Archive for the 'Crude' Category

Cyprus An Excuse Not A Reason

I have been asked so many times what will derail the market and each time my answer has been the same “nothing we currently know about.”  The next question is the most important: how much is this exogenous shock worth to the market and where will it go from here?  Better lucky than smart as I noted that I lowered exposure, partially because of the move in the market YTD but largely due to vacation last week. I feel I have time to buy.  Right now we are dealing with the emotional and unprecedented impact of taxing insured depositors.   To me the issue is not whether other countries do this – they won’t – but whether the ECB can convince Spanish, Italian, etc., depositors, that they will not suffer a similar fate.  Frankly, but for the fact that the unintended consequence of this action will be to tighten credit as depositors likely pull funds from other banks in more troubled regions, the Euro should arguably be stronger.  The ECB, complicit in this move although not the depth of it, has drawn the line with Cyprus, a country of 1 million that accounts for a half percent of EU GDP where allegedly half the bank deposits are from the less upright Russians (perhaps an oxymoron).  More importantly, given that the size of the needed bailout was almost at parity to the country’s GDP, and the bank debt more than 8X GDP according to a World Bank report, there would be no likelihood of repayment.  Arguably, this should strengthen the Euro since it is finally showing the limits of what Germany/ECB will do but of course isn’t.   It will make US banks more attractive but won’t near term.

So what now?  It seems to me that the next move is up to Draghi and he will have to lower rates to offset the tightening caused by this incident.  US Treasuries will catch a bid as other suspect Eurozone countries look for a safe haven and US banks may benefit to a certain extent.  However, the stocks won’t today as that nagging and unjustified feeling of contagion momentarily takes hold.

Bottom line: We were due for a 2-5% correction and this is as good a catalyst as any although the actual impact on global growth is non-existent thus creating a buying opportunity.  However, my larger concern, one that is growing, is China.  While they have the funds to paper over any bailout issues, their bad debt dwarfs that of any other regions   Local government loans equate to more than $1.5 trillion.  The faltering Chinese steel industry has bank loans of $400 billion  in an industry that China’s prior regime promised to downsize but instead production has grown.  And it goes on.  China won’t be recovering any time soon and the impact on commodities will continue.  I have no plans to increase exposure at this point but am also not sure this will be a big downside catalyst.  I am, however, adding to my short in iron ore.

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The European Spring: Why Caution is the Best Market Position

In typical Hollywood fashion, the producers of the successful Arab Spring

have announced the sequel,  The European Spring, starring the people of

France.  In fact, pre-filming has already begun for the 3rd installment in

the series, The US Spring which will be airing the first Tuesday in

November.

The French

The French hosting elections on a Sunday is itself an interesting issue; I

have to assume they value their days off during the work week too much to go

to the polls than they value their leisure time on Sundays.  Logistics

aside, the polls point to a victory by François Hollande and socialism again

taking front and center stage in the City of Lights.  (Why shouldn’t

Parisians leave the lights on – the government is footing the bill.)   Of

course, Sarkozy can pull it out in the final days if he is able to draw in

the fence sitters and Le Pen acolytes; this should not be completely

discounted.  But assuming Hollande wins, I have heard the argument that this

event is already priced into the market. So will the rhetoric about

endangering the EU fade as political campaign promises often do?  Not on

your life.  With legislative elections upcoming on June 10th and June 17th,

the rhetoric is just beginning.  Those arguing against France’s

participation in the bailout fund and austerity as the path to growth will

be emboldened to speak even louder.  That, after all, will be the proven

path to winning a seat in the National Assembly of the Fifth Republic.

The Greeks

The Greeks have their own election on Sunday.  With massive unemployment,

there is hardly a reason to hold their elections on the weekend. Don’t these

people need something to do during the week or is that when the beaches are

less crowded?  From all reports, it looks like the coalition will survive by

the slimmest of margins. The rhetoric here too will build as their exit from

the EU remains the likely end game.  But if the coalition falls apart,

either on Sunday or near term, then the collapse of the EU is an immediate

fait accompli.

The Rhetoric

So the chatter will increase as the citizens of France, the Netherlands,

Italy, etc., continue to question with increasing authority and anger, why

they should labor under austerity programs in order to support the

irresponsible governments of Spain and Greece.  This will continue to

pressure the indices particularly as Spain and Italy continue coming to the

market to roll over their debt. At present, there is no avenue to growth and

Draghi seems unwilling to inject anymore stimulus into the markets until

governments put forth growth initiatives (and maybe, actually do cut

spending).

