Greece is falling apart, just like thetrader has been arguing over the past months. Instead of taking the big STOP, the country is prolonging the inevitable default by new bail outs, resulting ultimately in a huge fire sale, where crown jewels will be sold at a fraction of what it is worth.
Don’t forget, Greece is a relatively small country and a rather modest Economy. The biggest Mediterranean Elephant nobody dares even talking about, Spain, is about to tip over. The very peculiar Latino macho culture has during the history created a very strange attitude towards losses. Generally speaking, the Spaniards “never” take the STOP. In crisis, restaurants put prices higher, instead of lower in order to fill up the place. Same logic applies to the housing market. Although prices are falling, people talk of “was” prices, they increase prices in order to try fooling a tourist or two getting the trade done in the middle. This culture and mentality is hard to understand, unless you have lived in Spain for many years.
According to us, having spent many years in different Med countries, including Spain, this mentality will ultimately bring forward the big Panic when people realize the huge holes in Bank’s balance sheet.
Some charts on Spain, the next headache of Europe. Espana, everything under the Sun. Click each chart for better view;
Quick summary of Momos holding Greek debt;
Japan banks 500 million USD
Spanish Banks 600 million USD
USA banks 1.8 billion USD
Italian banks 2.8 billion USD
UK Banks 3.2 billion USD
French Banks 19.8 billion USD
German Banks 26.3 Billion USD
Other Eu countries 15 Billion USD
Trichet’s (ECB) aggressive buying has some exposure too….With the paper they bought about to default, look for ECB seeking new equity, in the middle of the Flash Crash around the corner.
Contagion effects of the Greek situation will be spread beyond only the Banks with exposure having to write off the debt. Eastern European countries such as Bulgaria, Romania etc will fall into trade and funding problems when Greece defaults. Austrian banks on the other hand have large exposure to Eastern Europe etc. Europe is interconnected, and the problems facing this the region are huge.
If Central European leaders get their way, and include private sector participation in the next Greek bailout, the result could be the default of Greece, a whole new banking sector bailout, and a run on Greek banks including to a European Commission document obtained by the Financial Times.
The document details how any private sector involvement in the Greek bailout would likely trigger a partial default for the country, ending the ability of Greek banks to use sovereign debt as collateral at the ECB. That would result in the need for a bailout of around €20 billion for Greece’s banks. Greece may not be able to go back to the market for many years to sell its debt as a result of the event. Finally, the resulting plunge in confidence in Greece may lead to a bank run in the country.
You can read portions of the document at the FT. But what this does confirm is that European officials, including the leaders of Germany, Finland, and Austria, are aware that a credit event (of unknown severity) will be triggered in the event of private sector involvement in Greece.
If they know that, then they must also know that a run on Greece’s banks, or lack of access to ECB financing facilities, could be incredibly dangerous for other European countries and their banking sectors.
The debate clearly is still over the terms of private sector involvement. If Germany isn’t willing to acquiesce to a no private sector involvement deal, then we’re going to get some sort of damaging event, regardless of final deal details. (MoneyGame)
As we have argued for the past months, markets need to correct. The last weeks fall in equities markets, is much needed. This correction should take us to our medium term target of 1200. The single most important factor that could take us much lower though is the lack of liquidity. The fact, fund managers can not execute orders without having a zillion algos frontrunning them, and withdrawing orders, could create a big frustration, where market participants start selling out illiquid stocks, and the end result is another Flash Crash, although this time much bigger. Considering the fact, majority of investors are short vol and therefore short gamma, the moves will get exaggerated as people try to cover their short gammas in a illiquid market.
Thetrader has argued for volatility having been mispriced for a very long time now. Investors think VIX should be priced at close to 10 and not 20. What will happen, if we get VIX establishing itself at 30, and traders are positioned for a “summer no action trading”, looking at realized vol from the past? This market is not healthy, nor has risk been priced healthy for more than a year.
Some points and charts from cap context/thetrader;
Today saw yet another day when the much-expected dip-buyers failed to appear as equities underperformed credit even as both markets dropped significantly. As a measure of the relative selling pressure in equities today, the chart above shows that we saw a very notable underperformance relative to our risk basket expectations.
Further macro disappointment combined with the anticipated approach of an endgame in Europe, the disappointing post release performance of Pandora’s IPO combined with high beta selling and Energy and Materials weakness was further sign of concern.
In talking with clients and readers alike, we get the sense that there is not enough fear that this will end badly. Simply put we have become cognitively biased to expect ‘someone’ to buy-the-dip. It has not happened this time (yet) and unfortunately the market is also not well protected and has become ill-prepared. We discussed credit option vols before as being very tight relative to realized vol and the cycle we tend to see in volatility (implieds and realized) following ‘events’. This has played out once again as the last two moths or so has seen skews flatten notably (and the term structure) – which for now seem very prescient as contrary indicators since every man and his small labrador now seems to be an expert on VIX (short-term near the money vol).
