Toro's Running of the Bulls Market Blog

Companies Do Not Trust European Stress Tests

Should you? 

From the FT

Leading UK and continental European companies are increasingly shunning banks from Spain, Italy and even Germany because they do not believe the Europe-wide stress testing of banks gave a true picture of their financial health.

Corporate treasurers from groups with revenues of more than $240bn told the Financial Times they were conducting their own tests to gauge for themselves banks’ robustness.

“What we are increasingly concerned about is credit risk,” said the treasurer of one of Germany’s largest industrial companies. “Even after the stress tests, we have to ask ourselves: are the banks healthy? The tests have opened up more questions than they have answered, especially here in Germany.”

Stuart Siddall, chief executive of the Association of Corporate Treasurers, said companies were taking a more proactive approach to assessing how financially strong banks are: “Everybody is spending a lot more time today on counterparty risk than they did before.”

Counterparty risk – the risk that a bank will default and be unable to meet its obligations – shot up the list of concerns of companies after the Lehman Brothers collapse two years ago.

Those worries had again intensified around the time of the official European bank stress tests in July, several treasurers said.

“There is an element of whether the emperor has any clothes on and what to do if he doesn’t. The stress tests were a joke,” said the treasurer of a large European media company. ...

A treasurer at a FTSE 100 company in the UK said: “We have no business with Spanish banks and a couple of Italian and German banks. If US banks are refusing to deal with these guys, then why should we?”

I doubt this is over.

What the Future Holds

This is an excellent post from China Financial Markets.  The abridged version is

1. The euro will not survive in its current form.
2. This crisis rivals the Great Depression but is more like The Long Depression of 1873.
3. The European crisis will be accompanied by a trade shock which will bring about a significant contraction.
4. The recovery in countries affected by the crisis will not begin until their debt is written off.
5. This will go on for many years.

Crash

I have no idea what caused the collapse intra-day today, whether it was a bad trade or the withdrawal of liquidity by the machines or what.  What I do know is that it was amazing to watch.  At one point, the Dow was down nearly 1,000 points.  I have never seen anything like it.

I got lucky.  On Monday near the close, I hedged out all my equities positions to net flat.  I had also been buying gold calls the past week and have been long the dollar since the beginning of April.  So my book since Monday's close has been long gold, long the dollar.  

I closed out most of my dollar long position and have kept only a small position.  That does not mean the euro is going to rise.  In fact, it will probably keep melting down.  Remember, it was 85 cents several years ago.  And on a purchasing power parity basis, it is worth $1.15-$1.20, so it is still expensive.

I am a long-term bull in gold but have traded in and out of the yellow metal over the past eight years.  I started buying a week ago when the price action was acting very well.  I expect that we will go back and re-test the $1225 highs, back off a bit, then blast through it.  I expect to add to positions on a break to new highs or on a light pullback.

My equities book right now looks primarily like this - long small banks, long semiconductors, short the S&P 500 and Russell 2000. 

Over the past year, I have been buying banks, primarily very small banks.  My criteria for banks has been to buy stocks trading below tangible book value that made money through the crisis and are forecasted to make money this and next year.  I own 14 banks, most that trade by appointment.  I hope to add to my bank position during this sell-off.

My semiconductors position is now a residual of a basket that I began building in 2008, and continued to buy through the end of the year and into the Spring of 2009.  At one point, I owned 18 different chip companies.  I have sold most of my basket and now own six names.  I will sell into strength.

The hedges I own are the Direxion Russell 2000 3X Bear ETF, ticker TZA.  I own the double inverse Horizons S&P 500 Bear Plus ETF in my Canadian RRSP account, ticker HSD.TO.  I also hold the double inverse Horizons S&P/TSX 60 Bear Plus Fund, ticker HXD.TO for other accounts I manage in Canada. 

My intention in buying the leveraged inverse ETFs was not to short the market but to eliminate equity beta.  Since Monday afternoon, my net position became net short, so I peeled a small part of my hedge.  Interestingly, during the 600 point 20-minute plunge this afternoon, I tried to sell some TZA, which is normally pretty liquid.  However, it did not get filled, even though I kept it open for 20 minutes. I pulled the order as the market bounced.

