Category: Economics

Negative interest rates have a very odd effect on the financial math. Certain European countries are selling short-term debt at negative yields, which is somewhat odd. Specifically if you bought a bond from Germany with a 2-year term, you would receive a yield to maturity of -0.06%. If you just held your Euros under the bed, you would receive a yield of 0%.

This is somewhat of an interesting statement by the market in that holding Euro cash is more risky than holding German debt. The decoupling of sovereign debt and its underlying currency is quite steadfast in Europe, while it is highly unlikely you will see such an occurrence in Canada or the USA unless if investors have a good reason to believe that the Canadian dollar or the US dollar will be broken.

I will not talk at this point about Quebec separation and the impact to the Canadian dollar.

I believe it was George Soros that was quoted that the recent bailout agreement with Greece would last “between one day to three months”, and it appears the answer will be less than a week. With the Greek government exercising a political move to have the bailout criteria go to a public referendum, it once again ratchets up the risk of a sovereign default and extends the drama and impact on the financial markets.

Even if this wasn’t the case, I would think that the next focus would be on Portugal’s solvency.

How long can the people of Germany and France allow their governments to subsidize the lifestyles of people in other countries? This is essentially the political question – admission to the Eurozone will inevitably have to be revoked if countries go beyond a certain metric regarding their financial performance.

If there is another push on credit, we’ll be seeing the usual happen – US dollar up, US treasury bond yields down, and commodities taking a nose dive – the typical “risk off” trade. Everybody investing in the markets at this time is forced to become a macroeconomic/geopolitical analyst to explain some of the risk in the securities they are investing in today. There will probably be continued aftershocks as this drama continues to unfold.

Now that the European debt situation is seemingly resolved, the markets are now on rally mode. Credit is loosening again and this gets reflected in the price of debt and equity.

How long will be it before the other countries in Europe line up at the trough?

The fundamental problem is debt accumulation and it is not solved by a one-time papering over – somebody has to pay for it. It is just a matter of when.

Of course this is sour grapes because of my high cash position, and I do suspect that plenty of others are on the sidelines. This is especially for pension fund managers that have to make their mandated 7.5% return on assets while sitting on a mount of 10-year treasury bonds yielding 2.2%. They are forced to buy equities since there is no other assets that can possibly generate a higher return.

Commodities are also making a return, assisted with the US dollar depreciating again over the past month.

This is almost turning out to be a mirror image of the 2008 financial crisis – in October of 2008, the world’s problems were solved with things like TARP and QE, but it took another six months for the markets to fully digest it and reach a panic low. It is something I am open to believing may happen again.

While the Canadian markets were closed due to Thanksgiving, the US equity markets skyrocketed up 3.4% on the S&P 500. There was no particular news other than nothing catastrophic happening over the weekend, but it has been my experience that sharp rallies up tend to be due to traders caught on the short side that suddenly buy into the markets.

I also remain fascinated with the history of the markets from 2008 to 2009 – about how most of the actual crisis was over in October of 2008, but the reverberations and pessimism came to a crescendo in February and early March. This was despite the fact that TARP and practically every liquidity measure conceived had been implemented and all that was left was for that excess liquidity to end up shoring credit across the entire marketplace.

The whole world knows about Greece, but calculating the after-effects of a default or restructuring is the tricky part – if credit goes into a deep freeze once again, we will likely see a miniature version of that crescendo. It could also be the case that we have seen it – if that is the case then the time to buy is now – but you’ll never know it until after the fact. This is indeed gives markets such an impression to outsiders that it is all luck. I remain pessimistic, however, mainly because the underlying cause of the problem – profligate spending by governments – has not been resolved. Any recovery is likely to be temporary at best until economic foundations can actually heal.

All eyes continue to remain on the macroeconomic situation in Europe.

There is also the the other continuing drama in the Middle East area, but it is always difficult to determine whether it is media sensationalism working its ugly head or whether there is something genuine brewing there.

I note with interest half-way through the market session that commodity stocks are getting hammered. In particular, I observe that most of the oil/gas majors (e.g. Suncor (TSX: SU), EnCana (TSX: ECA), Canadian Oil Sands (TSX: COS)) are trading down despite the underlying commodity (West Texas Intermediate) remaining seemingly range-bound around the $90 mark.

I also believe the market is seeking resolution to the Greek debt crisis (specifically the formal point in time where the EU gives up on them), but just like how the resolution of the US debt ceiling failed to provide relief for more than a trading day, I do not believe the resolution of the Greek crisis will resolve the EU situation – in particular the key countries are Italy (10-year yield chart) and Spain (10-year yield chart) – if their yields go higher then the crisis will morph into something much larger. Italy did, however, pass a measure which closes the theoretical gap in their own deficit. The usual European bank suspects (Societe Generale, Deutsche Bank, etc.) are all trading down around 5-10%, pricing in some future problems.

Also, for the first time since the 2008-2009 financial crisis, Goldman Sachs (NYSE: GS) briefly traded under $100. Their preferred shares (e.g. GS-PB, callable, perpetual with 6.2% coupon) are still trading at around 99 cents of par value, so that side of the market is not seeing much fair, just the equity. If you go to page 157 of their last quarterly SEC filing, they managed to vaccuum up money out of the market in 48 of 63 days – this is significantly worse than their previous track records. For example, in the previous quarter (page 139) they made money on 61 of 62 days in the market. Think of who you are competing with if you are involved in the short-term trading business – at least in a Las Vegas casino if you shop around correctly you will get about 99 cents of equity on one dollar bet in a hand of blackjack. Against Goldman Sachs Casino, you will be lucky to see 90.