Via Peter Tchir of TF Market Advisors,
On October 27th we rallied 40 points in SPX and hit 1285. So far today we are up 32 points and are at 1185. About the only positive thing I have to say is that 1185 is cheaper than 1285.
The reasons for the rally are largely based on headlines and rumors out of Europe and being too pessimistic about what happens if there is no “solution”.
IMF bailout money:
A story in an Italian newspaper stated that the IMF might be preparing a 600 billion Euro loan for Italy. Not only has it been denied by the IMF, it makes no sense based on data the IMF itself provides. IMF financial resources included only $385 billion of forward commitment capacity – less than half of what is allegedly being prepared for Italy. If the IMF is talking about such a massive program, a program far beyond the scope or scale of anything else they have ever done, where are they going to get the money?
Assuming the IMF has more than the $385 billion seems like a big leap of faith. Will any existing quota members meaningfully step up their commitments? I don’t believe that will happen, particularly not in the US. Will they borrow money from the ECB? It is unclear whether they are legally allowed to do that, and even if they are legally allowed, how happy will some major members be about seeing their money leveraged?
The IMF is real, and is out there trying to help, but their resources are limited, and they are just as likely to be preparing financings for countries impacted by continued problems in the weakest European nations. The IMF typically insists on defaults and restructurings before providing significant money, and that is probably why they have experienced success in the past. They broke those rules in Greece and it is quite obviously a mess. The IMF will play a key role in any solution to the crisis, but that money may well be held in reserve to provide funding post some defaults, rather than another feeble attempt to kick the can down the road.
EFSF – not even what was promised
The EFSF guidelines came out on Sunday. They were more confusing and more complicated than I expected. Most of the programs proposed fail to use any leverage. The “leveraged” part which seems to be leaning towards the “insurance” format, provides relatively few new details. There is still NO explanation of how the EFSF will get leveraged money! Believing that these confusing and relatively weak documents ensure that the EFSF will get leveraged up is folly. In fact, it is becoming less clear by the day that the EFSF can even raise 440 billion Euro of unleveraged money. This is the most bizarre part of the rally.
Eurobonds, Fast Track Treaties, Integration
Yes, Germany and France are pushing for some fast track approaches to integration. Has anyone bothered to figure out why? Clearly it is because it is good for Germany and France. They will get control over other countries and may even get some collateral provisions in case of default. I can see why this is great for Germany and France. It should also become clear to many of the other Member States, that it is a bad deal for them. Default or leaving the Euro is NOT the end of the world. In spite of the hype about the cataclysm that would ensue if any country defaulted, there is scant evidence of that. In fact in the rest of the world, default and restructuring has been the first step on the road to success for over indebted countries.
The fast track path is a ploy that is an attempt by Germany and France to gain control over a situation where right now, the weak countries have more power because of the weak protection bondholders have. The fast track may get some traction, especially with puppets in charge of Italy and Greece, but I suspect reaction amongst the masses and the other countries will be far from docile.
Eurobonds have no chance of working. Worst idea out there, still. There is no way to implement them in a size that is meaningful, without buying back existing debt of the weak countries. Doing that will make it clear that Germany and France are over the edge, and the Eurobonds will trade incredibly poorly. They will actually cost the Eurozone countries more as a whole than if each country continues to issue their own debt. Eurobonds realistically would require several years to implement, and would only gain traction if the countries were more equal and the economic situation was stable. None of those conditions currently exist.
Greece and No Default?
Somehow there is a theory that the IIF negotiations failing are good because it is a realization that private sector shouldn’t be forced to lose money. Similar comments came out regarding the ESM (the permanent replacement for EFSF). Without haircuts, Greece will never be sustainable, and the backlash against banks will continue to grow. If the banks continue to be the prime beneficiaries of all the government bailout money and are not penalized there will be growing demands for some form of government punishment. This comes on the back of a Bloomberg story about much profit banks made on the back of government support.
In the end, I think a likely solution is more likely to cause further pain for bank shareholders, not less. At some point, the governments will look at bank shareholders to foot the bill. They benefited from the good times, get the main benefit of bailout money, and made most of the dumb decisions that have caused this mess. The banks continue to say that if you wipe out the banks, there will be no lending or recovery. There is a growing view that you can wipe out shareholders, but so long as creditors and depositors are protected, the banks can continue to lend, and will finally bear their fair share of the costs.
Is break-up and default the equivalent of Armageddon?
A big reason the market wants to rally on any positive noise is the firm conviction that default or break-up is the equivalent of Armageddon. The belief is that without a bazooka or magic bullet, the markets and economies will basically cease to exist, so the only logical conclusion is that the bazooka or magic bullet will be given. That is incredibly extremely, and for banks, incredibly self-serving. The issue is not so black and white. Default and break-up does not have to be a disaster. That is especially true if much of the money that was going to be part of the magic bazooka is provided after the the defaults and break-ups have occurred. In fact, all that money could be targeted much better and the system would be simpler and the worst of the zombie banks would be gone.
If default or break-up leads to Armageddon, then investors are right to place more hope on some moves that attempt to keep the status quo alive a bit longer. If default and break-up just causes some problems, different ones than exist now, but ones that can be addressed and fought, then it is far less smart to assume that this isn’t the endgame that Europe is heading for. Banks in particular would bear the brunt of that pain.
They seem good. They were up. Though I’m not sure if shopping hours were also up by more than 7%? We also need to see what happens for the rest of the season – we had amazing weather this weekend which may have encouraged people to get out of the house. This data definitely seemed good, but the jury is still out on how good and how sustainable it is. A 3% move in the S&P can’t be justified by this alone.