This note was originally published at 8am on July 16, 2014 for Hedgeye subscribers.
“And a young prince must be prudent like that,
giving freely while his father lives
so that afterwards in age when fighting starts,
steadfast companions will stand by him and hold the line.”
As many of you know, I recently joined the ranks of fatherhood after a solid run as a bachelor. Fatherhood is great on so many levels, but also very intriguing intellectually. As my daughter emerges on her 6th week, her mother and I have started talking a lot about sleep training, or lack thereof.
It seems there are many different (and really divergent) views on how to encourage a baby to fall asleep on a timely basis and, also, how to to ensure she gets the right amount of sleep. On one extreme, there is the "cry-it-out method," in which the infant figures out how to sleep on their own. On the other extreme is "attachment parenting" in which the infant is basically brought into the familial bed.
After doing a survey of my friends, one suggestion that was most unique was to read Beowulf just before bedtime. I’m not sure if we will employ the so called “Beowulf Method,” but admittedly if it didn’t put our little Emmy to sleep, it would certainly work with her parents.
Speaking of sleep training, global asset markets continue to be in deep REM sleep. In our Q3 themes deck, we emphasized this with our theme: Volatility Asymmetry. A few highlights from that theme include:
- U.S. equity volatility is literally at an all-time low and well below the 20-year mean of 20.05;
- Fixed income volatility is also literally at an all-time low and the current reading is 54.03, which is in the 1.5% percentile versus the long run mean of 99.7; and
- Finally, the JPM Global foreign exchange volatility index is at 5.45 versus the long run mean of 10.6.
Yes, it is official -- the world’s central banks have lulled the markets to sleep, for now at least.
Back to the Global Macro Grind...
The interesting thing about global markets of course is that global risk can happen all at once. Any of you that have invested and thrived over the last decade know this fact only too well. As of late, so do those investors that have parked capital in Portugal.
No doubt most of you have been following the woes of Espirito Santo family of financial institutions in Portugal over the last month. This morning the news actually got incrementally worse. Specifically, Riforte Investments SA, a holding company in the Espirito Santo family, missed a $1.2Bn payment of commercial paper yesterday.
The Portuguese Central Bank Governor was quick to put on his super central banker cape and fly to the rescue. In prepared comments, Carlos Costa indicated that shareholders of the parent were standing ready to inject more capital if needed. In the short run, this has actually helped as Banco Espiritu Santo’s bonds and stocks have recovered a portion of their losses.
Nonetheless, as we’ve highlighted in the Chart of the Day below, Portugal has disconnected with Europe rather quickly in the last month or so. Over the month, Portuguese equities are down more than 12% and are now down on the year just over 4.2%. Of the major markets in Europe, only Russia is down more (for some obvious reason related to the Ukraine).
No surprise, Portuguese sovereign debt has seen a comparable spike in yields. While the 10-year yield of Portugal is still at a reasonable 3.73%, the fact remains that this yield has widened dramatically versus its peripheral peers Italy and Spain. We have also seen Portugal’s sovereign debt auctions have a much tighter bid-to-cover as of late.
The big question remains whether this is a canary in the proverbial global market coal mine, or, conversely, whether the bad news is priced in. Our Financials Sector Head Josh Steiner likely put it best in his weekly Risk Monitor note when he wrote the following (emphasis mine):
“Portugal's Espirito Santo Group continues to dominate news flow on the banking front. Both EU and US global bank swaps are widening sharply, and TED Spread is beginning to widen as well. For now, there appears to be no reason to assume that Espirito Santo's problems are widespread, but there is a rising level of uneasiness as investors ask how could this bank, which was under so much scrutiny for the last few years, suddenly be now having such problems?”
His point is an astute one and time will tell whether this is the awakening of risk that seems to be broadly not priced into global asset classes.
Unfortunately for Europe, which remains under the strains of too much debt, the economic data coming out of Europe as of late, with the exception of the United Kingdom, has been less than robust. Most telling this week was the reading from the German ZEW economic expectations index.
Expectations coming into the number were for a notable deceleration, but the actual number was much worse than expected. Specifically, July printed 27.1 versus expectations of 28.2 (29.8 prior). In reviewing the leading indicators for May, industrial production fell for a third consecutive month, missing expectations, and factory orders also missed. The ZEW Current situation survey also fell sharply from June while consensus expected a slight deceleration. That gauge printed 61.8 versus expectations for 67.4 (67.7 prior).
Growth slowing and banks imploding . . . perhaps our call that the U.S. Federal Reserve will be more dovish than consensus (read Jan Hatzius) believes will happen sooner than expected. But, hey, China just beat GDP by 0.1%, so there is that...
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.49-2.58%
BSE Sensex 24786-26149
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research