The End Of Act I

Tyler Durden's picture

Via Peter Tchir of TF Market Advisors,

So Act I has played out and to be honest, has left the audience feeling a bit underwhelmed.  While no one expected it to be easy, a couple of additional scenes have not helped the mood.

 

The “squeeze” effect is over.  On Friday we really liked the possible squeeze names – those that had been most beaten up.  They have responded incredibly well.  JEF went from 11.30 on Thursday to hit a high of over 13 but has been fading.  MS from 14.51 to 16.70, but also off the highs.  In CDS, MAIN got as tight as 168 yesterday, only got as good as 169 today, and finished a bit weak.  So the easy short squeeze leg is over for now (which was part of why it felt like a fade this morning).

 

The Geithner press conference was  a little too weak.  We weren’t expecting the scene to be a show stealer, but it was very flat and noncommittal. It could be interpreted part of the overall plan to keep pressure on the treaty negotiators, but it may be that Geithner didn’t want to say anything that would turn out to be dead wrong within a week.

 

The S&P move was clearly ad lib, and has been digested surprisingly well.  The more I think about it, the more concerned I am about the actions.  I think the fact that S&P seems to have forgotten about EFSF (and possibly EIB) is a bit scary.  From everything they have written about EFSF it was obvious it had to go on negative watch, which leads me to the conclusion that it is a different group and they weren’t communicating.  I think this will taint EFSF permanently.  If S&P removes the negative watch for France and Germany, the market will quickly forget about it.  Structured products tend to not to forget so quickly.  It will be hard to convince investors that the AAA EFSF is safe.  I think there is now virtually no chance of using EFSF on a leveraged basis, and it will not even be a cheap source of funds on an unleveraged basis.  The EFSF is contingent on so many pieces, that I believe it has been permanently damaged by S&P’s action.  There will be a nagging doubt in investor’s minds that lasts much longer than for sovereign debt.

 

Which leads me to my next concern about the rating actions.  Lots of people are comparing it to the US.  In the US it was pretty clear if our politicians demonstrated an ability to work together and compromise, we would have been taken off watch (or at least not downgraded).  We also need to show a real attempt to rein in the deficit.   Those two actions were complimentary.  Show political leadership and fiscal conservatorship and get a better rating.  That is not how Europe is set to play out.  If France and Germany get everyone to agree to try for treaty proposals, you will have demonstrated political resolve, but it will also require capital from those two countries.  They will have to provide money.  France, which is being threatened with 2 notches if there is no agreement, is allegedly back to AAA if they get agreement and have to spend a lot of money?  I think S&P may have painted itself into a corner, because it is not that European political agreement and fiscal prudence go hand in hand.  Agreement will be positive for other countries in Europe, but France in particular may still have to face a downgrade.

 

Maybe it really is simple, and Europe gets an agreement to agree and they get taken off watch, but I think S&P has opened a can of worms, and it will impact EFSF long term, and France may not be let off the hook so easily.  The rating agencies will also likely wait to reverse their decision until after policies are implemented.  The ECB and Fed and IMF can flood the EU with money the moment they get the photo-op, but the rating agencies will be more careful.  I think this development is not only troubling, but does start to cap the potential upside of any post agreement rally.

 

Completely out of Europe’s control is the deterioration in China and Russia.  China had bad economic data and the stock market is down over 5% in a week.  Russia had elections that have led to rioting and a 4% decline in the market today.  The IMF certainly has been hoping for more support from those two countries and is likely most concerned about Russia where the political situation has changed enough that they may have to renegotiate whatever side deals they thought they had.  BRIC without the R&C just isn’t that helpful.  This was out of the control of the EU but is real and could become a sub-plot that needs to be addressed.  Our own data, while improving and okay, is not off the charts great and the political will here to help Europe is already pretty low (that is why Obama is letting the unelected dynamic duo of Tim and Ben do as much as possible).

 

The drama still has to run its course, but I think fears of a bad ending will take over for now, while the audience waits for some more scenes.  It is key to remember that Merkozy, as director, has no interest in releasing positive scenes too early as that would take pressure off the participants, so expect more nagging doubts to be added to a market that is balanced, if not a bit too long for the moment.