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The Spanish bailout that will only make the EU more fragile

No lasting joy forecast for Rajoy

The markets are likely to hurrah this morning as news of the Spanish bailout is celebrated. Spain’s banks have been given a €100 billion bailout from the EU and the headline could easily be interpreted as good news. The reality, however, is that this bailout is incomplete, unratified and unpopular.

Furthermore Spain’s bank bailout has been largely free of conditions – unlike the bailouts of Greece, Portugal and Ireland, they will not have to suffer enforced austerity. This strengthens the hand of parties like Syriza in Greece who want to get rid of austerity – let’s not forget they are Greek elections on Sunday. Therefore, this bailout makes the EU and the Euro project even more fragile as the risk of sovereign default and eurozone exits becomes more real.

Firstly the EU is yet to specify which bailout fund will pay for Spain’s banks. Will it be the EFSF (European Financial Stability Fund) or the ESM (European Stability Fund) which is not yet signed into law? If it is the EFSF – there are legal issues surrounding it. Money was paid into the fund by Eurozone members on the premise that it would only be used for sovereign bailouts, not bank recapitalisations. There is pressure from Holland and Finland, not to mention other states, who want to vote against the bailout before it is agreed.

Secondly, Spain technically has to backstop the loans to it’s banks. Many economists believe that the tipping point where a nation can no longer pay back its debts is when the debt/GDP ratio is over 90%. Now with this bailout equivalent to 10% of Spain’s GDP, Spain is pushed over that level and onto the path to insolvency. Moreover, this Spanish federal debt does not include that of its regions – which adds another 13% onto it’s debt/GDP ratio.

One last bugbear that the markets seem to be forgetting is that Spain’s bailout is without many conditions. Unlike the bailouts of it’s other European members, there is no harsh austerity requirements attached. As Greeks go to the polls once again on Sunday – I would not be surprised if they give a mandate to Syriza to rule because of their unjust treatment. With Syriza in charge, the austerity package would be in ripped apart, Greece would be truly insolvent and would not be repaying the EU’s bailout. Long term, this means exiting the Euro, short-term they are likely to be subsidised by Germany. But how long would the Germans be prepared to put up with that? Then what about when Spain needs a bigger bailout? Or Italy needs one? They are too big to fail and too big to bail. Although we are now veering into the realm of the hypothetical – I would imagine this could set the precedent for Spain and Italy to leave the Euro.

Even if that doesn’t materialise soon, it is impossible to see how this bailout solves the Eurozone crisis. I am shorting the FTSE now in out of hours trading at 5560 with a stop loss at 5660. Once the bailout mania disappears, I think we will see the markets realise the dismal fate of the Eurozone once again and they will fall.

 
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Posted by on June 11, 2012 in Trading Ideas

 

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Eurozone crisis – why you should avoid listening to the mainstream press

The best use of newspapers?

A few months ago, when I was starting up this blog and my trading, I would begin my day by reading the finance section in the Telegraph and the Financial Times on my smartphone. At the same time, I discovered blogs like The Slog and Zerohedge.

As time passed, though, it became ever clearer that most journalists in the mainstream financial press were trapped in a 24/7 news cycle, and never analysing the real underlying issues. One moment they would praise Merkozy for solving the problems of the Eurozone – markets would rise and the world was saved. The next, the Eurozone was falling apart and it seemed as though nothing could be done to save the peripheral eurozone states.

However, if you were reading the aforementioned blogs, and/or had an independent and an analytical mind – you would have realised that the crisis was always there all along, and all the politicians were doing was kicking the can down the road. The eurozone crisis was/is not going to go away without either a collapse of the Euro or a large scale default by some Eurozone countries.

Now tonight I was reading the column by Philip Aldrick in The Telegraph – which almost made me spit out my tea.

Greece is at the epicentre of a new euro crisis – and its chaos will spread

If Greece refused the money, or if the IMF refused to lend, the consequences would be dire. With the economy plunged into immediate crisis by the currency’s collapse, an even more severe austerity would be thrust upon the people. There simply would not be the money to public sector pay wages, for example. With tensions seething, the neo-Nazis might even gain further ground.

Oh dear, oh dear, oh dear.

Firstly, the crisis was there all along, so it is not a “new euro crisis”. It did not miraculously reappear overnight after being solved. The Greek election was planned for the weekend, and a collapse in the pro-bailout parties’ support was always on the cards. If you don’t believe me, you were not reading The Slog.

