on Portugal and Spain

Earlier this week, we learnt about the Portugal bailout and the Finnish giving sufficient leeway.
I think that most of the people / parties with a good understanding of the issue argued that Portugal needed a hawkish IMF bailout, not a dovish EU bailout.

By proceeding with the latter, Portugal and the EU decision-makers are buying time and procrastinating on must-to-do measures that would be a win-win for the Portuguese and for all its euro-partners. Some of these measures would include the privatization of stated-owned companies, economic liberalization (winding down subsidies, cutting red tape), deregulation of the labour market, and many more measures aimed to improve Portugal's competitiveness under a no-depreciation monetary system like the euro.

Elsewhere, Spain gave a pretty bad piece of news regarding the employment / unemployment measures. Surprisingly, the former were worse than the latter. Let me explain myself: 7110 people were added to the unemployment list in April (cyclically adjusted) adding up to 4,746,552 unemployed people in Spain ... which is 'rumbo a los cinco millones'.

But to make things worse, the number of employed people by the public administration rose significantly.

Take a look at these figures:

+ Pasive population: 23,5m
- Under 16: 7,900,000

- Above 64: 7,800,000

- in between, not listed / not searching: 7,700,000

+ Active population: 23m

- Civil servants / funcionarios: 3,185,900 (12 months before they were 3,088,000)

- Unemployed: 4,746,552

- Self-employed: 2,830,000

- Employed by private corporations: 11,935,000 (12 months before: 12,165,000)

It is quite clear that the Spanish workered is being cornered, suffering the heavy toll of the worse-ever political class seen in this country. This load, and the anticipation of heavier future loads as the deficit is reduced draws a rather ugly painting both for employers and especially for employees.

In the meantime ... the EUR is soaring and Spain, despite its dozens/hundreds of international pro-trade offices around the world (ICEX for Spain, IVEX for Valencia ...), is still unable to export anything but sun.

How is this translated to the stock markets?

... keep shorting Spanish-based assets like real estate.

JPM gave a call earlier this week about some peripheral-countries companies.

The buy list included these companies:

Spanish: abengoa, bbva, campofrio, inditex, tecnicas reunidas, telefonica,

Portuguese: cementos de portugal, semapa

Elsewhere: BIOX GA, DCC ID, GLB ID, ICON ID.

The sell list included:

Spanish: ACCIONA, ALMIRALL, SABADELL, B. VALENCIA, B. POPULAR, BANKINTER, BME, Corp Fin Alba, FCC, Gas Natural, Prisa. Sol Melia.

Portuguese: BCP PL, GALP PL
Elsewhere: TPEIR GA, EUROB GA, OPAP GA, TT GA, GCC ID,

My favorite 'buys' are
1) Santander (san.mc) at around 8+eur/share. It has a very diversified business portfolio; a stable Tier 1 capital (9+%), and very attractive dividend yield (7 / 8%)
2) Grupo SOS (sos.mc). Now suffering selling pressure from the 'cajas', which became shareholders at 50cent/share in the last debt restructuring deal and seem to be selling their stakes. I want to believe (and have some info to back it up) that the price is depressed below its fair value, reflecting that supply/demand imbalance.

3) Telefonica, good dividend yield, international exposure (including LatAm, WE, ...

On the sell side, during the last year I was a keen short-seller of ...
1) Popular (pop.mc) based on the previous arguments regarding the spanish labour market, and its consequences over the purchase power of society overall, and of the real estate prices in particular. Now that euribor is higher I would keep short-selling at around 4.5eur/share; and the same for the rest of national banks (not international).
2) BME seems cornered: the electronic venues will probably prove to be quite harmful in the long run; no international or diversification opportunities ... so keep collecting dividends but I also see a sell when it's lurking / hovering around its previous peaks.

3)Prisa is in this list for 'meritos propios'. Imo, a firm candidate for the worse company in the spanish investment market.

on Greece

Interesting comments from Alphaville (from Citi’s Greek banking team).

