A View from the Trenches, March 22nd, 2010: "A short summary to start the week"
Please, click here to read this article in pdf format: march-22-2010
To be fair, one could say that during last week, nothing really new,
really surprising, took place. Instead, we saw the revival of
“repressed” market themes and fears, that helped volatility rise last
Friday. Those themes or fears are:
-Inflation: Under this theme we have to include two
sub-themes: Aggregate price level and asset prices
Last week we learned about increasing pressure on the aggregate level
of prices (however this is measured by the monopolies that are the
Reserve Bank of India or the Bank of Canada) in India and Canada, adding
to the inflation fears in China. India saw a policy rate hike and the
market now discounts one in Canada, over the second quarter of 2010.
We are clearly at an advanced stage in the credit expansion process
(initiated on December 5th, 2008 at 2 pm, when the Fed bought its first
pack of Agency debt within its Agency debt purchase program, which ends
this month). We use the operative word “clearly” because, by now any
digression in the markets’ expectations vs. the “rate” of money supply
results in a clear hike in volatility and valuation correction. This is
now a structural problem and it will get worse before it gets better.
From an asset price perspective, the unintended consequences of
quantitative easing policies are unfolding, leaving us in awe. Last
week, two research teams (BofA and Barclays Capital) published separate
and interesting comments on how fertile the environment is today for a
renaissance in LBOs (leveraged buyouts). Yes, while the world is seeking
to deleverage, the unintended consequence is that credit spreads and
rates have tightened enough to grant LBOs. Of course, such LBOs would be
limited to a certain segment of credits and banks are more regulated
than before. Nevertheless, the mere fact that this is a possibility and
that speculative trades are recommended thereupon has caught our
attention. We took note.
-Political risk: Regulation and protectionism
Honestly, we dislike discussing political risk. Even more so when such
risk is in the developed world. But the risk is there, unfortunately and
may affect us through the FX market. We will make only this comment on
the US-China dynamics: We don’t think that China’s goal is to hold the
value of the Renmimbi steady. What China wants to hold steady is the
financing of US sovereign debt. Furthermore, we see such purchases as
one of the most flagrant injustices in the history of income
redistribution. Every time the People’s Bank of China buys US debt,
millions of Chinese workers are being denied the opportunity of a higher
standard of living, for the benefit of fellow exporters who, at the
same time, have no alternative but to deposit their profits offshore, in
safer harbors like Australia or Canada. This is a disgrace which
ultimately can only be resolved from within. But China is not a
democracy and any shift from the current status quo will be against
established interests. The more the US pushes the line here, the farther
we will be from reaching a solution. In the meantime, this is
unsupportive of the USD and supportive of the Canadian dollar.
-Europe’s institutional problems
Last week, Germany publicly invited Greece to explore the possibility of
a solution outside of the European Union. From the beginning, we have
dissented with the mainstream view (held for instance by Jeffrey
Rosenberg, from BofA) that Greece’s problems are only a short-term
liquidity issue (refer: “An institutional perspective on the Euro”
www.sibileau.com/martin/2010/02/10 ) We have said
that the Greece situation reflects an institutional problem that
endangers the very existence of the Euro. We think we were right on this
one. In fact, more than a month ago, we said:
“…As investors, what should we interpret as a catalyst, as a
defining moment? Here’s our view: If the IMF has to intervene, the
European Union will definitely be a Confederation. This is unfortunately
the path of least resistance. This is the easiest and less painful
path. If the IMF is engaged, the Euro will no longer be considered an
alternative global reserve currency and the bid that there was under
such belief will no longer be there. We shall be sellers of Euros under
this scenario. This is the worst-case scenario, for if the EU citizens
lose purchasing power, the global recovery will become a long-term
dream…”
And as soon Germany’s position was known on Thursday, the Euro
suffered materially. In summary, we think that this spring, the world
will enter into totally unchartered territory. What is about to happen
politically and in terms of monetary policy has never been seen before.
Therefore, any quantitative assessment done based on historical stats
will be pure misleading inference.
Martin Sibileau
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