner rather than later.
Heck no. There is a real risk that Spain won’t act in time. There is a risk that earnings continue to disappoint or something about the U.S. election spooks the market, or any other number of reasons the market can continue to sell-off, but I think we get support. The sense that Spain is finally about to ask for money will offer support. QE and the $85 billion a month is hard to completely ignore. Even Apple feels like it will find support around these levels, and the indices cannot do too much with Apple hanging in.
So no clear sailing, but I think the bias is for the market to do okay here. I think stocks can outperform fixed income, and credit in particular. The weak earnings will be cause for concern in the high yield market. Even with CLO’s clamoring for loans, which will help stressed companies, the reality that the chase for yield has to be tempered by risk, is at least beginning to creep into investor’s minds.
In the end, I suspect any OMT rally to be short lived. I do not think the program will look very aggressive, and while Greece lingers as a concern, there will be a wait and see attitude amongst investors. With shorts having been taken out of the market (naked sovereign CDS bans for example) I don’t think the rally will be that strong.
Until Friday, I had been negative. I thought we had been at levels where the rally from any action would be negligible and that it wasn’t going to happen just yet. At these levels, the rally would be meaningful enough that you don’t want to miss it, and the timing seems to have accelerated. So I can be constructive here.