Damn! I know That Invite Was Here Somewhere

merci, ben

danke, ben

謝謝你，本

Gracias, Ben

ベン、ありがとうございました

σας ευχαριστώ, ben

شكرا لكم، بن

 

The world over, in every language, from French to Mandarin to Greek to Arabic, the same words are being spoken with incredible enthusiasm, often in a voice that cracks with unbridled emotion and gratitude.  They are 3 simple words: Thank you, Ben.  But there are always the forgotten ones, those who declined the invite. Now, they lay in their beds, pulling their pillows tightly over their heads, cursing the loud music and laughter coming from next door as they hold firm to their righteous beliefs that such frivolity does no one any good, it’s too late, it’s too dangerous, it’s sacrilege, it’s too Keynesian.  Good luck with handling the outflows.

 

Frankly, I don’t care if Keynes is throwing the party, or Bernanke or Draghi.  All I want is to have a good time.  I don’t care if the host pays the caterer after I leave or doesn’t – ain’t my problem, ain’t my job.  And cleaning up – that ain’t my job either, I’ll be long gone before the mess has to be cleaned up.

 

I was in a similar situation once.  I was in college, working weekends at a job that started at 6 AM so I decided to go to bed early. It wasn’t my usual M.O. but I had peaked earlier in the week and was exhausted. With the party in the dorm just getting going, I found myself tossing and turning and cursing out those morons next door.  Finally, I threw off the covers and threw on the jeans and joined in.  Someone else would have to throw the towels in the washer at the tennis club (or I would just fold the dirty ones – who would know? They sweat like pigs anyway).

 

So the bears have a choice: let common sense and a strong belief that what Bernanke is doing is wrong and miss the party or say “what the hell” and join in. If they’re smart, they took the latter route and realized that it’s not their job to debate economic policy and what the long term impact of QE’s will be; it’s their job to make money and when the world over is easing – except for the Chinese who’s contribution is to pay lip service to it – you have to lift the glass.

 

Thus the only question is how much of a good time is too much?  Can I throw back that lost jelly shot or is it time to hail a cab and head home.  For me, my margin of error is sometime before Rosie O’Donnell starts looking like Kate Upton and when I start talking about how, at 5’8” inches (maybe), I used to be able to dunk a basketball. But having been around long enough, I’m not going to get greedy.  I’ll be back to shorting materials soon but for now I drink the castor oil and am long some of the worst positioned companies I could find: steel and iron ore. I do feel guilty going to the dark side but these are only trades.

 

My favorite quote of the day comes from Home Depot as they announce the closure of 7 big boxes in China:

 

“China is a do-it-for-me market, not a do-it-yourself market, so we have to adjust,” the company said, although the country’s slowing economy is also not helping.

 

Are these really the same people that are going to take over the world?  They can’t even find their Chosen One although I had heard he was spotted in Macau driving a Ferrari with a Pamela Anderson look-alike (circa 1998) in the passenger seat while looking for a role as an extra on The Hangover III.

News Flash: Europe is Slowing; News Flash: China is Slowing

March 22, 2012

News Flash: China is Slowing

News Flash: Europe is Slowing

News Flash: Goldilocks May Have Left the Building

“There is the school of thought, of which I am not a student, that believes we shouldn’t worry about China and Europe since U.S. GDP is not overly reliant upon either Europe, 2% of total U.S. GDP, or China, 0.6% of GDP, but given that our economic revival is not particularly robust, any potential hit to growth has to be regarded seriously.   And it is the strengthening domestic economy, abetted by perhaps misplaced optimism on the global economy that overshadows the current weakness abroad.”

Like most, I tend to operate from selective memory. Sometimes I have to venture far into the archives to find a pearl of wisdom, other times the proverbial ink has yet to dry. Fortunately, this occasion finds me in the latter camp leading to a trip back to March 6th.  I actually present this somewhat cheekily since the S&P has had a nice move since the date I wrote the above but completing the thought, I remained bullish equities within a much reduced net long position laboring under the belief the non-US swoon would not really hit our economy until year end.  That is still the case from an economic standpoint.  It shouldn’t be a surprise to anyone that the massive credit issues in Europe have caused a slowdown nor should anyone be surprised about China, where economic indicators have revealed a contracting economy for 4 months.  However, with the market being a discounting mechanism perhaps I was too optimistic.  I went on to say:

“To bottom line it, the market is in a consolidation phase and faces the likelihood of a minor correction near term while remaining highly dependent upon data in the U.S. and continued optimism about the European and Chinese economies.” 