I have been expecting a 5%-10% correction for some time now.  Today, we got it, with the S&P 500 down 13% intra-day from the highs of a few weeks ago.  I had thought it would merely be a correction in the midst of a cyclical bull market. I'm not so sure now.  This may be a correction within a cyclical bear market but I must respect the action, and the market action today was just horrible, no matter what the reason for the sell-off. 

Sovereign debt crises are very serious, and must be respected.  I expect more downside pressure in the near-term.

Europe, a Parable

There are two neighbors who live in a subdivision.  One neighbor is Hans, the other is Nikos.  They both bought similar houses next to each other at about the same time for the same price.  Hans put 20% down to buy his house and borrowed 80%.  It has a fixed interest rate and his payment is well within his means. Nikos also has a mortgage, but he put 5% down and borrowed 95% with a variable interest rate.  Nikos stretches to meet his mortgage payment every month.

Hans is an automobile engineer.  Nikos is a clerk for the government.  Hans is more productive than Nikos and earns more money.  Hans works 50 hours a week while Nikos works 35 hours a week and gets every third Friday off.  Nikos could work longer, but the weather’s nice so he chooses not to.  Hans plans to retire at 67 and is saving for retirement.  Nikos plans to retire at 57, but he doesn’t have much savings and is running up his credit cards buying lots of stuff.

But Nikos is putting too much on his credit card. He can no longer maintain his lifestyle and pay his debts.  One day, Nikos skips a mortgage payment.  The bank decides to check his credit rating.  It has fallen dramatically.  The bank then checks Nikos’s income.  The bank discovers that Nikos lied about how much money he made on his mortgage application.  So the bank calls Nikos and tells him they have to either raise his interest rate or cancel the mortgage.  This is a problem for Nikos because he’s maxed out his credit card and can’t borrow from anywhere else.

So Nikos goes to his neighbor, Hans, and asks him for a loan.  Hans, who likes Nikos but disapproves of his free-spending ways, says OK, but on the following conditions

• Nikos has to get a higher paying job, which would require him to work longer and not take a long weekend every three weeks.
• Nikos can’t retire at 57.  He has to work to 67.
• Nikos has to start paying down all his other debt.
• Nikos has to start saving more.

Nikos says “No way.  I like my lifestyle.  I’m not giving it up.”  

Hans replies, “Well, I work hard for my money. If you aren’t willing to alter your lifestyle, I’m not lending you anything.  Why should I lend you my hard-earned savings if you aren’t willing to change your free-spending ways?”

“But I deserve to live this way!”  Nikos yells.

“Sorry,” says Hans.

Nikos goes across the street to Francois.  Francois and Nikos have always gotten along pretty well, so Nikos asks for Francois for a loan.  Francois is afraid that Nikos may have to sell his home and move.  Francois doesn’t want Nikos to move because he is having an affair with Nikos’s beautiful Greek wife, so he lends him the money.

And that is the eurozone.

 

Sunburning, Getting Blasted and Chasing Bikinis on the Algarve is a "Human Right" - EU

Byron Wein once called Europe an "open-air museum."  It is hard not to see why.

The European Union has declared travelling a human right, and is launching a scheme to subsidize vacations with taxpayers' dollars for those too poor to afford their own trips.

Antonio Tajani, the European Union commissioner for enterprise and industry, proposed a strategy that could cost European taxpayers hundreds of millions of euros a year, The Times of London reports.

"Travelling for tourism today is a right. The way we spend our holidays is a formidable indicator of our quality of life," Mr. Tajani told a group of ministers at The European Tourism Stakeholders Conference in Madrid on April 15. Mr. Tajani was appointed to his post by Italian Prime Minister Silvio Berlusconi.

The plan -- just who gets to enjoy the travel package has yet to be determined -- would see taxpayers footing some of the vacation bill for seniors, youths between the ages of 18 and 25, disabled people, and families facing "difficult social, financial or personal" circumstances. The disabled and elderly can also be accompanied by one other person. The EU and its taxpayers are slated to fund 30% of the cost of these tours, which could range from youth exploring abandoned factories and power plants in Manchester to retirees taking discount trips to Madrid, all in the name of cultural appreciation.

