Tuesday, September 27, 2011

Europe needs to move faster

Imagine that a fire from a gas-fired barbeque broke out on your condo-apartment balcony. The heat is too intense so you call the Fire Department. The fire fighters arrive, but they don't put out the fire. (We aren't sure if the balcony is stable enough to hold fire fighters so we have to formulate a durable policy for dealing with future fires in this building.) Instead they call the fire inspector.

The fire inspector arrive 20 minutes later. By this time, the fire has spread to your living room. He calls for plans to the building in order to ascertain the structural integrity of the balcony, the location of gas lines and wiring, in order to assess the situation.

An hour passes. By this time, the fire has engulfed most of your condo-apartment. The fire inspector then calls for a summit meeting of stakeholders (unit owners, residents, etc.) in order to come to a consensus on how to best contain the fire...

Does this sound like the EU? Sometimes the slow deliberative process of democracies is the best way of achieving consensus and formulate the best policy to deal with situations. During emergencies, we need someone to take control, now.

The market is waiting for the fire fighters to act, not another summit
Mohamed El-Erian of Pimco recently commented on last weekend's G20 meeting and believes that Europe doesn't have six weeks and waiting until November may be too late:

“They don’t have six weeks,” said Mohamed A. El-Erian, chief executive of Pimco, the world’s largest bond manager. He said fear had reached the very core of the 17-nation group that uses the euro currency, with the price of insurance on German debt rising substantially this week.

The light already is flashing yellow,” Mr. El-Erian said. “They can’t allow it to flash red. You have to give people a vision of what you want the euro zone to look like.”
Simon Johnson, former chief economist at the IMF, recently wrote that the IMF isn't big enough to rescue Europe. Of a greater concern is how s-l-o-w the process is [emphasis added]:
Complaints may be heard this weekend, but there is no one at the IMF meetings who can persuade the key European players to move faster in their decision-making. The politicians will take their own time – prodded periodically, no doubt, by the financial markets.

Do not expect a fast resolution or, therefore, a quick turnaround in the global economy.
The fire spreads
The markets may not have the patience for another series of meetings and the long involved process of stakeholder consultations and legislative ratification. Events are spiraling out of control.
The latest idea for a levered EFSF faces many roadblocks. The head of the German constitutional court has issued a blunt warning that no further fiscal powers may be surrendered to Europe without a new constitution and a popular referendum. What's more, Angela Merkel faces tremendous opposition to the concept of an enlarged EFSF. Neil Hume of FT Alphaville reports (via BarCap) that:
According to Die Welt, the FDP’s financial spokesman, Otto Solms, argued that any attempt to introduce leverage through the backdoor would lead to the withdrawal of FDP support for the EFSF, as the contingent liabilities for the German taxpayer would rise in an undue fashion.

Moreover, even the main opposition party, the SPD, which so far had signalled its broad-based support for the EFSF reform, has signalled its discontent. The SPD’s speaker on budget issues, Schneider, argued that any introduction of leverage that would not feature explicitly in the EFSF reform bill discussed and voted on this Thursday in the Lower House would be a de facto circumvention of Parliament, and that this would simply be unacceptable to the SPD.
According to the Telegraph, Spanish elections may be on the horizon. (Will that hold up their EFSF ratification vote?)
Spain today called a snap election for November 20. The government is seeking a mandate to push through unpopular reforms, with both parties committed to cuts.
The Guardian reports that on the Tuesday that the Greeks are expected to vote on a revised property tax, the next tranche of aid may be delayed:
Anger with Greece over its failure to properly implement reforms in return for a €110bn bailout from the International Monetary Fund, European commission and European Central Bank in May 2010 led inspectors from the "troika" to abruptly suspend a visit to Athens this month.

Tasked with compiling a crucial review of the country's fiscal progress, it was hoped the monitors would return tomorrow. But continued distrust over Athens's ability "to walk its talk" – despite repeated assertions that it would do "whatever it takes" to rein in Greece's runaway public debt and deficit – has reportedly hampered negotiations. Despite the government's attempt to appease rescue creditors by unveiling a new round of draconian cuts last week, the Greek finance minister, Evangelos Venizelos, received a cool reception at the IMF's annual meeting in Washington last weekend. Christine Lagarde, the body's managing director, insisted that headway could only be made with "implementation, implementation, implementation".
Maybe the Greeks and the markets don't realize how serious this is. The Guardian article went on [emphasis added]:
"I cannot give you any specific date, but certainly, it is very difficult to imagine that [loans will be released] by 3 October," Amadeu Altafaj Tardio, a commission spokesman, said. He refused to be drawn as to why Greece's troika of lenders were delaying their return. Once the mission was concluded, he added, monitors would have to send their findings to other eurozone countries before a decision could be made – a lengthy process that would mean the instalment not being disbursed before the middle of the month at the earliest.

We don't have a lord!
The European saga is starting to sound like the Monty Python farce from The Holy Grail [emphasis added]:
ARTHUR: Then who is your lord?
WOMAN: We don't have a lord.
DENNIS: I told you. We're an anarcho-syndicalist commune. We take it in turns to act as a sort of executive officer for the week.
DENNIS: But all the decision of that officer have to be ratified at a special biweekly meeting.
ARTHUR: Yes, I see.
DENNIS: By a simple majority in the case of purely internal affairs,--
ARTHUR: Be quiet!
DENNIS: --but by a two-thirds majority in the case of more--

A golden opportunity for traders?
If there are so many obstacles in the way, then why are the markets rallying? Citigroup speculates (via FT Alphaville) that it's portfolio rebalancing by pension and endowment funds:
Remember that this year it has been about a recurrent theme of rallying into the month end which has happened in 6 out of 8 months only to be followed by drastic falls straight afterwards at the beginning of the next month. End of August / September is a great example of this in Europe with the estoxx 50 rallying 8% in the last week of the month only to fall by a similar amount in the next week. Monthly asset allocation into the underperforming asset class?
Specifically [emphasis added]:
•  Large declines in US and global equity markets in August coupled with bond outperformance could see large monthly asset rebalancing by US pension funds- rotating OUT of bonds and INTO stocks. This may have a profound short term impact on risk assets.
•  Here are the monthly results as of Close Of Business 9/22/11. This assumes that the hypothetical portfolio is 60% equities (split 75% into US equities and 25% international) and 40% SBBIG index.
•  The international equities are down 12.6%, the domestic equities are down 7.33%, and the SBBIG index is up 1.68%.
•  This implies a 2.6% rotation out of bonds and into equities. Historically speaking this is quite a strong number, though down from this time last month.
•  It’s interesting to note that last month, on 8/24, the signal was at 2.77% in favor of equities but by the end of the month it had dropped to 2.02%, after equities strongly outperformed bonds in that last week.
If an investor is rebalancing to a fixed asset allocation by selling bonds and buying stocks in the face of these macro risks, then the market action this week represents a golden opportunity for nimble traders to sell into those buyers of risk.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.


Michele said...

Great analogy and insightful analysis as always. Now if someone could just explain to me why anyone thought the euro was ever going to work in the first place.

Right now I think the euro's not dead, it's just pining for the fjords.

MCB said...

The analogy is great. I am going to steal it, then use it to describe every government action.