This will update my outlook and clarify my views.  The market is in a consolidation phase with a slight bias to the downside in the very near term as we are in a good news vacuum pending earnings.  Optimism still reigns regarding China’s ability to manage their way out of their declining economic fortunes and the yields on sovereign debt in the countries that matter, while recently forfeiting some of their optimism, are still at much more reasonable levels.   THE KEY FACTOR GOING FORWARD WILL NOW BE EARNINGS SEASON which I suspect will acquit itself well in most areas of the economy except for certain sectors, such as coal and steel, where I have been very visibly short, and which have already updated their outlook.   (Every steel company, regardless of business model, has disappointed but has guided to a turn in fundamentals resulting in a nice move off the bottom.  I am still short.  And coal remains in a death spiral.)   This will provide support for the market at that juncture but for now, in a good news vacuum, the path of least resistance is slightly lower.

But the key to a further rise in equities is the direction of US govt bonds.  While flows continue into bond funds in a meaningful way and out of equities in a less meaningful manner, a situation that surprises me, I believe this will reverse. I am short through TBF and TBT because I believe most investors have come to expect unabated and unprecedented performance and don’t realize that a an 85 bps back-up in yield from 2.15% to 3% will result in approximately a 7% loss in capital, an untenable risk/reward when considering that any appreciation of Treasuries is in the best case, severely limited.   And as the EU sovereigns continue to hold these levels, funds will flow from bunds and bonds into their higher yielding debt.

Within the slowing of global growth view, I remain short the Euro and Aussie dollar, materials and transportation, CSX (dicey), and long technology, big US banks, and defensive value.  The market will continue to pause, but not collapse, into earnings season and unlike each of the other reporting periods since the bottom in March 2009, expectations are much lower setting up for decent equity performance for the next quarter unless sentiment regarding Europe and China fall off a cliff.  I realize this straddle risks my being likened to a sell-side strategist, a label more feared than “moderate Republican” but that’s how I see it.

 

Did You Hear the One About the Bull… China, Europe and Global Growth Stocks

There is an oft told, though not particularly amusing story about an old bull and his son who stood atop a hill glancing down at a herd of attractive heifers. Exercising his fatherly duties, the newly divorced elder bull cautioned the youngster about charging down the steep slope to, let’s politely say, curry favor with the cows that grazed below.

“Com’on, Dad. Let’s go get ’em.”

“Easy there, boy,” the father cautioned, “it’s not always good to move too far too fast. Just ask the hare that lives in that hole next door to the barn.”

“I guess you’re right,” the son responded. “Slow seems to win an awful lot.”

“Slow is not the same thing as deliberate. Deliberate is what I’m after.” “But what about the Roadrunner, Pops?” the young stud inquired, “That darn bird seems to win every time and he looks like he’s havin’ an awful lot of fun racing around.”

“You may have a point there, kid,” came the response as the father looked below, a smile forming on his lip, a twinkle brightening his dark brown eyes. “Let’s deliberately run down there and have a good old time. Don’t know what I was worried about.”

Setting aside his discipline and years of experience, the old bull was drawn in by visions of what could be if all went right. He galloped down the hill, pausing ever so briefly to enjoy himself along the way. But all good things eventually come to an end and often the easier it seems in the beginning morphs into greater difficulties at the end. Well, it didn’t end well that day for the elder bull who would eventually keel over, ending up as a set of loafers and matching billfold. In the interim, though, he sure had fun.

As with the bovines portrayed above, it’s been a quick and happy romp for the Wall Street bulls, of which I have been one. However, I have no intention of keeling over while hanging on for one more conquest. To some, the bull market is showing signs of tiring while to others, the indices will continue to move higher. Me – well, I have ratcheted down my exposure to a slight positive bias to the market – short global growth, long defensive. I am positioned this way because I see the cows at the bottom of the hill looking decidedly less attractive in the second half of the year when the slowdown in Europe and China become much more evident. That will be when the austerity measures come full measure and the realization hits that Germany alone can’t drive the EU economy but, rather, is itself dependent upon an increasingly inward looking and slowing China as well as its EU brethren who were the direct beneficiaries of Deutschland’s indirect largess via the troika. It is also when we will revisit Greece, if not sooner, and possibly Portugal. So without EU governments being able to stimulate their own economies through major public works projects; without their banks, despite the LTRO, having enough balance sheet to lend (or choosing instead to make easier money through the risk-less carry trade); without the ECB actually being able to print money; and with China’s property bubble gushing air instead of hissing, the headwinds will likely cause a downdraft in the averages.

