Why Sovereign Defaults Matter… and Why Spain is a BIG Deal

Wednesday, May 9th, 2012

by Graham Summers, Phoenix Capital Research

The following is an excerpt from my latest client letter explaining why Spain is such a big deal and why when it defaults it’s game over for the EU.

I’ve received a number of emails asking me why Spain is such a big deal for the global banking system. To fully understand the implications of Spain, you first need to understand how the global financial system works “behind the scenes.”

We’ll start first with the US financial system, particularly the Primary Dealers which are the real controllers of the monetary supply (via lending).

If you’re unfamiliar with the Primary Dealers, these are the 18 banks at the top of the US private banking system. They’re in charge of handling US Treasury Debt auctions and as such they have unprecedented access to US debt both in terms of pricing and monetary control.

The Primary Dealers are:

1. Bank of America

?????2. Barclays Capital Inc.

3. BNP Paribas Securities Corp.

4. Cantor Fitzgerald & Co.

5. Citigroup Global Markets Inc.

6. Credit Suisse Securities (USA) LLC

7. Daiwa Securities America Inc.

8. Deutsche Bank Securities Inc.

9. Goldman, Sachs & Co.

10. HSBC Securities (USA) Inc.

11. J. P. Morgan Securities Inc.

12. Jefferies & Company Inc.

13. Mizuho Securities USA Inc.

14. Morgan Stanley & Co. Incorporated

15. Nomura Securities International Inc.

16. RBC Capital Markets

17. RBS Securities Inc.

18. UBS Securities LLC.

These are the firms that buy US Treasuries during debt auctions. Once the Treasury debt is acquired by the Primary Dealer, it’s parked on their balance sheet as an asset. The Primary Dealer can then leverage up that asset and also fractionally lend on it, i.e. create more debt and issue more loans, mortgages, corporate bonds, or what have you.

Put another way, Treasuries, or US sovereign bonds, are not only the primary asset on the large banks’ balance sheets, they are in fact the asset against which these banks lend/ extend additional debt into the monetary system.

A similar banking system exists in Europe though in that case there are no single unified EU bonds/ Primary Dealers. Instead we have 17 countries all of which issue sovereign bonds that their largest banks purchase and park on their balance sheets as assets against which they lend.

So, let us consider Spain.

According to data collected from the Bank for International Settlements, IMF, World Bank, UN Population Division, UK banks are sitting on €74 billion worth of Spanish sovereign debt while French banks and German banks are sitting on €112 billion €131 billion, respectively.

So, as a ballpark estimate, roughly €317 billion worth of Spanish sovereign debt is sitting on banks’ balance sheets in these three countries. This debt is then recorded as an asset against which these banks have leant out money to corporations, property developers, etc. at a ratio of more than 10 to 1.

?

Let me explain this last point. Basel III requirements which have yet to be implemented will require banks to have equity and Tier 1 capital equal to roughly 10% of risk weighted assets. Before this, Basel II only required equity and Tier 1 capital equal to 6% of risk weighted assets thereby permitting leverage of 16 to 1.

However, these ratios are only for risk-­?weighted assets. Let me explain this term: a bank’s risk weighted assets are determined on its in-­?house models based on how likely it is that a given asset (loan) will enter default.

In other words, the banks get to determine themselves how risky their loan portfolio is and then leverage their balance sheets accordingly. This is like asking an alcoholic to assess how much alcohol he should have.

Oh, and bank executives are highly incentivized to downplay the risks as their pay is often based on returns on equity (which in turn is based on leverage). So it shouldn’t be a surprise that EU banks are downplaying the risk to their portfolios.

What I’m trying to say here is that the entire EU banking system is based on capital requirements that are an absolute joke. The banks not the regulators determine how risky their assets are and leverage their balance sheets to the maximum levels possible based on their in-­?house assessments.

And to top it off, modern financial theory believes sovereign bonds to be “risk free.” So banks can use their sovereign bond exposure as a strength against which to balance out their riskier loans.

THIS is the fate that awaits the European banking system. Every single EU bank has leveraged itself based on financial models that consider sovereign bonds to be “risk free.” Moreover, EVERY EU bank is leverage to the hilt based on its OWN in-­?house assessment of the riskiness of its loan portfolio.

So… when Spain defaults (and it will) you will very likely find the entire Spanish banking system collapse. This in turn will bring the entire EU banking system to its knees as collateral calls and margin calls are made across the board when EU banks’ portfolios take a “haircut” on their senior most assets.

This is why Greece was a big deal and why the ECB and EU political leaders were so careful to manage its default… because they know that if anything resembling a messy default occurs, the ENTIRE banking system can be taken down.