Secondly, if Greece left the Eurozone and the new drachma collapsed, then the Greek economy would not nosedive, rather, it would stride onwards. Tourists would flock to Greece to take advantage of cheap (drachma) holidays, and a devaluation would make Greece’s general price level much lower to foreigners. Growth would return, and unemployment would tumble from an export-led recovery.

Thirdly, there seems to be a real issue with political correctness regarding the neo-nazi Golden Dawn party. Of course, they may be a bit nutty – but Greeks were putting two fingers up at the old political establishment, Brussels’ draconian bailout terms and savage austerity. Keeping Golden Dawn out of power should not be a priority – they are merely a symptom of rebellion against the EU. If you repress the Greek people through humiliating bailout terms, then they will vote for anyone who will stand up against them.

However – most of that is tangential to my point, which is you should not use the newspapers as your primary source for information these days. Read The Slog, Zerohedge, & Seeking Alpha (for several opinions) too, and you will be surprised at what you find and how accurate many of their predictions are.

But this also has ramifications for traders and journalists.

Traders who are armed with the truth, despite what is being said in the mainstream press, will surely profit from the information disparity between themselves and the other market traders who digest the FT, and the newswires.

As for journalists, if they were prepared to go out on a limb more, do more investigative research, or even just copy stories from the blogosphere – like the recent pillaging of Greek university and hospital funds – then they would have some incredible scoops which would propel their careers.

In the meantime though, I rather like this information gap – because I can see what the news agenda will be before many people are aware of it. But then again, maybe the Eurozone crisis will be resolved (once more) by the end of the week?

 
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Posted by on May 8, 2012 in Trading Ideas

 

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How democracy will triumph over the EU – and take down the Euro with it

"Madame Merkel, 'ave your fiskalpact et la France will 'ave zees baguettes!"

As I write, voters in France are casting their ballot papers in the first round of the presidential elections. Francois Hollande’s Partie Socialiste and Sarkozy’s right-wing UMP party are expected to proceed to the second round, where many predict that Hollande will win. What this means is that Sarkozy, who has been a bastion of saving the Euro with a big bazooka, or a firewall, (or perhaps his stool) – will be out of office. Instead, Hollande will be in power and he wants to renegotiate the Fiskalpact that Merkel and the EU have imposed on the Eurozone.

Hollande wants the agreement to have more focus on growth and jobs, as opposed to cutting budget deficits and national debt. This could raise hackles in Germany and Brussels, as George Magnus of UBS notes (quoted from Zerohedge)

If Hollande, as leader of the Eurozone’s second economy, were to try and stand up to the German government, he would not only feel he had a popular mandate to do so, but doubtless act as a lightning rod for a wave of sympathy and Euro-angst from other Eurozone countries, such as Italy, which are becoming increasingly worried about the character and consequences of the current German-dominated approach to the Eurosystem crisis.

This “German-dominated approach” which Magnus talks about, involves bailing out the “fiscally-irresponsible” countries and then impose swinging austerity on them – at whatever cost. But since this is not easy to do in a democratic country – the EU has implanted their ‘technocrats’ to enforce the fiskalpact.

In Athens riots are almost a daily occurrence, unemployment is over 50% among young people, and at 22% among the overall population, according to official (and probably untrustworthy) figures – I suspect it is much higher. The Bank of Greece scandalously embezzled funds from universities and hospitals to pay off the Eurocrats. In Italy, Burlesconi was ousted to make way for Monti and the EU elites are putting pressure on Spain. The EU is forcing these countries to destroy their economies with austerity – with non-elected rulers.

The contempt held towards its citizens by the EU has led to the rise of popularist, nationalist parties. If we look towards Greece, the main parties are struggling to hold power in the upcoming elections, whilst fringe parties are garnering votes. Rajoy in Spain is trying to insist that his country will not need a bailout because he does not want to suggest Greek-style austerity. Even in Germany, where Merkel is not up for re-election until next October, her political support is slipping because many Germans do not want to throw good money after bad to the European periphery.

The question is: how much longer can this continue? The EU was established to prevent another war in Europe, but its actions seem to do little but provoke one.