China lowering their GDP target doesn’t bother me that much for a few reasons. First of all, it wasn’t a surprise – in fact, I mentioned it last week. No great vision on my part since it was the consensus estimate. Even more supportive of my fortune telling acumen, the government had leaked major portions of the statement. The bears fear not though for China has always outperformed their targets and is perhaps setting the bar low for the new comrades coming into office. And doesn’t it matter that 7.5% growth, which may in fact turn out to be 8% if history is a guide, will equate to just slightly less than the same amount of growth as in 2011 owing to a larger base from which to measure the change? (I actually find it somewhat amusing that much of what I read from the Street believes that China will continue to grow at 9-10% despite a clear trend lower.) But the action will turn inward as China grows the domestic economy through consumption rather than exports. This, to me, means less fueling of the global economy. And, of course, slower growth is, at the end of the day, slower growth. I am still not convinced China will have a soft landing – far from it. The property bubble is continuing to deflate and the central government still has little interest, it appears, in bailing out the Rolex wearing, Ferrari driving, developers. This has been made extremely clear in the beating back of measures enacted by local governments, including Wuhu and Shanghai, to foster a recovery in property prices through employing mechanisms such as relaxing credit or allowing the purchase of a second home. Not least of all, let’s not forget that some important economic indicators in China are showing contraction or multi-year weakness. There is the school of thought, of which I am not a student, that believes we shouldn’t worry about China and Europe since U.S. GDP is not overly reliant upon either Europe, 2% of total U.S. GDP, or China, 0.6% of GDP, but given that our economic revival is not particularly robust, any potential hit to growth has to be regarded seriously. And it is the strengthening domestic economy, abetted by perhaps misplaced optimism on the global economy that overshadows the current weakness abroad.

Not a lot has changed in my favorite longs and shorts with the exception of initiating a short position in U.S. bonds but I will leave that story for another note. I still prefer domestic focused companies that provide downside protection through yield or have branded franchises with a strong IP advantage or value proposition: VZ, QCOM, WLP, HK and CSC, a very interesting value name with a new CEO, low valuation and strong prospects for a turnaround. JPM is very attractive, as is WFC. They will pick up significant share from the moribund European banks, a taste of which was in WFC’s recent moves including announcing an expansion in Europe and buying BNP Paribas energy business. Strong foreign banks such as UBS will also benefit. This is an incredible opportunity for domestic banks to replace the earnings they lost from Dodd-Frank. Coal remains a core short, despite the decline in the price of the shares. Aside from WLT, which derives almost its entire earnings from met coal, virtually every other coal company generates 70-80% of revenues and earnings from steam coal. This is true of even two of the world’s largest met coal producers, ACI and BTU. Reportedly, ACI’s acquisition of Massey is not going well, an asset they clearly overpaid for, and Moody’s put them on negative watch. Additionally, as part of China’s 5 year plan, they intend to increase coal production by only 3.7%. This is despite the fact that reportedly, 40% of power generators in China that use coal lost money in 2010. Imbedded in the 4% inflation target in the 2012 plan are higher utility prices which is intended to provide relief while lowering usage. Domestically, the warm weather has resulted in stockpiles that utilities will take a long time to work off and the conversion to natural gas from coal at these plants is continuing, arguably picking up momentum. This is occasioned not just by price, but more so by environmental mandates. As to bituminous or met coal, my view on steel remains that as Europe falls into broad recession, China cools and construction continues to weaken, steel prices will continue to weaken. This will lead to more exports from Europe into the U.S. and, of course, China keeps adding to steel mill capacity. I am also short JCP, purely an issue of timing on the turnaround and what is already reflected in the stock price, and KSS. Both troll for customers in a very tough space. On the other side, I am long M.

To bottom line it, the market is in a consolidation phase and faces the likelihood of a minor correction near term while remaining highly dependent upon data in the U.S. and continued optimism about the European and Chinese economies. This Friday’s jobs number could untrack the indices either way but watch out for the second half when the can hits the wall.