The Sequel

So this is the sequel to the Arab Spring as the Europeans rise up and say no

mas.  It is a more civilized uprising, as they perhaps torch candles instead

of themselves, but an uprising nonetheless. And then, in November, it will

be our turn.

Add to this the slowing US economy – yes, slowing, not a pause, and the EU

and China continuing to slow, and you have a rather poor outlook for US

equities.  But Brazil is the bright spot, isn’t it?  Nope. China is the

economic delta for Brazil.  We had an earnings season that few had expected

in terms of growth and outlook but the skepticism about the future is what

preys most acutely on the market, and, the economy.  Sure there are bargains

to be had but like most retailers, there is never one clearance price.  And

yes, Treasuries are fully valued and arguably in a bubble, but that’s been

the story for a while too.  I don’t know who is good picking bottoms and

tops so I’m staying low beta and fairly neutral.  There is very little

chance that under this scenario, allocators have a call to arms for

equities.  That will happen but not now. Not perhaps unless there is a

Romney victory and Europe puts forth some plans for growth.  I would

actually support a position that puts Greece in default, cuts back on

austerity in favor of responsible spending for growth  but I’ll leave my

daydreaming for when I’m at the chick flicks my wife occasionally drags me

to.

I continue to be short global cyclical stocks such as materials.  I hate

beta, except perhaps on the short side and bunting instead of the long ball.

As my favorite metals and mining analyst, Pete Ward, said to me yesterday,

“steel has very high barriers of exit.”

During your market respite, you may want to read an excellent new book: The Big Win.

http://www.amazon.com/The-Big-Win-Learning-Successful/dp/0470916109

The Only Difference Between China and Spain is the Color of the Rice

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China:  Yesterday’s WSJ article on Bo Xilal (page A11) highlights the issue that should provide pause to anyone blindly bullish on China and materials stocks.   It reveals a story of monstrous leverage using property as collateral.  When Bo Xilal rose to the top political seat in Chongqing, the city’s debt was estimated to be 162 billion yuan. At the end of 2011, at least one informed estimate approached 1 trillion yuan.  I like the sound of “trillion” but it only translates into roughly $150 billion, perhaps not bad for one of China’s fastest growing cities.   And maybe that’s not a lot by Western standards for a permanent population of 28 million but the rate of change is significant and places Chongqing’s debt at 100% of GDP versus China’s broader estimate for the country at 22%.  The proceeds of borrowings and  land sales went into highways, state owned businesses and social welfare programs.  But unfortunately, these expenditures don’t throw off enough “income” to offset the cost of the leverage.  (Let me know if you’ve heard this story before – perhaps while travelling through the warmer climes of the EU.)  Taking on debt against land at all time high prices is exactly what got the rest of the world in trouble.  Add in the debt on developers’ balance sheets and leverage at the business level through off-balance mechanisms such as LOC’s and household real estate purchases at prices that exceed current levels  and the only difference between China and Spain will be the color of the rice.  Of course that’s an exaggeration but suffice it to say that perhaps China does not have the iron grip on its politicians, people and economics that so many pundits, economists and portfolio managers give them credit for.  With the central government’s decreasing appetite for individual excess – 感謝什麼,博 (Translation: Thanks for nothing, Bo)  I doubt that there will be as much sympathy for fat cat capitalists who have traded their Mao suits for Prada as was shown to the indebted by the rest of the world.  And I doubt Chongqing is the only city modernized by taking on significant debt as Bo is not the only politician seeking to climb the political ladder by leveraging the future.  In fact it is estimated that local property sales accounted for approximately 40% of revenues and lending for cities throughout China.  Wu and every other politician has been very clear in stating that property prices remain too high.  Three cities, including Shanghai, have tried to ease property controls but the government forced their immediate cancellation.  Yup, the rulers on high are resolute n sending a message that excess, driven by inflating property values at the risk of the people, is over.  The only question is if they caught it in time.  Fortunately, I don’t have to answer that question since the near term impact will be the same.

The great unwind in China is on its way.  Let’s see how that works out as their export economy fades.  And how it works out for us.