The Eurozone’s underlying problem is its currency. In the past if a country was struggling it would devalue its currency, exports would become cheaper, imports would become dearer and the domestic economy would naturally recover. However, the Euro puts a straight jacket on these economically challenged countries because  fixed currency rates prevent them from devaluation. If the likes of Italy and Greece want their economies to recover, then they will need free-floating exchange rates, not austerity.

National politicians will realise this in due course, once the pressure from their people becomes too great. Once one country sets a precedent about leaving the Euro, or attacking the EU, then others will quickly follow. Hollande may be the start of it – maybe he won’t be. Greek elections in the next fortnight may be the catalyst, where the likely result is an eclectic mix of parties opposing austerity, maybe they won’t be. But however you look at the Eurozone crisis, democracy has to triumph over the EU, and consequently rip the Euro to shreds.

To trade on this, I would get out of stocks (and short-sell them) right now, and buy German Bunds and gold. The equity markets have recently undergone a rally – totally ignoring the fact that the West is in a dire economic state – reality will reassert itself soon enough. Shorting the FTSE 100, I would put a stop loss at 6000, I think there is a good risk/reward ratio there, and I do not expect it to reach that state.

German Bunds are not a perfect hedge, as a Euro collapse would lead to the Germans accepting a large part of the ECB’s losses. However, if you are a Eurozone bank, the safest place to park your money is in German bonds as their budget is fairly balanced, and if the Euro broke up your bonds would become denominated in New Deutsche Marks – which would appreciate greatly against other currencies. So I would recommend buying these for their safe haven status.

As for gold, if the world does go into an Armageddon type scenario due to Europe, gold will be one of the few safe places for your money. It has been trading in a fairly cheap range by recent standards and I expect it to climb much further. I would put a stop at $1600 an ounce if I were trading today.

I currently hold all three positions, and got into them at an earlier stage. Since then, all three positions have been profitable.

 
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Posted by on April 22, 2012 in Trading Ideas

 

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Greece’s woes will tank the stock market over the coming days

Yes Angela, it is that bad

Tomorrow is the ultimatum for Greece’s private creditors, as they must decide whether to accept the “voluntary” haircut on their bondholdings. To cut a long story short, if they accept the deal they will receive unattractive, long-dated, low-interest bonds for roughly 30% of face value. Should creditors decline the deal however, Greece’s government is going to enforce Collective Action Clauses (CACs) which will force creditors to accept the terms.

So what, you say? Anyone with any sense would have dumped their bonds ages ago, and those who do hold them have largely written them off. The reason why this matters is how this “voluntary haircut” is seen by the ISDA (International Swaps and Derivative Association) with regard to CDS (Credit Default Swaps). If the CACs are activated by the Greek government, then the ISDA is expected to see it as a default – and deem that the insurers of CDS must pay out. On the other hand, if the haircut is accepted by creditors, then the CDS will not pay out.

So tomorrow is a crisis point, and the way things are looking the CACs will come into play. I am unsure of the threshold for the CACs to be enforced, but I think it is 66% of bondholders, and as of this afternoon, only 39.3% had agreed.

The problem is that nobody is certain that the ISDA will behave in this manner. In fact, if they do declare payouts, the insurers are likely to fight tooth and claw in a long legal battle to not do so. If the ISDA do not, then the parties who have insured their debts are likely to have an equally long and laborious legal battle on their hands.

The fact of the matter is, if losing 70% of your investment doesn’t count as a default, then what does? Many banks, hedge funds and investors have insured their investments with CDS and if they won’t be paid out on the Greek deal, then surely they won’t be paid if other Eurozone nations go belly up. If CDS fail to deliver, then the instruments will become redundant and fears of contagion will spread across peripheral Europe as investors will flee their positions. Bond yields will rise in the periphery, the value of those bonds will fall, resulting in major harm to Europe’s financial sector.

Wranglings about CDS, the risks of the Eurozone breakup and a potential meltdown, would make you think that the market would crash. But no, the FTSE 100 last week almost hit 6,000 and has only retreated slightly since that point. The markets seem to have totally underestimated the severity of this Eurozone crisis. If investors lose faith in Italy and Spain then we’re heading towards Armageddon scenario.

At 8:00 AM tomorrow morning sell all the shares you own. Short-sell the FTSE 100. I may of course be wrong, this process may be a slower than estimated – but it would seem that the market is a captain aware of the stormy waters ahead, but complacently sailing into them. A wreckage is not far away.

 
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Posted by on March 7, 2012 in Trading Ideas

 

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