This note was originally published at 8am on October 05, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Adventure is just bad planning.”
-Roald Amundsen
Yesterday, in the Early Look Keith wrote the following:
“Again, I’m not calling for a new bull market. Neither am I saying that Growth Slowing has ended. I am simply suggesting that you see this for what it is in most things US Equities (and some things Asian and European Equities) this morning – a Short Covering Opportunity.”
Call us lucky or good, but with the SP500 moving 44 handles upwards in the last 45 minutes yesterday, yesterday was a short covering opportunity indeed.
A key point underscoring that call yesterday was that global macro fundamentals, on the margin, were not getting worse. Alongside that, of course, was that consensus was hyper bearish. I was reminded of that this morning when I saw an advertisement on Google that was trying to sell a list of banks that are “doomed to fail”.
Certainly, we have a bearish view on the global banking system. That said, when companies start running advertisements to sell lists of banks that are “doomed to fail”, the surest takeaway is that a lot of the bad news surrounding bank failures is priced in over the short term. In the Chart of the Day, we’ve flagged this advertisement.
The other positive catalyst for global equities today is Moody’s downgrade of Italian government debt by 3 notches. To the credit of Moody’s, the ratings agency has at least gone from being completely irrelevant and wrong to being a classic contrarian signaler. The market decides when debt is downgraded, not Moody’s, and the market downgraded Italy many months ago.
Our view of Europe is that it would require a crisis to lead to an appropriate action that would at least lead to a reprieve in the European debt crisis contagion in the short term. Yesterday, the crisis came in the form of Dexia, the largest bank in Belgium. Dexia is also a significant global banking player and is roughly twice the size of Washington Mutual for comparative purposes.
The negative rumors out on Dexia yesterday were rampant. There was speculation that an emergency board meeting had been called to discuss Dexia’s accounting for Greek debt. Rumors suggested that a breakup of the bank was imminent. To raise capital, the bank was supposedly preparing to sell its profitable Turkish and Asset Management businesses. Etc. Etc.
In the case of Dexia, we should be clear, where there is smoke there is fire. In a chart that we have flagged numerous times over the last couple quarters comparing tangible equity to tangible assets of European banks, Dexia is by far the worst capitalized of the major European lenders at 1.5%. (Incidentally, Deutsche Bank is the fourth worst capitalized bank in Europe at 2.8% tangible equity to tangible assets.)
As with any global economic crisis, though, comes a great Keynesian opportunity. Last night the Belgian Prime Minister put his Keynesian cards on the table and said the following on national radio:
“One of the possibilities to consolidate Dexia Bank Belgium is, at a certain point, to ensure that it is taken up by the government.”
To this hockey head, that sounds like an explicit back stop for Dexia and, at least, a short term reprieve for the weakest major bank in Europe.
The other marginal positive from Europe, which was a key catalyst for U.S. equities yesterday, was an article from the Financial Times that Eurozone officials are examining ways of recapitalizing banks. Like an addict, the first step in solving your problem is actually admitting you have one. After months of denial, European officials leaking that they will recapitalize bad banks is an admission of their problem and a short term positive.
In addition, German President Angela Merkel made the following statement yesterday:
“No one can say for certainty what would happen if Greece defaults. Before I make a nifty step into an adventure, I have to ask whether we can really handle this and can we oversee what we are doing? Solidarity is always cheaper than if we were to go it alone and wind up with the problem Switzerland has . . . that the currency level is so high that you can’t export any products anymore. Today, going it alone is not path to a better future.”
Not surprisingly, Merkel sums up German situations quite adroitly. On one hand, Germany has and will continue to bear the bulk of the financial responsibility of Europe’s Sovereign Debt Dichotomy. On the other hand, German has been a major economic beneficiary of a common currency in the Eurozone.
Undoubtedly Merkel has not forgotten 1992 to 1995, the last time that other European economies found their combination of demand growth and real exchange rates against the German economy unsustainable. The results were massive and abrupt depreciations against the Deutsche Mark. In turn, the appreciation of the Deutsche Mark against Germany’s key trading partners led to a collapse in German exports and competitiveness. Despite internal politicking, the Germans ultimately understand that the Euro benefits them.
And so the nifty adventure in Europe continues.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