With that in mind, the clock is ticking on Europe. On that note, I fully believe the EU in its current form is in its final chapters. Whether it’s through Spain imploding or Germany ultimately pulling out of the Euro, we’ve now reached the point of no return: the problems facing the EU (Spain and Italy) are too large to be bailed out. There simply aren’t any funds or entities large enough to handle these issues.

So if you’re not already taking steps to prepare for the coming collapse, you need to do so now. I recently published a report showing investors how to prepare for this. It’s called How to Play the Collapse of the European Banking System and it explains exactly how the coming Crisis will unfold as well as which investment (both direct and backdoor) you can make to profit from it.

This report is 100% FREE. You can pick up a copy today at: http://www.gainspainscapital.com

Good Investing!

Graham Summers

PS. We also feature numerous other reports ALL devoted to helping you protect yourself, your portfolio, and your loved ones from the Second Round of the Great Crisis. Whether it’s a US Debt Default, runaway inflation, or even food shortages and bank holidays, our reports cover how to get through these situations safely and profitably.

Tags: Amp Company, Barclays Capital, Bnp Paribas, Bnp Paribas Securities, Cantor Fitzgerald, Citigroup Global Markets, Citigroup Global Markets Inc, Daiwa Securities America, Deutsche Bank Securities, Deutsche Bank Securities Inc, Goldman Sachs, Hsbc Securities, J P Morgan Securities Inc, Mizuho Securities Usa Inc, Nomura Securities International, Nomura Securities International Inc, Rbc Capital Markets, Securities America Inc, Sovereign Bonds, Ubs Securities
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Europe Continues to Tumble as French Banks Hit Hard on Greece Default Idea

Monday, September 12th, 2011

by Trader Mark, Fund My Mutual Fund

The whole Greek tragedy is getting a bit tiring after two years of discussing it.  As mentioned Friday, it was leaked Germany was preparing to ring fence their banks from a Greek default, which was a change of direction after years of insisting no one in the EU would be allowed to fail.  Of course the issue now is other countries – especially France – now have to do the same thing and backstop their banks ala USA 2008, as these institutions are carrying paper on their balance sheets which is worth far less than they have been forced to admit.  Today the French banks have taken it on the chin as I suppose ‘the market’ is demanding the same from France as Germany did last week.

• Mounting fears over the possibility of a Greek debt default and signs of division within Europe’s policymaking circles over how to deal with the crippling crisis combined Monday to send bank stocks sharply lower.
• Senior German politicians have suggested publicly in recent days that an orderly bankruptcy of Greece may be part of a solution to the country’s problems. The notion, which has been a taboo so far in Europe’s handling of the crisis, has spawned uncertainty in financial markets.
• …..many of the continent’s leading financial groups, such as Deutsche Bank and BNP Paribas, down some 10% as investors worried over their exposure to potentially bad European debt.
• France’s Societe Generale, which dropped 10%, tried to calm investors with a statement saying its exposure to the euro’s more imperiled economies is diminishing — at euro3 billion — and that it was accelerating plans to raise over euro4 billion ($5.4 billion).

Once ‘the event’ is over (with Greece) it will be interesting to see where ‘the market’ focuses on next i.e. do attacks on Portugal begin anew? Or are they considered in better shape?  Whatever the case it appears central banks are going to be busy backstopping everything on Earth once more.  Ironically the resignation of Mr. Stark Friday – who was against bond buying by the central bank – could open the door for the ECB to go full Bernanke down the road.  (which of course the markets will love!)

As for markets the levels I’ve been speaking about the past few weeks are still in play, 1120(ish) and then 1100 (intraday low on Fed announcement day). With 3 big bad days in a row (including today) we’re again prone for a snap back rally at some point mid to latter week perhaps, but it remains a market only for short timers. Also later this week markets should begin their Pavlonian giddy reaction to anything Helicopter Ben does – which is certain to be ‘Operation Twist’ a week from Wednesday.

Tags: Backstop, Balance Sheets, Bank stocks, Bnp Paribas, Central Banks, Change Of Direction, Debt Default, Deutsche Bank, Euro3, Financial Groups, Financial Markets, French Banks, German Politicians, Greek Tragedy, Mutual Fund, Onc, Policymaking, Ring Fence, Societe Generale, Taboo
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More 2010 than 2008

Tuesday, August 16th, 2011

This Week’s ETF Selection: iShares CDN Russell 2000 ( Ticker: XSU )

Europe’s debt crisis continues to hammer global equity markets. Investors fear a repeat of 2008. While that is a possibility, current conditions make it more likely that we will see a repeat of 2010 instead, when markets wilted in the summer heat before starting a rapid six-month rally.

The fall in equities has been swift and sharp. From their April highs, equity indices like the S&P TSX 60, the S&P 500, the MSCI EAFE and the MSCI Emerging Markets fell between 17 and 21%, erasing all the gains for the year-to-date and putting them all solidly in correction territory. The VIX Index, a proxy for market panic, hit nearly 50, a level last seen during the May 2010 Flash Crash but far below the all-time October 2008 high of 90.