The decision of whether to haircut or not is a cost-benefit analysis. For Greece, we believe, the pros include: immediately lower interest payments; faster progression to positive fiscal balance; and less pressure on the government to press on with austerity measures. The cons for Greece could include: denied access to the capital markets; deterioration in relations with Euro Area and EU members (if the haircut is done “prematurely”); and a round of recapitalisation for the domestic Greek banking sector and some Government entities (such as the social security fund). In order to minimise the cons of haircutting, Greece will likely await a macro inflection point — where real GDP growth starts turning positive and the primary balance enters positive territory. This is important as it could potentially allow Greece easier re-entry into the capital markets. Such an inflection point, according to our and other market participants’ estimates, could be the year 2013.

on Bernanke and the US

I think that Mr. Bernanke deserves a lot of credit for what he has accomplished:

The US is semi defaulting by dollar depreciation, which will indeed help the US to grow its way out of debt.

Elsewhere, the dollar depreciation will boost 'Corporate America' results, which in turn, will spur Americans to spend more, as they feel richer due to the 'wealth effect'. Needless to say, to avoid losing purchase power they have to put their dollars to work (which was an intended consequence from Ben as well), either in real assets / invested in equity, or convert them to other currencies (increases the supply of usd, the demand of the target currency, and therefore pushes the usd lower).

Given that the usd is already quite cheap by PPP and other more sophisticated valuation metrics, the first option is the most sensible: buy shares. They are still fairly priced.

It seems that the market has risen (from the lows) by more or less the same proportion as earnings have done; therefore the valuation multiples are still at around the market bottoms.

E.g.: (implied) ERP on April 1 =5.31%. Source: Prof. Damodaran

The dark side of this policy of boosting the economy by dollar depreciation is that social imbalances are growing at a faster peace than expected/desirable. The skilled professionals enjoy a labor market with little unemployment and high salaries. Especially bankers, who have received subsidies (from the taxpayer) to make their annual bonus. While the mid class is being skewed, and the low class is probably still suffering at levels that remind them of the crisis.

--

Ben S. Bernanke

Was the Howard Harrison and Gabrielle Snyder Beck Professor of Economics and Public Affairs at Princeton University, Ben Bernanke received his B.A. in economics from Harvard University -suma cum laude-capturing both the Allyn Young Prize for best Harvard undergraduate economics thesis and the John H. Williams prize for outstanding senior in the economics department. He holds a PhD. from the Massachusetts Institute of Technology.

Angela Merkel warned that Germany could abandon the euro

"If this is the sort of club the euro is becoming, perhaps Germany should leave,"

Altough the Euro area would lose the corner stone, and the best example of how economic rigor leads to well-grounded and stable growth, I think it is one of the best ideas I have recently heard from any politician in Europe.

First of all, the current situation of Europe is unsustainable:

• With the current spreads, the PIiGS can not bear such a cost of the debt indefinitely,
• The longer it takes to change their current situation, the more they'll have dig in the whole, and
• The greater the economic differences between some leading countries (DE, NE, ...) and the tail of the animal (GR, IRE, PT, and SP)

With this scenario, my favorite solution is the so called 'United States of Europe', which would imply to go beyond the monetary union, to achieve a fiscal union (which Spain really needs to get rid of half of its political class).

The second solution is to go thorough some kind of disintegration in the Euro Club.

Much has been said about the countries that should leave the euro and the costs embedded.

'PIG'-countries are all small , that greatly benefit from a common currency, and would find expensive the logistics to leave the Euro.

On the other hand, Germany has the size to bear its own currency much better, and there are fewer advantages for them to be in the euro than to smaller countries (e.g.: benelux)

One solution could read like this:

PIIGS remain in the Euro, so that their liabilities do not appreciate due to the change in currency.

And the list of healthy countries, create their own currency and kick the can.

The banks will suffer equally because their liabilities will be denominated in a 'foreign currency' that will lose value, but ... the ECB can open a window of opportunity for them to exit.