"The commission is literally considering paying people to go on holiday," Mats Persson, of pro-reform think-tank Open Europe, told Britain's News of the World. "In this economic climate, it's astonishing that the EU wants to bribe people with cheap holidays."

Greece Gets Bailed Out. Who is Next?

First, right up front, full disclosure - I am long the US dollar, so I'm talking my book.

A deal has been struck between Greece and the EU.  Greece may receive a loan of €30 billion, paying ~5% interest.  Merkel must be pretty confident of upcoming regional elections.

Euro-zone finance ministers agreed Sunday that if heavily indebted Greece were to get a bailout, it could receive as much as €30 billion in loans this year at about 5% interest from fellow euro nations.

The move puts Greece closer to a bailout as it heads into a week headlined by an auction of Greek treasury bills Tuesday. That is seen as a crucial test of whether Greece can still borrow from capital markets. If it can't, it would likely have to turn to the European Union package.

The ministers didn't decide to give Greece the aid; that step would require the unanimous assent of euro-zone leaders. But they laid out terms—especially an interest rate—in an attempt to convince wary financial markets that the European Union does indeed have a plan in place.

I am not sure why this is bullish for the euro.  The euro gets its strength from the fiscal strength of its core region - France, Germany and the Benelux countries - or at least its relative strength.  Bailing out Greece transfers liabilities of the profligate countries in the south to the core. 

This deal had to get done.  Banks in Greece were getting their lines pulled and were on the verge of collapse.  It does temper a run on Greece but it weakens the foundation of the euro in the same way that the US bailing out its financial system weakened the structural foundations of the dollar, especially if larger countries like Italy and Spain are next in line with cap in hand.

UPDATE - Bloomberg is saying it is €45 billion, including €15 billion from the IMF.

European governments offered debt- burdened Greece a rescue package worth as much as 45 billion euros ($61 billion) at below-market interest rates as they try to end its fiscal crisis and restore confidence in the euro.

Forced into action by a surge in Greek borrowing costs to an 11-year high, euro-region finance ministers said they would offer as much as 30 billion euros in three-year loans in 2010 at around 5 percent. That’s less than the current three-year Greek bond yield of 6.98 percent. Another 15 billion euros would come from the International Monetary Fund.

Invest in France, Have Your Building Blown Up

From the Financial Times.

Workers at a failed French car parts supplier are threatening to blow up their factory unless the company’s two biggest clients – Renault and PSA Peugeot Citroen – stump up extra compensation.

Employees of the engine parts maker New Fabris have rigged up a series of gas canisters inside a factory workshop which they say will be detonated on July 31 if the two carmakers fail to pay €30,000 to each of the 366 workers facing unemployment.

The company, which went into receivership for the second time in two years last month, holds an estimated €2m of stock ordered by the two carmakers, as well as a machine belonging to Renault valued at about €2m.

The threat could [emphasis added] still be an empty one as government officials said there appeared to be some doubt as to whether the gas canisters were full. Nonetheless, the government is taking the threat seriously, fearful that the lastest hold up marks a significant increase in labour tensions that have been present for several months. The fire brigade has been put on stand-by and emergency service reinforcements sent to the area near the factory in Châtellerault in western France, according to a news agency report.

Earlier this year France was hit by a wave of boss-nappings, where workers held factory managers hostage, sometimes for several days, to force better redundancy payoffs or protest at factory closures. Most ended without violent incident. ...

Guy Eyermann, member of the hardline CGT union that appears to be leading the protest, insisted that the battle would not be abandoned. “Are we capable of blowing up the factory? Yes we are,” he told a gathering of about 100 workers yesterday.

Why would anyone invest in a plant in France, or at least in a plant that does not serve the French market?

Barney Frank is a Jackass, but He is Correct. And What America can Learn from Sweden.

I caught the last snippet of Barney Frank's interview on CNBC this morning.  I wanted to track it down and watch the whole thing, so I went to the CNBC website and dug it up, which you can watch here.  I would highly suggest you watch it. 

Frank acts like a jackass at the end of the interview.  Mark Haines was asking legitimate questions, and Frank responds like a petulant, teenage Prima Donna and storms off.  However, he is absolutely bang on in his argument, and is correct when he says that shareholders should have increased power over corporate boards.