The market weakness is not surprising given all the punches they have taken all year. In January, expensive commodities led to inflation, higher interest rates in developing markets, riots in the Arab world, and lower economic growth. The Japanese disaster hurt supply chains. Greece nearly defaulted before it was saved. U.S. politicians bickered over debt. The latest punch was S&P’s downgrade of U.S. debt.

S&P’s action, largely symbolic, coincided with the latest round of selling pressure, but it did not cause it. In fact, investors seeking safety bought even more of the downgraded U.S. debt,  pushing prices on 10-year U.S. Treasuries to within a fraction of face value and yields to an all-time low of 2.13%. The U.S. dollar rallied as well to nearly parity with our Loonie.

What really triggered the equity sell-off was fear over the solvency of French and Italian banks holding large amounts of Greek, Irish and other poor quality sovereign debt. If a Lehman-sized bank like Société Générale and BNP Paribas were to fail, then we could well see 2008 lows.

In that sense, conditions now resemble 2008: U.S. credit crisis then; Euro-zone credit crisis now. However, the differences are greater. Banks are much better capitalized and less leveraged than in 2008. With the lessons of 2008 still fresh, finance and central bank officials have a better idea of how to respond to a credit crisis. In 2008, banks stopped lending to each other and hastened the fall of Lehman and Bear Stearns before that. Now, the cost of inter-bank borrowing has gone up slightly in the Euro-zone but credit is still flowing, and central banks are there to provide liquidity if it becomes necessary.

Economies are growing, albeit slower than expected. After a year of record profits, U.S. companies have reduced their debt loads and are sitting on over $1 trillion in cash reserves. U.S. employment continues to rise in fits. Any move by corporations to expand production will boost employment further.

Then there is the possibility of economic stimulus. The U.S. government’s hands are tied but other countries can step in. One possibility is China. It has let its currency appreciate nearly 7% since May 2010. That should see China’s trade surplus with other countries, especially the United States, shrink. It may also spur rich Chinese firms to buy overseas assets.

Finally, there are corporate valuations. The price to earnings ratio of the S&P 500 is at about 12, well below the long-term average of 16. Dividends on the Dow Jones Index are yielding about 2.6%, a full half a percentage point over the 10-year Treasury. Both are good indicators of a cheap market.

Of course, it may get even cheaper, simply on the selling momentum. But a resolution of the Euro debt situation would see markets stage a quick and sustained rebound, perhaps on par with the 20 to 30% rallies we enjoyed in the second half of last year. When they do, the best ETFs to be in will be the ones that overreact to market movements. Also, with the possibility of the U.S. dollar weakening on further stimulus, Canadian investors would do well to go for a currency hedged ETF. The iShares Russell 2000 Hedged to C$ (XSU-TO) ETF of U.S. small cap stocks meets both these requirements. Conservative investors could choose a large cap ETF.

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Tags: Bnp Paribas, Canadian, Commodities, Credit Crisis, Debt Crisis, Euro Zone, Global Equity Markets, Italian Banks, Loonie, Lows, Market Panic, Market Weakness, Msci Eafe, Msci Emerging Markets, Outlook, Russell 2000, Societe Generale, Solvency, Sovereign Debt, Supply Chains, TSX 60, Vix Index, Xsu
Posted in Canadian Market, Commodities, ETFs, Markets, Outlook | Comments Off

Sovereign Risk Crunch: Asian Banks Commence Cutting Credit Lines To French Banks, Sparking Self-Fulfilling Prophecies

Thursday, August 11th, 2011

by ZeroHedge.com

Remember how we joked (but were dead serious) that the IMF is now simply a figurehead organization, and the real global bailout cop is China? Well, that may not be the case for much long. Reuters has just broken news that at least one bank in Asia, and five other in process, has cut credit lines to major French lenders “as worries about the exposure of French banks to peripheral euro zone debt mounts, banking sources told Reuters on Thursday.” Why is this worrying? Because as is by now well-known, the PBoC has been as aggressive a buyer in the primary market of European market as most European banks, which as is well-known immediately turn and pledge said debt as collateral to the ECB for 100 cents on the euro, and the fact that its proxies are now quietly withdrawing from the European market as lenders of last resort, is probably far worse news than a rumor that the S&P may cut France.

Reuters continues:

That sudden rise in risk perception, combined with sharp share price falls in French banks, prompted some banks in Asia to speed up reviews of counterparty risk and look at whether they should cut exposure to European lenders, sources at each of the six banks in Asia said. Contacted about the moves by the banks in Asia, a spokeswoman for top French lender BNP Paribas <BNPP.PA> in Paris said: “We never comment on market rumours.”