The chart above shows that investors are starting to get ‘protected’ again in terms of large drops – something we said could not happen until we saw a notable drop in skews since the forced selling into weakness was unlikely unless crash risk was less richly priced. We are only back to the average skew levels for the year – which could signify some slowdown in the selling – and the fact that we are close to the 200DMA and the Japan quake support lows will likely spur a small rally – but for now we see consaiderably more downside risk to equities, expect HY vol to rise notably more than equity vol, and see the up-in-quality trade playing out everywhere.
The chart shows a GDP-weighted measure of European Sovereign risk – much more broad and applicable than the more liquid traded index SovX. We compare it to the EURUSD rate. Unlike, SovX which spikes around, our measure is much more codependent / correlated with EUR over time. Note the drop in the sovereign risk in late 2009 as risk was transferred from public to private balance sheets initially did not ‘help’ the EUR.
The current theme is up-in-quality and up-in-capital-structure as the balance sheet recession pokes it ugly head up again and the necessary monetary and fiscal policy remedies proposed in textbooks to fix this ongoing deleveraging and balance sheet repair seems politically most unpalatable.
The last two years have been characterized by a fundamental hope that recovery is sustainable (on the back of large government-funded fiscal and monetary policy actions), thathousing will rebound (and hence bank balance sheets will slowly but surely repair themselves), and a virtuous cycle in the corporate bond market.
There are other more complex signs of trouble (index skews, curve steepness, correlation shifts) but the bottom line is that there is a large crowd of increasingly anxious long credit positions stuffed into the majority of buy- and sell-side firm’s portfolios and it seems that we have reached a tipping point in terms of their ability to soak it up at the margin.
Yeah buts or What-Ifs-> Government passes new spending bill or cuts taxes (will help in short-term but will be sold into by professionals as we have seen recently on any pop higher as view is that slower global growth will exaggerate a hole far bigger than even a reserve currency holder can fill without drastic implications); Earnings and profits beat (they are beating analyst expectations at the cost end of the spectrum and if credit starts to flag then they will have to improve on their own – not via accounting help); Cash on balance sheets (Japan did the same and then burnt through this pile as healthy growth never returned – furthermore they used this to reduce debt and not to juice returns as the balance sheet recession continued – this is what we will see here); repatriation of foreign cash (same happened in Japan and a lack of domestic opportunities for growth will mean further hoarding of cash with no multiplier effect for stockholders); Transitory slump (expectations of a second half recovery in global growth seem predicated on the mean-reversion of every Keynesian macro view – while we do not expect an end-of-the-world type event – though wouldn’t be surprised – slower than expected growth and peak margins will not help encourage above trend growth anytime soon).
The credit market is critical to further growth in the domestic and overseas markets as it enables firms to avoid delevering and the deflation that will cause – if we see credit continue to weaken as we believe it will (despite fund inflows) then we could be set for further cyclical deterioration. Credit markets are bloated with inventory and the marginal trade seems more driven by traders looking to unload into strength than ride any more momentum – this is the first such shift since the crisis and can quickly become self-fulfilling on the way down as fund flows withdraw from riskier assets (HY for example) and force selling at inopportune times (and note that most funds have very low cash levels to soak up any outflows as they have been trying like crazy to keep pace with a market forced higher by the Fed’s QE2 crowding out).
And the conclusion;
Be prepared for much more volatility, low liquidity and ultimately a Flash Crash, but such an event is a Black Swan event, and can not be predetermined…..
We wrote about Alpha going Beta earlier this spring, When Alpha goes Beta…... It sure seems some big hedge funds are going down that path. With p/l swings of 10-20% in a month, one wonders where the hedge is? With the markets having mispriced volatility for such a long time, the exit in both equities and short volatility strategies might turn out to be rather closed. Running huge hedge funds, where investors think they have some hedge on, but the exposure seems more of a geared all in long, might disrupt the market, if investors start the redemption wave. WSJ reports on Paulson’s hedge fund (one of the biggest in the world);
Prominent hedge-fund investor John Paulson, who runs the $38 billion Paulson & Co., has suffered sizable losses in recent weeks amid fresh worries about the global economy, pushing a key fund deep into the red for the year so far.
Mr. Paulson’s $9 billion Advantage Plus fund lost more than 13% in the early part of this month, through June 10, leaving it down 19.65% for the year, according to two investors briefed on the performance.