The results are similar in both arrangements: an array of countries much more similar to each other than the current mix in the Eur. Because the third solution, to do nothing, to leave the differences between the core and the periphery to increase, provoking mutual nettle when default events occur is (IMO) the worse one.

Trichet made a good step forward calling for a fiscal union in the Euro the last month, but he needs to be piercing: no politian will be willilng to give up its 'kingdom', and action is needed asap.

Escenario Macro

En abril la banca griega ha perdido depósitos por 5.7 bn. sumando ya un descenso de 15.6 bn. en el año, más de 10.5 bn. desde depósitos de familias. La asistencia en liquidez desde el ECB es básica para la banca griega en estos momentos, donde los mercados de financiación internacional están cerrados despues de que las agencias le hayan retirado el rating de "inversion" a Grecia.

Provocara la salida de capitales una crisis ? o el BCE cubrira el descubierto??

Spain vs Euro

... Zapatero: "ya se esta notando la recuperacion"

Standard & Poor's baja la calificacion de "AA+" a "AA"

la rebaja de la calificacion de la deuda estaba anunciada, pero lo que me parece que va a traer juego, es que la mayor parte de la deuda espanyola es a corto plazo. Desde un punto de vista empresario-gubernamental, tenian que haber aprovechado estos meses atras que el mercado estaba valiente para emitir deuda a LARGO PLAZO!

...y endosarla a unos niveles de riesgo que todavia eran aceptables.

Ahora cuando quieran hacer roll-over de la deuda que tienen, va a salir mucho mas caro. Lo cual es malo para las finanzas del gobierno (que somos todos).

Pero mirando un pasito mas alla... igual nos vendra bien que la barra libre se haya acabado. Esa mayor dificultad para el gobierno de endeudarse, es el toque de atencion de los mercados financieros que necesitamos los espanyoles para pararle el carro al gobierno inconsciente y derrochador que tenemos.

Con el euro tenemos juego para rato ... (lease las tensiones entre la competitividad de alemania y holanda vs PIGS al jugar todos con una misma moneda.

Yo creo que o se toman decisiones muy serias (y creo que la talla de los politicos no es tanta) o al final estamos condenados al fracaso. O bien deshacer el euro y volver a nacer con peseta, o sufrir un "periodo correctivo" de ... diez, veinte ... treinta? anyos. Hasta que tengamos un presi con lo que se tiene que tener, que baje la deuda a cero, y despues los impuestos a las empresas (y volver a empezar aqui tambien:)

saludos!

Money supply, banks and the economy

The banking sector is configured to be very conservative: not only in its origins, where people left their gold for a receipt, and received nothing in exchange except the feeling that their gold was secure and well kept, but also currently by all the government regulation. In the very same moment the public institutions are setting limits to the elasticity of the money, they are pushing all the industry to that edge.

Otherwise we would expect a more diverse range of strategies by the banks in their natural competition, i.e.: some more risk averse and less profitable for its customers, and others less risk averse and capable of offering better conditions* in response to the riskier situation for its customers –those different strategies as normal ways for individuals to compete in a society that Darwin describes holds perfectly for companies in a market with competition.

In that Darwinian scenario, the interest rate would be the price at which supply and demand meet each other (much tighter than current conditions), thus, a deflationary trend would be the standard situation for the economy, (e.g.: Smith describes it so some hundred of years ago.

The current conditions are pretty different. Maybe we are more intelligent and can obtain more profits for society and the banking sector thanks to ... Maths 2.0 or thanks to the backing support of the governments, or maybe .... It is only that we have too much money around, too cheap to borrow, and too low banking requirements.

That would better explain the great benefits of the banks ... and the skyscraper in Dubai.

The problem though, is that with this configuration, the banks shrink at the same time as the economy does. They are not neutral, but pro-cyclical, digging deeper into the economic pain. So, what should be changed in order to avoid messy situations like the current? What to change so that the financial sector doesn’t make the problems worse?