Societe Generale <SOGN.PA> had no immediate comment to make while a spokeswoman for Credit Agricole <CAGR.PA>, which will publish its second-quarter earnings later in August, said the bank would not make any comment.

The banks in Asia and the sources — a mix of risk officers, senior traders and loan bankers — could not be identified because of the sensitive nature of the information.

The head of treasury risk management for Asia at one bank in Singapore said their credit lines to large French banks had been cut because of the perceived risks in lending to these counterparties.

“We’ve cut. The limits have been removed from the system. They have to seek approval on a case-by-case basis,” the treasury risk official said. The bank official declined to name the French banks.

A senior credit trader in Singapore said that when a bank’s shares fall that sharply their risk officer will automatically look at how much exposure they have to that lender.

And more:

Banks’ heightened responses could exacerbate the market strains if they all acted simultaneously with portfolio-at-risk modelling, analysts said.

“The thing is if they all use it at the same time they will all sell at the same time when risk goes up, and that will drive prices down and it is like a snowball because then the prices go down and then your value-at-risk ratio will tell you ‘oh, I must reduce my risk even more’,” said Mark Matthews, head of research at Julius Baer.

Several of the traders and bankers in Asia said that while they had not cut all exposure to any particular institution, they were very cautious about taking on new trading positions with them.

A senior risk officer at a bank in Singapore said “obviously we are having a review”, when asked if they were reassessing their positions with European counterparties.

Bankers and risk officers at the five institutions in Asia that were still dealing with French banks said that while short-term lending of up to 30 days was still taking place, they were conducting a thorough review of longer-term credit lines regardless of the type of transaction.

“It’s all in relation to (our) take on a French bank’s credit risk, regardless of whether it’s a swap or interbank lending transaction,” said a senior loan banker at a Japanese bank.

What happens next is well known to anyone who lived through the fall of 2008: credit lines withdrawn means investors dumping stock in droves, means depositors staging physical money runs, means more credit lines withdrawn, means immediate liquidity crunch, means rumors of insolvency, means self-fulfilling prophecy, means scramble to get funding first from ECB, then from Fed, but by then contagion has spread and the entire financial system is in danger of imploding, means several trillion in FX swap lines activated to prevent a run on the dollar, which also happens to be the funding currency, means another scramble to bail out capitalism.

Granted this is a downside case assessment.

Copyright © ZeroHedge.com

Tags: Asian Banks, Bailout, Bnp Paribas, Bnpp, Cagr, China Well, CréDit Agricole, ECB, Euro Zone, European Banks, French Banks, Market Rumours, Pboc, Risk Perception, Second Quarter Earnings, Self Fulfilling Prophecies, Sensitive Nature, Societe Generale, Sovereign Risk, Treasury Risk Management
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Beware Contagion from Greeks Bearing Rifts?

Thursday, June 16th, 2011

by Leo Kolivakis

Richard Barley of the WSJ reports, Beware Contagion From Greeks Baring Rifts:

Euro-zone politicians may be fiddling while Athens burns. Tuesday’s meeting of finance ministers brought no progress on how to address Greece’s funding problems and avoid setting off a financial crisis. But conditions in European markets are deteriorating. The main risk from Greece has always been contagion, and that process is already under way.

Most directly, prices of Portuguese and Irish bonds have fallen sharply, with 10-year yields rising above 11% and the cost of insuring their debt at record levels. The gap between Spanish and German 10-year bond yields is at its widest since January. The market is effectively giving no credit for any reforms or budget policies set out in the past six months.

The next link in the chain, the banking system, has been affected. In Spain, progress by banks on regaining market access has gone into reverse: Average borrowing from the European Central Bank jumped to €53 billion ($76.32 billion) in May from €42 billion in April.

Meanwhile, the contagion into core banks may be being underestimated by investors. Moody’s on Tuesday said it could downgrade France’s BNP Paribas, Société Générale and Crédit Agricole due to their holdings of Greek debt, and the ratings firm is looking at whether other banks could face similar risks.

Disturbingly, the worries have now reached non-financial companies, which have been virtually bulletproof this year. Investment-grade bond issuance has come to a near-standstill. The yield premium on Portugal Telecom‘s February 2016 euro bond over German Bunds has widened a stunning 2.3 percentage points in the last two weeks, data from Société Générale show. Italian and Spanish credits are under pressure too. The credit market now starts by pricing government risk and then works back to price debt from financials and companies, one investor says: Greece is a destabilizing influence at the center of the market’s deliberations.

When German Finance Minister Wolfgang Schäuble last week proposed a seven-year maturity extension for Greek bondholders, setting up the current standoff with the ECB, he suggested there was a chance to minimize the negative impact on financial markets. That was always an optimistic hope. The reality is that markets are starting to wake up to the risks of a Greek debt restructuring. Europe’s politicians need to act fast to stem the tide.