The Market: New Year’s Resolutions Are Made To Be Broken; More Positive On US Equities

The Market: New Year’s Resolutions Are Made To Be Broken

 

I sat back and marveled at the action in the global markets on Tuesday, wondering if these non-human entities had all of a sudden turned human making New Year’s resolutions to ignore underlying fundamentals and rally 2% a day. But guess what, markets don’t drunkenly warble Auld Lang Syne in symbolic banishment of times gone.  There is no Lord of the Calendar presiding over the indices, ripping the pages of 2011 from the binding, erasing the memory of an ailing global economy, resetting expectations to a level of attainability where economic indicators such as Eurozone PMI indicating a contracting economy are now a positive indicator.  In fact, the only symbolic symmetry I can find is in the economic hangover rattling the brains of money managers finance ministers and newly crowned technocrats the world over.

 

So as January rolls around we are still faced with the same positives and negatives, each release of data driving the markets, each tick of the currency market correlated to the price of commodities and equities.  But here’s THE but: I am more attracted to US equities than I was in 2011.  That is my resolution for the New Year BUT unlike those who resolve to lose significant weight in 2012, my complete transformation won’t happen in one day although it should endure past the next buffet – I mean, rally.

 

Yesterday’s Unicredit rights offering was not a positive sign for the markets.  The 27 investment banks underwriting the offering reportedly accounted for three-quarters of demand for the $9.8 billion offering, a high price to pay for a call option on future fees and one which toxifies (literary alert: new word) their balance sheets in the name of fees and, no doubt, in response to arm twisting by the ECB.  Shareholders were diluted to near zero and the deal was underwater from the first tick.   Can’t imagine there is much appetite for these types of deals going forward as it will swell “bad” assets at the banks involved, somewhat ironically I might add.

 

I still believe that we will see nationalization or partial nationalization of some banks.  The reason is simple: as with Unicredit, their problem loans and refinancing needs exceed their market caps.  Additionally, compliance with Basil standards has led to these banks pulling in credit lines, the most immediate response, which has stifled credit and slowed economic growth.  This, of course, is why the ECB has initiated their lending program.  I surmise that Draghi has had conversations with the banks taking advantage of this lending facility to participate in the new issue market.

 

Next week is critical as Italy and Spain come to market seeking capital from charitable buyers.  European debt is actually not a bad play if you can hold it longer term because it is extremely unlikely that either country will default.  However, I’m not playing and believe the price they have to pay to fund themselves will be extraordinarily high and for Italy this is only the beginning of their refunding.

 

All of this comes down to the fact that there is still no plan to “cure” the credit crisis in Europe, absent austerity measures that will likely not be enforced or enacted to the necessary magnitude and will only be effective in continuing to drive the EU economy into recession.  It is a lose-lose situation.  The loan facility has removed fears of a Lehman type moment but that is not nearly enough.  We still need to see the heavy artillery from the EU in the form of stimulus.  For example, Italy has had one of the slowest growing economies over the last 20 years of all OECD nations.  They can’t cut their way to growth.  I look at the banks continuing to park funds overnight with the ECB at record levels as insider trading: they know their market better than sell-side analysts or pundits and if they are willing to take such an imbalance in rates of return in exchange for the safety of the ECB, the problems are as bad as I imagine them to be.

 

But China will save us all!  No they won’t; they will look out for themselves and prey on the markets as they always have.  They see commodity prices declining so they will not enter the markets and be the support mechanism until they are down to their last copper penny.   China is on the bad end of two phenomenon:  its property bubble bursting and its primary end market’s  – the Eurozone – declining economy. Their trade surplus declined from $180 billion in 2010 to $160 billion 2011, numbers that any other nation would be happy with but not the Chinese.  This is positive for the US but may be a short lived victory as they dropped the value of the yuan this morning, a reversal of prior policy and a move that will undoubtedly flame already tense relations with the US.  This is a strong indication that the Chinese are very, and justifiably, concerned about their economy markedly slowing despite the recent PMI release.  This slowing will, of course, hit the global economy but especially Australia which is why I am short the Aussie dollar, albeit small for now.  Additionally, the property market in Australia is in horrendous shape and significantly hurting their banks and populous.  They have to lower rates, further pressuring the currency.