Paris Hilton, Europe and China, Energy – Natural Gas: the new HK and CHK, AAPL

The ratings agencies continue to be as effective as Paris Hilton at a spelling bee as seen by Moody’s latest action of putting some banks under review.   The real troubled period for the U.S. banks has, for the most part passed, so near as I can tell the ratings agencies are pressing their shorts.  To paraphrase the anti-motto of the UFT: “Those that analyze, analyze and those that can’t, work for the ratings agencies.”  Throughout my career, I never recall anyone resigning from a fund or investment bank to go on to the greener passages of the ratings agencies.  “I’ve finally made it; my dreams have come true.  I’ve landed this incredible position at S&P.  Sure I will have to get a night job to make up for the lower pay and have to adjust to working in a cubicle the size of a bathroom stall – it’s not easy balancing my family pictures on a roll of toilet paper – but I have my nights free and significantly less pressure since there is no penalty for being late or wrong.”  As a comedian feels about a significantly overweight individual with a very bad toupee, we should all be indebted to the ratings agencies for providing us with such easy fodder.

 

China continues to be a primary concern for me. I noted yesterday the downside of China’s check in the mail commitment to assist in the European bailout as a sign that things are worse for China’s economy than the market has believed.  I postulated the Chinese are seeing more than passing weakness in their economy as a derivative of the weakness in Europe, their largest trading partner.  And today we see the rationale for China’s magnanimous and proactive statement of financial support.  Foreign investment in China is declining and is at the lowest level since 2009, the bottom of the last recession.  Earlier in the week, the city of Wuhu terminated their policy of providing subsidies to home buyers at the behest of the central government, signaling to me that they are more concerned with a property bubble and inflation than they are with a slowing economy, recognizing what Greenspan failed to see.  China bulls remain steadfast in their conviction of a soft landing, the strategy underlying this belief is that the communists will deploy their massive (but fading) foreign reserves in support of Ferrari driving real estate developers, overextended municipal governments (40% of revenues from property sales and subsequent deals to develop), shadow financiers and the occasional overextended homeowner.  Now add in profligate European sovereigns and we have the first “born again” communist country.  Somehow, I believe this will not be the case, given their very long term view; they will let these folks all suffer their sins to a large extent and not be as generous as a Greek politician who has had way too many shots of ouzo.

 

However, with Europe estimated to account for approximately 18% of their trade, look for  increasing comments professing support.  In fact, China may decide to tender for the EU rather than picking off their assets piecemeal.

 

Greece will ultimately default even though the troika may put them on an allowance rather than providing a lump sum.  The installment plan buys the troika more time to put together a plan to ring fence the other over extended sovereigns.   A Grecian default, not to be confused with allowing the gray to grow out from your scalp, would result in a knee jerk reaction lower in the markets and then a move higher as the credit markets realize that the EU is finally ready to enforce fiscal discipline.   This would actually cause a major rally in the Euro but for now I am staying short, having rebuilt the position over the last week on the belief that all the good news was out and as crowded as the short trade was, the long trade was now the more popular investment.

 

I’m still in the camp of consolidation with somewhat higher equity exposure in lower beta, value stocks and short positions in commodities such as coal, steel and copper.    Perhaps we get a reaction move lower but with the massive liquidity in global markets and more due on 2/29 from the new and kinder “ECB”, bonds are the riskier asset and stocks more attractive.

 

And  one more thing, Apple.  I get that the stock action has accounted for a large percentage of the underlying averages but two things: the story is far from over and the market can move independently from the shares of AAPL.

 

Natural gas.  Looks like the lows may have been put in.  At the end of the day, we’re capitalists and the energy industry in this country is still one of the best managed sectors we have.  While the glut is not over, and hopefully the government recognizes the wisdom of incenting greater usage of natural gas as a replacement for crude, the shut ins are encouraging.  Of course, while the warm weather has increased “inventory” levels of natural gas and coal, these will be depleted at some point and are arguably reflected in the price of the equities to a large extent.  We have two CEO’s in energy that actually do what they say they will do: Floyd Wilson and Aubrey McClendon.  Floyd has been a major creator of wealth as he built and sold, to the benefit of shareholders, 3 companies. He is now in the process of doing it again with Halcon Resources (HK, a ticker in the Hall of Fame for its association with Petrohawk, has had its jersey unretired).  He makes no bones about it: I will build it and exit.  The $550 million he brought to the party underscores his commitment.  As to CHK, admittedly the debt levels, not so onerous in a different environment, are squarely in Aubrey’s sights and he has surprised the Street yet again by targeting higher levels of asset sales and further pay down of debt.  Underlying this, and somewhat unnoticed, is the transformation of a company too dependent upon natural gas (they have also announced they will shut in some gas)  to one with a stronger focus on liquids.  This is what will also drive the new HK – a focus on liquids as opposed to Petrohawk’s dry gas model.  Top CEOs understand and respond to changing market dynamics.

 

Disclosure: I am long HK, CHK, EUO and short AAPL puts.


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