Sometimes "No" Means Exactly That

From Mark Grant, author of Out of the Box

Sometimes "No" Means Exactly That

I was interviewed last night on BBC radio. The questions were good and the newsman was knowledgeable. The concentration was on Greece and Spain and as I detailed the real debt to GDP ratios for the two countries which included all of their liabilities and not just the ones that Europe wants to count the whoosh of breath could be heard across the Atlantic. I am afraid I startled the poor fellow as I explained that this was not my opinion nor was it a particularly complex matter past finding the data which requires some hours of digging around in Eurostat and the Bank for International Settlements data bases. Then it is just simple addition and the division by the official GDP for each country and you arrive at the conclusion. What is so eye opening then is the real number and this is why, of course, that these nations are in trouble as various liabilities turn from contingent to current as the economic crisis deepens. It should come as no surprise to the knowledgeable but to those that have long believed the official debt to GDP ratios put out by the European Union; the actual explanation and the dawning of what it means always seems to provoke a certain gasping of breath.

I do want to address one thing this morning that has been on my mind. I am not nor have I ever called for Armageddon or the end of the world. I find these kind of statements, by anyone, to be quite irresponsible and mostly self-aggrandizing. The world will pick itself up one way or the another and solutions will be found albeit quite painful ones for Europe I am afraid but there will ultimately be solutions. Over my many years on Wall Street I have seen one soothsayer after another rise and fall and then try to repeat the experience with the next Big Call. This is not what I do nor do I find any appeal in this kind of behavior at all. My commentary is certainly unique as it is almost totally directed at keeping you out of trouble and it is the rare moment when I suggest something of interest. I learned long, long ago the great and terrible secret that if you can avoid losing money that you are way ahead of the Great Game and better placed than your competitors.   This is why Grant’s first ten Rules are the first one reiterated another nine times, “Preservation of Capital” which comes first and foremost and is a gift that just keeps giving if you get it right.

Difficult Times

As it dawns upon the world that Ms. Merkel means exactly what she says and is not going to back down you may expect a quite negative reaction in the equity markets and a widening of spreads for some risk assets along with a strengthening of the Dollar. I am talking about the “Trend” here and not some trading strategy for today’s business. Germany is not going to flinch and cannot both due to local politics and to the now obvious fact that Germany has just about reached the limits of what she is financially able to do with a $3.2 trillion economy. To put it quite simply; they have run out of excess cash and more European contributions are only going to weaken the balance sheet of the nation and seriously imperil Germany’s financial condition. I say, one more time, Germany is not going to roll over and all of the pan European schemes brought forward by the bureaucrats and the poorer nations are not going to go anywhere. There is one novel possibility here and that is that the Germans, like the British, may opt out. Germany, Austria, the Netherlands, Finland et al may just say, “Fine, go ahead if you wish to have Eurobonds and the like but we will not guarantee them.” All plans do not need to have an either/or solution and this may well be Germany’s position in the end which would place the periphery nations and France in quite an interesting, if unenviable, place.

“So do we pass the ghosts that haunt us later in our lives; they sit undramatically by the roadside like poor beggars, and we see them only from the corners of our eyes, if we see them at all. The idea that they have been waiting there for us rarely if ever crosses our minds. Yet they do wait, and when we have passed, they gather up their bundles of memory and fall in behind, treading in our footsteps and catching up, little by little.”


                       -Stephen King

Investing in Difficult Times

First you want to have a healthy position in Treasuries as the safe haven bet for the world as things begin to run askew and get worse. The Emerging Markets will get seriously hurt as the European banks funded these countries and these banks are now drawing in their horns and returning to their own home turf not just as a result of Basel III but as a result of their balance sheets, so full of fluff and tomfoolery, run up against the reality of their asset bases and cumulative loans no matter how Europe allows them to be categorized. Loans that aren’t paying and Real Estate securitizations that aren’t paying take the same bite whether you call them roses or daffodils or you claim their mark-to-market worth is some fantasy number concocted by the banks and approved by the central bank of any given nation. Many of the European banks have hit the wall now and are standing there staring at the tiles. With the few exceptions I would not want to be the holder of European bank obligations at this time.  Neither do I advise to be the owner of most of the European sovereigns; first as connected to their banks which are three times the size of the sovereign countries of the EU-17 but also because their real debt to GDP ratios are so far into the red that whatever solutions are found, and printing money will not help as there is plenty of liquidity in the world and the real issue is solvency, so that any grand liquidity play will not do much good past the shortest of terms. In fact, the liquidity play has run out in my estimation and now the hard choices, the unpleasant choices, are all that remain and they will be painful; any of them.

To capture any sort of yield is now a painful affair. The corporate debt that is deemed worthy and safe is trading within basis points of Treasuries and the spread is so insignificant that these names have become proxies for Treasuries and hold now, in my opinion, very little value. There is a tendency in the markets to regard the financials with one viewpoint as categorized in one basket. I do not share this view. The major European banks and the major American banks are now two totally separate categorizations in my view. It can be said that they are all banks but the leverage, the financial accountability and the basis for investment is the separation of the Earth from Mars now. For yield I would look at the senior debt and perhaps some hybrids/trups of the major American banks because they are not going anywhere and the United States does have the wherewithal to make quite sure of that. We are in a financial crisis no doubt and I expect a world-wide recession by the fourth quarter as caused by the antics of Europe and long experience dictates that you want to be at the top of the capital structure, not in equities or preferreds during this kind of cycle but if yield is high on your agenda then I would take a look at senior debt of the American financials which would be both the banks and some of the insurance companies. Choose carefully, be cautious, but at current spreads there is value in this sector in my opinion. Remember that dividends can come and go and that the dividends for Preferreds can be waved by the gesture of hands at some Board meeting but senior debt defines whether a company is still in existence and is far safer than other securities further down in the capital structure. In general the marks-to-market may decline but the senior financial debt will pay and there are not many good choices to get any sort of yield now.

In the Next Days

Germany will not back-up. This summit will prove to be quite contentious as the beggars want to be the choosers and that is not the way the world works. Hopes will get dashed and reality will invoke its presence and the platitudes of the last thirteen years since the EU was formed will run head on into the unavailability of funds and shockwaves will reverberate across the Continent. That is my prediction. Then Greece will beg and plead and perform its ritual dance but this time, after the Troika has looked at the progress of Greece and found it severely wanting; there will be no more money and it is even dubious that there will be any meaningful extensions. Spain will also dance the dance of the alms seekers and money will be given, virtually exhausting the availability of the EFSF funds which were pledged and are about to become a matter of payment $425 billion which will now be on the table for Greece, Portugal, Ireland and now Spain so that pledged liabilities become current liabilities and cash on the barrelhead is quite a different matter than promises to pay; as we all know.

Patience, patience; we are getting down to it and while the road has been long and the twists have been many and varied in the final analysis it will be the actual amount of the available capital that will answer the long awaited question of when this all ends. I submit that this Summit will offer all of us a “Moment” and that will be when Germany and the rest just say “No;” and then the tide turns, the water begins to pour out and realization, like the morning sun, dawns.

“I feel them steal softly upon my thoughts, pattering gently like drops of rain against my window of thought. And so I lay, wandering the long halls of my thoughts, allowing the shades of memory to slip quietly through my mind, remembering starlight and shadows, days of refulgent glory and nights of moonless pitch, and I allow the needle of the tiny compass inside me to swing wildly… First towards the bright dawn of the morrow…then towards the long night behind me: and I think, and I wonder… When Fate comes to collect one of her sons… which way will the compass lie?”


                              -Joshua Azevedo