 

Now here is the good news as I see it and it resides squarely with the U.S. market and as a devout patriot, I couldn’t be happier.  The US treasury and stock markets are the global default markets of choice. Despite 2011 4Q negative pre-announcements hitting a high previously seen during two prior recessions in 2001 and 2008, the economic data is getting better.   Today’s jobless claims number continues to trend downward, which I believe is a function of a smaller sampling and companies having already cut through muscle so perhaps not an indication of a vastly improving employment picture but positive nonetheless.   Corporate earnings lag the improvement in the economy as companies ultimately respond by hiring more workers.  However, I do see earnings estimates continuing to decline, particularly multinationals from the combination of weaker export markets and a stronger USD.  Analysts are too optimistic in their S&P estimates for 2012.

 

So I remain relatively lightly position in equities, short the Euro against the dollar and short the AUD.  The U.S. equity markets will continue to react to the worsening situation in the EU and have a tough time rising near term.  However, asset allocation to equities, which I expected to see last year and perhaps we did to an extent, will ultimately drive equities higher so I don’t mind increasing my exposure opportunistically.

 

My preference is in defensive, domestically focused companies including healthcare, specifically managed care, nat gas, well-positioned retail, MLPs, utilities, US telecom and strong brands such as SBUX.  Some of my specific holdings are: CHK (CEO continues to pay down debt and restructure production toward liquids from nat gas as he said he would), WLP (inexpensive, buying back significant stock, defensive), NS (7.5% yld, insider buying), QCOM (market leader), GM (cheap but not in love with name), KO (yield, defensive but currency issues), EUO, short FXA.  Would not mind being short LNKD, GRPN, NFLX and ZNGA. This earnings season will be marked by currency adjustments and caution about Europe so I will mostly stay away from those companies playing in those areas.

 

Meanwhile, with some stability returning to the political scene in the US and Romney moving to the forefront, any sense of his emerging victorious in November will finally motivate US companies to spend the massive cash hoard on their balance sheet.  This is not an immediate event, however.

 

So there you have it. Nothing much has changed, the focus required to write 20”12” instead of 2011 really the only thing new.  I get the hang of that relatively quickly, usually after writing about 5 checks and filling out a few forms.  The markets however, have not changed their ways at all, renouncing their resolutions after a mere two days.

 

In sum, I am more positively disposed to the markets and have slightly increased exposure but want to get a better glimpse of the earnings season and the critical refunding periods for European debt before getting longer.

France, Italy – Slow and Angry; EU Ratification Will Fail; US Stocks.

First some good news, the ratings agencies have finally cast themselves as the most consistent market indicator with an inverse correlation of 1.00  as downgrade events are now reflected in market moves higher.   Enough said.

Monti has not been in office long enough to change a roll of toilet tissue yet already had to call for a confidence vote.  This does not bode well for the future.

My view has not changed.  Achieving ratification of the EU treaty will be akin to asking turkeys to vote for Thanksgiving.  And even if the 24 non-French, non-German, non-UK governments do approve this union with a gun to their heads, compliance with their provisions will be tough to come by.  Monti made that clear today in a veiled threat to the Germans

“To help European construction evolve in a way that unites, not divides, we cannot afford that the crisis in the euro zone brings us … the risk of conflicts between the virtuous North and an allegedly vicious South.”

In other words, “don’t even think about asking us to do anything that we don’t want to do such as collect taxes.  Culturally, we don’t do that kind of thing.”

We saw some minor protests in the Italian parliament regarding the austerity measures, with the largest Italian labor union protesting more loudly on the cobblestone streets.  Put into perspective, these protests are targeted at austerity measures being implemented by the Italian government.  Can you imagine the anger when the Germans try to pull in spending?  The Greeks rioted in the streets against fiscal prudence and cost G-Pap his job before the treaty was a twinkle in Merkozy’s eyes.  I’m going to wait until Solution #6 makes the rounds at the next summit.

But I finally understand the lack of speed which the French operate.  In fact, yesterday’s legal accomplishments, the conviction of Carlos the Jackal for blowing up part of Paris and the conviction of Jacques Chirac for raping Paris, only took 30 and 20 years, respectively.  Translated into sovereign debt issues, that should give French banks enough time for the terms of the CDS they wrote on sovereign debt to expire.  Brilliant strategy.

Germany has made it clear they won’t pay up, the US will not contribute to the IMF to bail out Europe and China will use their foreign reserves to buy Europe – not European debt – but rather Europe.  I have asked many what they see as the solution to this crisis and no one has come forward with a solution prior to Europe’s Lehman moment. That’s what it took in the US, and we only have a 2 party system.