The United States has serious issues at the board levels of corporations.  Too often, boards are like clubs, with directors being too close to the CEO, who is often also the Chairman of the Board (another serious problem since no CEO should be the Chairman of the Board).  There is not enough independence amongst directors, nor is there enough independence amongst the compensation committee.

The best model for corporate governance in the world is in Sweden. In Sweden, shareholders have far more rights to oversee what management is doing with their money, including

• The separation of the titles of Chairman and CEO
• Mergers must be approved by shareholders
• Shareholders of a certain size can call extraordinary meetings
• The nomination committee to the board must have shareholder representation
• It is much easier to remove management, CEOs and directors
• Compensation is approved at the AGM
• A plurality of votes, rather than a majority, is needed to pass resolutions and amendments.

Reforming board structure in America along the lines of governance structures in Sweden would go a long way towards eliminating the venality and agency/principal risk inherent in corporate America, which contributed to the debacle in the financial industry.

What Worries Me

I would very much like to extend my appreciation to all the kind words yesterday.  One of the reasons why I started this blog was to provide unbiased (though, in retrospect, not always correct) observations about what is happening in the market.  If I have helped you understand things a little clearer, then I have accomplished one of the missions of this blog.

I have not gone away, at least not yet.  However, circumstances are changing such that it may no longer make sense for me to actively blog as I have done so in the past.  That decision remains to be taken, and I will continue to post, but only occasionally until decisions have been made.  Then, we will see.

I do owe at least one post as Isam reminded me in the comments yesterday. And that is what really worries me.

The economy and the markets have gone through a traumatic shock unlike anything we have seen in seven decades.  You know the story by now - housing bubble collapse, Lehman bankruptcy, subprime mess, credit market implosion, deleveraging, etc. 

I believe the market had priced all of this in, and more, given the record spreads in credit and dirt cheap valuations in equity.  If we are to break to new lows, then another convulsive shock must occur to the economy.  There must be something as big or bigger than what has already been experienced to send the market into a free-fall once again.

Bears argue that the shock is going to be commercial real estate and/or credit cards.  I disagree.  I believe the market has already priced in the decline for both.  The REIT ETF, ticker IYR, fell 77% from the highs, while credit card giant American Express fell over 80%.  Those are depression-like returns.  These are well known and have already occurred.  I also believe that both are no where near as threatening as what has already happened in the housing and mortgage markets.

But there is one thing that I believe is not well known, and it does worry me. 

And that is the potential collapse of Eastern Europe.

The collapse of the economies of Eastern Europe is an event that could rival or even surpass the collapse of the housing market, and I do not think American investors fully realize the ramifications of such a collapse. 

The region is not particularly important in terms of global output.  However, it is the exposure of European banks to the former eastern-bloc countries that could cause a chain reaction which could bring down the European banking system, causing the economy to plunge further and markets to collapse once again.  Given the hodge-podge of European financial regulation and a patchwork political system, the European authorities are less able to respond to such a crisis than the United States.

By some accounts, the eastern European countries are in worse shape than the Asian countries were at the start of the Asian Contagion in 1997, with sky-high indebtedness and large current account deficits.  Western European banks financed the borrowing in eastern Europe, and large defaults could bankrupt the European financial industry.

I do not know if the ultimate denouement is the implosion of the European banking system triggered by a collapse of the highly-indebted countries in Eastern Europe, but it worries me.

France Threatens to Walk

From Bloomberg

French President Nicolas Sarkozy will walk out of this week’s Group of 20 summit if his push for stricter international financial regulation flops, Finance Minister Christine Lagarde told the British Broadcasting Corp.

Sarkozy will refuse to sign any statement if he feels “the deliverables are not there,” Lagarde said in the interview. “I think he is very determined.”

My first thought was "So?  Who cares?"

But amazingly, someone (who isn't French) does.

"It’s a bombshell to be honest,” said Philip Whyte, senior research fellow at the London-based Center for European Reform. “If such a high-profile leader would walk out of the summit, it likely would be seen as very negative on the stock and bond markets. It would highlight the disunity among the leaders when the times require a show of unity, concrete actions and stabilization.”

I just can't see it.

Heck, I didn't even know France had a stock market...