Markets have started to wake up to the risks of Greek debt restructuring? No kidding? The problem is that Eurozone politicians still have their heads up their asses (I’m sorry, calling it like I see it, and there is no way I’m going to sugarcoat this crisis). With each passing day, there is a huge risk of another international banking crisis — and this one will make 2008 look like a walk in the park! (Had lunch with two of Montreal’s most promising hedge fund managers yesterday and they’re both bearish on this market).

Meanwhile, over in Greece, Reuters report that Greeks of all ages want politicians to pay:

Greek workers of all ages and professions, pensioners, students, the old and young marched on parliament in Athens Wednesday to vent their anger at the country’s politicians and their austerity plans.

Tens of thousands took part in the protest rally, which follows three weeks of peaceful evening gatherings in the central Syntagma Square of people from all walks of life, tired of tightening their belts a year after Greece received an EU/IMF bailout.

“I feel rage and disgust,” 45-year-old civil servant Maria Georgila, a mother of two, said in front of parliament.

“These measures are very tough and they won’t get us out of the crisis. I can’t believe they have no alternative.”

Like others yelling “Thieves!” and raising open hands toward parliament in a traditionally offensive gesture, 38-year-old Maria Koutroumba said she felt betrayed.

“They are traitors, they’ve plagued the country,” the unemployed woman said of the politicians as she helped form a human chain around the parliament building.

“These measures are hurting us, the ordinary people,” said Koutroumba, who used to get by on short-term contracts in the private sector but is now out of work, like over 800,000 Greeks.

The jobless rate hit a record 16.2 percent in March as cutbacks to rein in Greece’s huge debt burden of 340 billion euros stifled the economy further. The EU and the IMF expect the Greek economy to contract 3.8 percent this year.

Greece’s international lenders have also insisted that the country sell 50 billion euros of state assets to reduce its debt mountain.

“More people must take to the streets and say that Greece is not for sale,” said Koutroumba, who spent the night on the square and said she would stay as long as needed.

Greek lawmakers were due to discuss a new austerity package of 6.5 billion euros in tax rises and spending cuts this year, including higher tax on cars and restaurants and slashing the public sector workforce.

“We wouldn’t be here if they (the politicians) had made sacrifices as well,” said 60-year-old pensioner Panayotis Dounis, who said he had joined the non-political rally in front of parliament nearly every night for about half an hour.

BREAD AND OLIVES

Dounis said he wanted no violence at the anti-austerity rallies. Most protesters marched peacefully Wednesday, though the rally was marred by clashes between stone-throwing youths and police.

“I am willing to make sacrifices, to live only on bread and olives, but what are they (politicians) doing for us?” asked the former builder, who retired last year.

“I want them to work for four years without getting paid, for Greece, for their country,” said Dounis, whose three children are jobless and who believes MPs can afford to work for free for a while.

Singer Vassilis Theodorakopoulos, 32, who performs in various places to make ends meet, has been camping in central Syntagma Square for the past 20 days.

“All of these governments must vanish,” he said. “We want to reorganize Greece away from any memorandum, the EU and the IMF.”

If I were an ordinary Greek citizen, I would be enraged as well. While Greece’s elite are parking their money offshore in Cyprus, Switzerland, UK and Germany, most Greeks are struggling to get by on crumbs, bearing the brunt of the strict austerity measures being imposed on them. There is no long-term game plan on creating jobs, much like in the US where the jobs crisis is getting worse. I think politicians from around the world should carefully listen to professor Robert Shiller below on how to revive America’s ‘animal spirits’.

Copyright © Leo Kolivakis

Tags: Banking System, Bnp Paribas, Bond Issuance, Bond Yields, Budget Policies, Bunds, Contagion, Core Banks, CréDit Agricole, Euro Zone, European Markets, Finance Ministers, Government Risk, Investment Grade, Market Access, Portugal Telecom, Rifts, Societe Generale, Standstill, Wsj Reports
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Kathleen Gaffney and Martin Fridson discuss Bond Investing

Monday, January 31st, 2011

This week on Wealthtrack, Consuelo Mack talks to two of the bond world’s brightest top managers on the outlook for fixed-income investments in 2011. Kathleen Gaffney, co-manager of the Loomis Sayles Bond Fund, and Martin Fridson, high yield guru and Global Credit Strategist at BNP Paribas Asset Management, tell us what to buy and what to avoid in bonds in the year ahead.

Note: The transcript of this interview is not available yet, but will be posted here as soon as it arrives.

Source: Wealthtrack, January 28, 2011.