French banks will be nationalized as will others throughout the EU.  But that is only part of the solution. Ultimately, the other twin, Mario Draghi, will have to print money and buy more bonds.  The decline in the Euro is far from over – this is only a momentary respite.

Of course, none of this bodes well for US equities.  While Europe represents only 15-20% of our end market, the contagion casts a much bigger shadow.  S&P estimates will have to come down as the dollar strengthens, resetting valuations.  Europe will cascade into recession and China’s economy will continue to contract, further hurting global growth and the US recovery which has been tracking nicely.

The E&C sector and commodities have to continue to weaken as global growth slows.  I like domestic stories that are not dependent on a burgeoning economy for earnings growth.  Managed care remains a favorite and these companies continue to raise their earnings outlook as MLR improves with fewer doctor and hospital visits. WLP at 8.3X EPS with a massive buyback (20% of shares on top of 5% retired earlier this year) still looks cheap.  If employment ever picks up, this will add to growth. Sequestration provides a better result for them than the elusive budget deal. Health care overall looks attractive. MDRX, a company that provides technology solutions to doctor practices and hospitals, supported by a $30 billion incentive boost from the government to put all patients on electronic records, is inexpensive and it is an attractive acquisition candidate for a company such as ORCL that is on record as saying it wants to increase its presence in this business.  I took a small position in CSC, a stock that has been justifiably destroyed, while I do more work on it.  Meantime I get a 3% yield which appears safe.   And of course, there is QCOM, unique in its fundamentals in the tech space.

RIMM – the only question on this company is which will last longer – my phone or the company. Right now its neck and neck.  I used to love my Blackberry but now the service and my 18 month old phone, perform as well as Michelle Bachman at a debate.

As to Bachman, she has to stop using Tammy Faye Baker’s make-up person to be taken as a “serious presidential candidate” (her words).

Have We Seen The Future: The European Solution/ China Slowing?

Being bearish is so exhausting.  I felt so lonely; every day reading analyst research reports increasing estimates, strategists targeting S&P 1300 – it was getting to me. And then the endless articles about the negative feedback loop, castigating those who dared voice a jaded view on the economy.  Much like those kindergarten girls who I coached in soccer many years ago, I thought every broad based comment was directed at me.  I needed a break.  I decided it wouldn’t be that difficult to change my outlook since I tend to be more optimistic than pessimistic. I find life much easier that way and with my golf game if I focused on the negative, if I only looked at the blemishes, I would be a really bad tennis player instead of a decent golfer (caution: literary license at work). I looked for an opening, a sign of what could go right.  Europe was the biggest near term issue and I decided to put myself in the Germans’ shoes. I took off my Tod’s, after all, they are a sign of profligate Italian spending, and figuratively put on a pair of Jackboots. I channeled Merkel and decided that the German motivation for holding the Euro together was stronger than the Greek’s desire to derail it.  After all, given that Germany is one of the strongest economies in the world with trade surpluses only recently surpassed by China, if they were to have their own currency it would decimate their export economy.  Germany needs weak partners in the Euro so that their machine tools and cars look cheap to the rest of the world. 

 

I took off all my short exposure, primarily index shorts, beginning of last week, which of course, took my long exposure higher. I added to this by increasing my holdings in some core holdings including KO, QCOM and WLP, and picked up a bargain in NIHD. I started to pare back exposure yesterday, first at a leisurely pace, only to see the news about the potential framework of the European bank recapitalization erase about a third of yesterday’s gains. The news wasn’t a surprise to me; I had written that I had expected bumps in the road to EU resolution from “leaks” and dissension to occur before we reached the moment of resolution. Slovakia didn’t scare me; their decision was an easy one – either return to using live cattle and goats as a currency or approve the ESFS.  For the Slovakian politicians, with 50% of their trade into the EU, it is only a question of how many new Mercedes and Volkswagens they could wring out of the Germans.  My reason for cutting back exposure was fairly simple which is that the market move higher was, in my view, entirely due to Sarkozy and Merkel guaranteeing a “deal” by November 3^rd.  For bulls, the European debt crisis had been the governor on the market, holding it back from much higher levels, believing that corporate earnings remain robust and that China is not slowing.  But has the market been too generous in taking Merkozy at their word when they have arguably done little to earn it.  And, by the by, the EU isn’t only about France and Germany.   