The Enhanced Partners fund, which had been a big winner this year, lost nearly 7% in the first 10 days of June, …
Don’t forget, at least we Europeans have other countries than Greece with mountains of problems. Spain, nobody really dares talking of, is the next country to restart the anti Austerity protests. El Pais reports,
How to improve growth and create jobs? Cut public spending. How to elude pressure from the financial markets? Cut public spending. How to become more competitive? Cut public spending. A major portion of the annual report released by the Bank of Spain is devoted to a defense of belt-tightening, not just as an unavoidable measure (the public deficit was in excess of nine percent of GDP last year), but also as the most efficient way to leave the economic crisis behind.
Once the prescription has been written out, the institution headed by Miguel Ángel Fernández Ordóñez goes on to demand discipline in order to avoid deviations from the norm.
“Strict compliance with announced plans is inexcusable,” said the central bank chief at the report’s presentation on Wednesday.
Fernández Ordóñez pointed straight at the regional governments as next in line for some budgetary streamlining.
“Nearly half of the adjustment measures [...] should be undertaken by regional governments and local councils,” reads the report, which praises the government’s plan to bring the national deficit down to 3 percent of GDP.
In order to make the plan a reality- and more importantly, to ensure that investors believe it- the central bank recommends setting a ceiling on annual spending for the regions, in line with the ceiling already in force for the central administration.
The report noted that, at the regional level, “spending deviations from budget forecasts were systematic, and exceeded three percent annually between 1984 and 2007.”
Although Brussels has applauded Spain’s recent efforts to rein in public spending through austerity measures, these have been enforced at the central government level. Given the country’s decentralized system, which grants wide powers to the regions, these are now being asked to conduct their own spending cuts to contribute to the overall deficit reduction.
The Bank of Spain applauds some of Madrid’s measures to curb regional spending, such as prohibiting their governments from issuing new debt, but the report also urges “considering the possibility of sanctions as an additional disciplinary measure.”
Despite their many differences, the economies of China and the U.S. share a number of key traits: both are corrupt, rigged, crony-Capitalist, rely on phony statistics and propaganda and operate with two sets of rules: one for the Elites, and another for the masses.
Given these similarities, it’s no wonder that the wheels are falling off both economies.
There are some key differences, of course, which will make the crashing of China’s boom all the harder. China’s leadership likes to do things in a big way, and so its campaign of “extend and pretend” over the past three years has been unprecedented.
This isn’t just the consequence of a Command Economy overseen by a Central State; the “extend and pretend” boom was fueled by stupendous borrowing by local governments and private enterprise as well.
This flood of money has severely distorted China’s economy, yet the imbalances are now normalized. The system and players have now become dependent on this level of stimulus, so withdrawing the distortions would have negative consequences. Yet allowing the flood of investment to continue will unleash higher inflation, which is already triggering social unrest.
Here are a few factors which are widely misunderstood or discounted by the mainstream financial media.
1. Over-reliance on property speculation for profits. What if 60% of IBM’s annual profits were earned from real estate speculation? Would this strike you as a sound company and economy? Yet that is the case for Lenovo in China;
Recently Liu Chuanzhi, the Chairman of Lenovo and the iconic figure of Chinese manufacturing, faced a serious dilemma while asked why of Lenovo Group’s profit in 2009 60% came from asset investment and only 40% came from manufacturing. He said “when the typhoons come, even a pig can fly in the sky. Everybody is profiteering from this. Why can’t we?” The typhoons refers to the property frenzy and the easy ways to make money.
2. Over-reliance on investment for GDP growth fuels malinvestment and systemic risk.
Full reading by Charles Hugh,
Power, even if you are loosing it, is so sweet, so nobody ever gives it away. Mr Papp not leaving. Kathimerini reports;
Following a day of feverish speculation that he would step down to facilitate the formation of a coalition government, Prime Minister George Papandreou said in a televised speech to the nation on Wednesday night that he had no intention of leaving power but would conduct a cabinet reshuffle and request a vote of confidence in Parliament today.
The comments came just hours after officials in ruling PASOK and conservative opposition New Democracy confirmed that the two party leaders had been in talks aimed at forming a coalition government.
Papandreou said he had made a fourth effort to win the broad political consensus that has been demanded by Greece’s creditors, the European Union and the International Monetary Fund, who pledged the country 110 billion euros in loans last year and are now discussing the possibility of a second bailout. But, the premier said, his “genuine efforts to create consensus” had been exploited by the main opposition party and turned into a “public relations exercise.”
Papandreou accused the opposition of leaking details of a preliminary conversation with the leader of the main conservative opposition, Antonis Samaras. “Today I made new proposals to the leaders of all parties to achieve the necessary national consensus…But before the substance of the matter had been discussed, certain conditions were made public that were unacceptable,” Papandreou said, adding that such an agreement would have kept “the country in a prolonged state of instability and introversion while the crucial national issue remains that of tackling the national debt.”