Tags: Bnp Paribas, Bnp Paribas Asset Management, Bonds, Consuelo Mack, Fixed Income Investments, Global Credit, Guru, high yield, Kathleen Gaffney, Loomis Sayles Bond, Loomis Sayles Bond Fund, Martin Fridson, Strategist, Top Managers, Wealthtrack
Posted in Bonds, Markets, Outlook | Comments Off

ETF Trading Idea For A Crumbling Euro

Thursday, May 13th, 2010

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This article is guest contribution by Michael Johnston, of ETFdb.com

And so the carousel ride continues. In 2008, the U.S. was the center of the investing world as the financial sector meltdown began. Then it was China’s turn, as earlier this year investors focused on Beijing’s plan to continue the impressive growth without overheating. Now Europe is clearly in the spotlight, with every development from Greece and the ECB rippling throughout global equity markets.

The recent turmoil across the pond has investors pondering the viability of the common currency system and reconsidering allocations to European equities (see ETF Options For An Ex-Europe Portfolio). Although the euro has stabilized in recent sessions, the consensus opinion among investors is that the currency faces a tough battle ahead. BNP Paribas is now forecasting the the euro will hit parity with the dollar in 2011. Barclays and UBS also have a pessimistic view, anticipating that the euro will decline to $1.20 within three months.

For investors who think the euro will continue its slide and take European stocks down with it, there is no shortage of trading ideas. The ProShares UltraShort MSCI Europe (EPV), which seeks to deliver daily returns equal to 200% of the inverse movement in the MSCI Europe Index, has seen an increase in interest over the last week. And there are a handful of ETF in the Europe Equities ETFdb Category that can be sold short to profit from declines in value.

Playing The “Euro Drag”

Some investors think that the euro has a rocky stretch, but aren’t quite convinced that weakness in the currency will dim the underlying fundamentals of European companies. “I think the euro is in trouble,” says Wharton finance professor Jeremy Siegel. “But that doesn’t necessarily mean that European stocks are not a buy.” For investors bearish on the euro, but not convinced that European equities are a “sell,” we present a unique market neutral ETF trading idea:

* Long Global X FTSE Nordic 30 ETF (GXF)
* Short iShares MSCI EMU Index Fund (EZU)

Both ETFs invest in European equities, but in the current environment the risk profiles of these securities are very different. GXF’s holdings are split between four Nordic countries: Sweden, Denmark, Norway, and Finland. While Finland (which makes up about 16% of total assets) has adopted the euro, the other four countries represented have avoided doing so. EZU tracks the MSCI EMU Index, a benchmark that measures the performance of equity markets of EMU member countries–those members of the European Union who have adopted the euro as its currency. An x-ray look at EZU’s holdings reveals allocations to many of the countries mentioned in the “next domino to fall” discussion: Spain, Italy, and Greece.

When considering international ETFs, most investors don’t give much thought to the impact that currency exposure will have on their bottom line returns. But because most equity ETFs are unhedged (HEDJ and DFJ being the exceptions), movements in exchange rates can either create strong headwinds or give an added boost (see EFA vs. HEDJ: A Better EAFE ETF? for a closer look at this issue).

The currency exposure obviously isn’t the only difference between GXF and EZU; these two ETFs have virtually no overlap among individual holdings. But the sector breakdown is relatively consistent between the two, with financials and industrials accounting for significant portions of total assets. If the euro continues to weigh on markets as it has in recent weeks, EZU will have a hard time keeping up with GXF (investors looking to make a more symmetrical market neutral play against the euro might consider going long HEDJ and short EFA or DWM).

Diverging Fortunes

Both GXF and EZU offer exposure to European stock markets, and the correlation between the two funds is relatively strong. But these ETFs have delivered very different performances in 2010; GXF is actually up slightly on the year, while EZU is down about 15%:
For more actionable ETF ideas, sign up for our free ETF newsletter .

Disclosure: No positions at time of writing.

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Tags: Barclays, Bnp Paribas, Carousel Ride, China, Currency System, ECB, Epv, ETF, ETFs, European Equities, European Stocks, Finance Professor, Financial Sector, Global Equity Markets, Impressive Growth, Jeremy Siegel, Meltdown, Michael Johnston, Msci Europe Index, Pessimistic View, Professor Jeremy, Proshares Ultrashort, Tough Battle, Wharton
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UniCredit Bank Warns Plunge In Sterling And Gilts, Britain Is Next “To Be Pummeled By Investors”

Friday, March 12th, 2010

This article is a guest contribution from ZeroHedge.com.

Kornelius Purps, director of fixed income at Europe’s second-largest bank, UniCredit, has issued a stark warning to clients who wish to invest in the Britain: “I am becoming convinced that Great Britain is the next country that is going to be pummeled by investors.” Ambrose Evans-Pritchard reports reports that “Mr Purps said the UK had been cushioned at first by low debt levels but the pace of deterioration has been so extreme that the country can no longer count on market tolerance” and that “Britain’s AAA-rating is highly at risk. The budget deficit is huge at 13pc of GDP and investors are not happy. The outgoing government is inactive due to the election. There will have to be absolute cuts in public salaries or pay, but nobody is talking about that.” And everyone was wondering why the U in STUPID stand for UK (actually make that just CNBC, who never really bothered to even read the original definition). So can the whole sovereign default wave skip the PIIS and go straight to the U?