The thing that I am not an economist may help make clear I am not going to solve it, but the fact that I don't understand the subterfuges of the government’s agencies, should help to understand that there is something wrong when the system is that complicated.

How is possible that the government can do it all: borrow money (government per se), and lend it to himself (through the SEC? From my point of view, the government should only be able to borrow money (and that is another topic, in politics, but... somehow it should be limited by an international agency: it is too cheap for any current "x" government to borrow money, win elections today, and even get some dark money extra), and leave the bill for the next government...

A first step (the libertarian step) should drive us to sounder money, therefore we would avoid expensive excesses of the system (dot com bubble, Real Estate bubble, Dubai, etc. That solution sounds good to “gold bugs” and “austrians”.

A second step (the keynesian’s) could intend to have the government helping the economy. Of course not spending what they don’t have as it’s common strategy for ex post crisis situations, but spending the money (when the aggregate demand shrinks or when the economy enters recession) they have previously saved.

That strategy would be twofold beneficially:
Saving in the good times and getting that money out of the stream, helps to cool down the peace of the economy. Even better, you can diversify and invest it abroad (as SWFs already do).

Then, when the economy is overheated and starts to fall (recessions are natural in economics, and they even have a good side too), that money that has been saved by the government can be invested better: getting it back to work in infrastructures, in IT projects and hardware to improve the technology of the public workers, etc.* -> Bearing in mind that it is a recession, and the government will face higher spending (e.g. unemployment subsidies) and lower incomes (e.g. less taxes from consumer spending, from companies profits, etc.

Regarding the financial regulation, William Wild has a good paper about the topic, advocating for a high-cost, low-return form of capital.link.
... that may get the banks out of the stock markets (a truly conservative banking strategy is not able to cope with the equity risk premium of the stock markets.

Pairs-Trading Strategies

Stock market strategies based on pairs trading have lower volatility. Since we're shorting one stock/indice and buying another. This is my recipe-list for such kind of trades:

- Market Size
Bigger companies will probably react sooner to general market information / events than smaller ones. e.g.: Repsol and Cepsa plummeted at different stages of the '08 crisis. chart

Emerging markets are more prone to suffer booms than developed ones (bk they are smaller, and more vulnerable to ... investors' sentiment, money supply, ...

- Macro / Politicians :) Controversial issue
But in my opinion, libertarian / conservative parties will do better for the economy in the long term than socialist parties at government (provided that they fit to the "clasification given" and act and govern guided by such ideas. e.g.: Spain before and after the socialist party got the government at '04. Trade: long DAX, short IBEX, FTSE. chart

In the States the difference is not that big, as republicans may be more prone to run war's deficits (Bush), and democrats to do good at economics (Clinton's reduction of debt), and the FED can play an important role on the stockmarkets (thru interest rates, SEC thru buying stocks ... everything is possible)

- Board of Directors

As Mr. Damodaran asks, Do they work for the investor? or for the CEO? Take a look at the funny board of Disney in '97.

Corporate governance principles include: board independence and leadership, board and executive compensation, audit integrity, corporate responsability, shareowner rights, emerging market principles ...

There are some rankings out there: good information to trade (with care)

- CEOs' Empire building aspirations

Acquiring other companies that do not provide particular synergies, overpaying...

The market is generally wise in its reaction. But in my opinion, most of the time underreacts (those CEO's are not going to stop till they ruin the company. e.g.: Jean-Marie Messier as CEO of Vivendi since '96.

As a former investment banker ... he was capable of much more than running a simple water-utility company, wasn't he??

His hubris drove him to turn the company into a Media Giant
In 2001, losses of 13 billions of euro.

2002: losses of 23.6 billion. French loss record

... eventually the "giant" wasn't that big: he had to sell the Veolia, the water business, Vinci, and some other acquisitions (Universal Studio / NBC Universal, from Seagram Universal, where he paid a 20% premium. British Sky broadcasting: UK's largest pay TV provider. American Nerworks ($10 billion).