 

So what is the market assuming?  My best guess is that equity investors assume a shock and awe plan which would entail:  massive liquidity injections into the economy whether in the form of a TARP like plan or some other mechanism: continued buying of sovereign bonds; capital injections into banks and backstopping future equity holders accompanied by massive dilution to existing shareholders; and either Greece defaults in a controlled manner, with a one time alimony payment, or a write-down of its debt to believable levels.  SIGN ME UP.  Actually I did sign up as I noted above.  Instead what we got yesterday was the hint that the banks may be given a period of time to raise their Tier 1 capital ratio to 9%.  They are a number of ways to do this: sell equity which they have said they don’t need thus limiting the appeal of doing so at 50% of book (I choose not to believe those numbers); convert debt to equity; or cut credit lines which, of course, has the impact of improving the balance sheet. If this were to be the plan, we saw the future yesterday in terms of US equity market reaction and today, in the sell-off of the European markets.  It wasn’t good.  But even assuming the markets go for this plan either because optimists win the day or because the market retreats thus lowering the hurdle rate what is acceptable, and the banks succeed in raising capital, there will be marked uncertainty during the period of capital raising and the eventual effect will be a slowing of growth as credit availability declines.  And this, of course, assumes that investors are as gullible in believing that Tier 1 capital is 9% as they were in believing the stress tests were accurate.  Bottom line, to quote that noted philosopher Michelle Bachmann “the devil is in the details.” 

 

The other issues of course are what a Greek default would do to the markets and the potential for a downgrade of French debt.  The best news for France is just like in WWII, they were on the sidelines while we fought the battle.  As the US came through virtually unscathed so will the French.  As to a Greek default, the result is more up in the air. Most equity investors I believe assume that any default would be accompanied by ring fencing the debt of Spain and Italy and this would be positive.  Who needs ouzo when we have grappa? Of course, any significant haircut only worsens the bank’s balance sheets but that is assumed to be taken into account as well. What about a big haircut: well, the banks responded to that potential today much like Hercules did when faced with the same scenario. 

 

But wait! Here comes Mario Draghi to the rescue.  That’s like putting Bernie Madoff in charge of compliance.  Draghi knows how to spend it so he knows austerity from the other side.  He will undoubtedly cut rates at either his first, or more likely, second meeting.  By that time, European numbers will show recession and commodities will have declined to a level low enough to provide cover for a 50 BP cut. 

 

Unless the Troika comes forth with a plan of shock and awe that removes all doubt about further contagion, I see the market fading.  Even if the shock and awe doesn’t dazzle, the surrounding issues are becoming too prevalent to ignore. In my view, as evidenced by the trade numbers form China, the European economies are slowing significantly.  US earnings season has a decidedly different tone out of the gate then those of the past 6 or so quarters. And Washington is still a mess. Actually the bright spot from Washington is that I expect a partial ray of sunshine as the Republicans and Democrats come to common ground on some mechanism to create jobs. I would expect infrastructure spending and military put to work in some fashion but keep in mind that there is a decent lag to the passing of the bill and the actual spend.  I also believe that if Romney is able to break to the front of the pack convincingly, it might actually help matters in D.C. and bring Obama more to the center while also giving business leaders hope if Romney can take a strong lead in the polls over Obama.  However, with no votes being cast in any primaries just yet, this is way too soon to call.

 Is China’s export economy slowing or are they trying to fend off a trade war and pressure to let their currency rise by showing such poor numbers?  Depends if you believe their numbers or not.  I do in this case but only because it supports my investment thesis on China slowing. I’ll take what they give me.  Jawboning down economic activity further pressures commodity prices allowing them to stockpile inventories. 

 JPM:  if JPM can’t put up decent numbers with the strength of their franchise, then what does that say about the rest of the financials?  The regional brokers are in for a world of hurt. JPM is picking up share in IB and still down 31%.

 Although I disagree with what appears to be the overriding premise of the OWS movement which is the distribution of earned wealth to those who haven’t earned it such as community organizers (sorry that slipped.  After all, community organizers are the farm team for the Presidency), I do admire their ability to mount a globally coordinated effort.  In fact, I would like to see them share their insights with the EU and Washington in terms of how to accomplish a purpose, any purpose at this point. 

 I think RIMM’s moment of silence for the passing of Steve Job’s lasted a bit too long.