From the Telegraph:

“Sterling is going to fall further over coming months. I am not expecting a crash of the gilts market but we may see a further rise in spreads of 30 to 50 basis points.”
Yields on 10-year gilts have already crept up to 4.14pc, compared to 3.94pc for Italian bonds, 3.48pc for French bonds, and 3.19pc for German Bunds, though part of this reflects worries about higher inflation in Britain.
Ian Stannard, currency strategist at BNP Paribas, said markets are fretting over how the UK will cover its deficit following the pause in quantitative easing by the Bank of England. The Bank has absorbed £200bn of debt, more than total Treasury issuance over the last year.

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“The UK may have difficulty in attracting extra investors to fill the gap. We think they will have to do more QE as recovery falters,” he said.
BNP Paribas expects sterling to drop to $1.31 against the dollar this year and reach parity against the euro despite troubles in Club Med. “We’re very bearish on the UK,” he said.

And the biggest insult to the island nation? The insinuation that Greece is actually better off that Britain.

UniCredit said Greece is better placed than the UK in coming months even if deficits look comparable. “The polls point to a minority government in the UK, while Greece’s government can count on a majority to push austerity measures through parliament. Secondly, the British tax system offers less leverage for a rise in revenue,” he said.
Paradoxically, Greek tax evasion creates scope for a surge in revenues from tougher enforcement. “It is not out of the question that we will see a positive surprise in Greece: is there any such hope for Britain?” said Mr Purps.

Well Mr. Purps, this means that there is still hope for America. As the still sentient part of the population has decided to show the corrupt administration and the criminals on Wall Street the middle finger and maxed out their withholding exemptions, all it will take is an order from the US politbureau that the Treasury can withhold 100% of every paycheck, and in addition, garnish wages in perpetuity, DCFed at Ben Bernanke’s favorite discount rate of -100%.

Tags: Aaa, Ambrose, Bank Of England, Basis Points, Bnp Paribas, Budget Deficit, Bunds, Cnbc, Currency Strategist, Debt Levels, Evans Pritchard, Fixed Income, Gap, Gilts, Issuance, Outgoing Government, Plunge, Public Salaries, Qe, Stannard
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Presenting Total Bank Assets As A Percentage Of Host Countries’ GDP

Wednesday, February 17th, 2010

This article is a guest contribution by Tyler Durden, ZeroHedge.com.

With the threat of sovereign default and contagion now pervasive within the Eurozone periphery, it is relevant to quantify the relative exposure of various banking centers’ assets as a percentage of host countries’ total GDP. The reason for this is that in Europe for many countries a sovereign default would not have as great an impact, as a risk-flaring contagion impacting these countries’ primary financial entities, whose assets account in some cases for multiples of host GDP. For example in Switzerland, the assets of the top two banks, UBS and Credit Suisse, alone account for nearly 600% of the country’s GDP. And while Switzerland is relatively isolated from the budget and deficit crises in the PIIGS and STUPIDs, other countries such as Italy, Belgium and ultimately France, Germany and the UK, are much more exposed.

• Belgium – Dexia: 180%of GDP
• France – BNP Paribas, Credit Agricole, SocGen: 237% of GDP
• Germany – Deutsche Bank: 84%
• Italy – Unicredit, Intesa Sanpaolo: 101%
• Netherlands – Fortis: 155%
• Spain – Banco Santander: 92%
• UK – RBS, Barclays, HSBC: 337%

Compare that to the top 5 banks in the US (a list which excludes hedge funds such as Goldman Sachs).

• US – JP Morgan, Citigroup, Bank of America, Wells Fargo and Fannie: just 56% of GDP.

The question which pundits should be focusing on is once the Greek crisis flares up and takes down several peripheral non-hosted banks, just what the interplay of a “falling domino” scenario will be not only on neighboring European countries, but also on the holdings of their domestic banks. Because it is inevitable that the same kind of bank run witness in Greece, will become a pervasive phenomenon and impact Portugal, Spain, Italy, etc, which would be the precursor to a global bank run.

The chart below demonstrates graphically the ratio between a given bank’s asset and the GDP of its host country. Unfortunately for Europe, there is a dramatic concentration of bank assets precisely in some of the most precarious regions. Which is why Germany may have kicked the can down the road for at least a month, but the issue will come back with a vengeance for the simple reason we have noted from the start of this crisis: only Bernanke has a money printer. Everyone else actually has to produce “stuff”, sell it and collect taxes if they want to fill catastrophic budget deficits. And the latter, as we have seen, is something the developed world has been horrible at doing over the past decade, courtesy of the Goldman-facilitated innovation explosion.