Another illustrative example in the Spanish energy sector:
Gas Natural took over Endesa (a much bigger company) for political motivations.

Prior to that, a bidding war had started between E.ON (Germany) and Enel (Italy) driving the bidding price above intrinsic value.
Iberdrola, EON and Enel have done much better than Gas Natural has. chart.

- Economic links between companies
Companies in one sector usually underreact to profit warnings of linked companies. Especially when the links are not obvious. In the article by L Cohen, A Frazzini - Journal of Finance, 2008, it is showed an example about two golf companies: Coastcast is a manufacturer of golf sticks, and Callaway Golf Corp. is its main client, a golf retailer. The latter announced a dramatic profit warning, dropped 30% in the market (efficiency OK), ... while the former kept trading around its price range (as if nothing had happened -efficiency KO-.

... eventually the gap was closed.

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To bear in mind the risk of these strategies.
Although market exposition can be reduced, leveraged is frequently over?used in these strategies, and history brings valuable examples: LTCM (biggest hedge fund, which had to be rescued by the SEC), Orange County (the biggest municipal bankruptcy @US), etc.

Technology@Crisis

Perrow's book Normal accidents (1984) summarizes that technology intensive industries are more prone to suffer those accidents, due to:

- Complexity (nonlinearities.

- Tight coupling (multiple stages of a process which depend intimately on prior stages executing correctly.

1xtra*: absence of negative feedback over an extended period of time.

It is hard-wired in human behavior that we underestimate risk if nothing has happened recently.

e.g.: nuclear power plants, chemical industries, space programs, ..
Since 1974, 18 national level Banking Crisis around the world ('77 Spain, '87 Norway, '91 Finland and Sweden, '92 Japan.

Rogoff & Reinhart find these among the causes of the current crisis:
- Rising housing and stock markets
- Capital inflowsLarge public debt/GDP
- Financial liberalization

Measures aiming Crisis Preparation and Crisis Prevention (gathered from specialists):

- Break up banks and broker/dealers that are too big to fail

- Create exchanges for CDSs and other large OTC contracts

Create financial N1SB for analyzing all blow ups

Require confidential disclosure regarding "network"exposures

- Implement counter-cyclical leverage constraints for bank-like entities

- Enforce "suitability"requirements for mortgage-broker advice

- Require certification for mgmt. and boards of complex financial institutions

Impose more mark to market accounting and risk controls

Impose capital adequacy requirements for all bank like entities

Create new discipline of risk accounting

Impose small derivatives tax to fund financial engineering programs

Revise laws to allow "pre-packaged"bankruptcies for finance companies

Change corporate governance structure (compensation, CRO role, etc.)

- Teach economics, finance and risk management in high school

Economic Outlook

Be carefull with the green shoots. Economic data / analysis is not all pointing towards a rosy future.
On the one hand, bigger than expected earning forecasts during the last week were released, supporting the rally experienced in the stock markets since march (because actually the earnings' improvement was in fact bigger than the rise by the stock markets).

But on the other hand, it was just released yesterday the June GEAB N°36, with gloomy perspectives for the months to come. Forecasting payment defaults in the UK and the US

... and (spanish):
Estas son las olas principales:
1- La ola del paro masivo. -> Massive unemployment.
2- La ola de las quiebras en serie, empresas, bancos, inmobiliario, estados, regiones, ciudades.
-> Wave of city councils, states, banks and corporation defaults.
3- La ola de la crisis terminal de los bonos del tesoro de EEUU, del dólar y de la libra y la vuelta a la inflación.
-> US' bond crisis. USD and GBP currency crisis, and back to (super)inflation times

Hope these guys are wrong bk otherwise the green shoots are going to get burned during the summer

So, be prepared for worst economic performance, and get a neutral/bearish market portfolio!
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GEAB 36: http://tiny.cc/Qu0Qj