Source: ZeroHedge.com, February 17, 2010.

Tags: Banco Santander, Bank Assets, Bank Of America, Bnp Paribas, Contagion, Credit Suisse, Dexia, Domestic Banks, Gdp France, Global Bank, Goldman Sachs, Host Countries, Host Country, Intesa Sanpaolo, Jp Morgan, Pervasive Phenomenon, Portugal Spain, SocGen, Tyler Durden, Wells Fargo
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Quantitative Easing: A Guide and Outlook to the ‘Nuclear Option’

Sunday, March 22nd, 2009

Last week, Ben Bernanke announced the Fed’s decision to employ ‘Quantitative Easing’ (QE), the ‘nuclear option,’ to save the credit market and the economy. On the news that the Fed will buy back up to $300-billion worth of long dated US treasury bonds, and acquire an additional $750-billion of mortgage backed securities, the US dollar plunged, the euro surged, Treasury yields nose-dived, gold bullion exploded, and stocks, oil and commodities gained handsomely.

We know what the immediate reaction has been to this, but what does it all mean in the longer term?

The main design of QE is to supply the money, by printing it, that is required to fulfill current demand for money arising from the deleveraging of balance sheets. Buyers need to be able to access credit and cash in order to purchase assets from distressed vendors. If purchasers cannot be facilitated via the market, the bids for the assets will keep falling until they can. QE means to provide the stop-gap measure. The other purpose of QE, is to make it possible for the Fed to enlarge its own balance sheet by assuming or acquiring ‘toxic’ assets in return for retiring debt from banker debtors, so that they can be freer to resume lending.

Until now, the deleveraging of market assets in favour of debt reduction has resulted in strong demand for cash, such that it has given the dollar a disproportionate boost – hence the strangely strong dollar.

Prior to the Fed’s move last week, this quote describes the current nature of the strong US dollar, from FT.com:

Hans Redeker at BNP Paribas said under normal circumstances, a rising deficit works against the domestic currency. “However, in this environment, deleveraging by institutions in order to clean up balance sheets will provide the dollar with a natural bid,” he said.

This deleveraging helped create a dollar shortage that drove the US currency sharply higher against the euro after the collapse of Lehman Brothers last September. Analysts said a similar situation seemed to be developing as equity markets plunged below their lows from last autumn.

The following is an excellent tutorial from Marketplace.com on Leveraging and Deleveraging:

Leveraging and deleveraging from Marketplace on Vimeo.
Quantitative easing supplies the cash via the printing press to those institutions in need of cash in return from the sale of levered assets, in the form of credit for buyers of liquidated assets. With credit for the purpose of re-purchasing distressed assets unavailable to would-be buyers, the market for those assets has suffered immensely; stocks, bonds, real estate, etc. As for the CDOs, only a daring breed of investors have shown interest, but they too may find it hard to get the credit to make it worthwhile, or the concessions and covenants.

The following is a tutorial from Marketplace.com on Quantitative Easing:

Quantitative easing from Marketplace on Vimeo.

Effectively, when you sell (or short) assets, the end result is that you end up long the cash. For those seeking to reduce debt, the cash disappears into the money pit, returning to the lender’s balance sheet. For those selling assets because they are risk averse, the money ends up for the time being in now zero-interest treasuries and short term cash equivalents. Therefore you end up with a strong dollar. When the market was over-using credit, it was short the dollar and the dollar was weaker. Now that the market is in a debt-reduction or deleveraging mode, it is long the dollar, therefore the dollar gains strength.

The Feds decision to employ the ‘nuclear option’ of QE sends a signal that there may be a great deal more deleveraging in store for the economy and there is substantial need to supply the money.

The immediate reaction is the weakening of the dollar, but that just provides temporary breathing space until the subsequent rounds of deleveraging sop up the slack created by QE, and what follows is a revitalized dollar, strengthened yet again by the deleveraging.

Graduated QE will periodically and gradually weaken the dollar, as it is dilutive, but the take up created by graduated deleveraging will gradually renew dollar strength. Ideally, if all the central banks in the G6 resort to this, there will be balance, but the timing may at times prove to be skewed by the independent agendas of the UK and the ECB.

The bottom line is that this first round of QE is just that. The first round. Bill Gross, Managing Director, PIMCO, points out that while it is a good move, it may not be enough, and that the Fed may have to expand its balance sheet to $5 or $6-trillion, as it takes $4 of debt to generate $1 of GDP growth.

Bill Gross: No, I agree with all of that. Its just a question, Kathleen, of ‘how big of a kick?’ There are a number of ways of looking at this. Goldman Sachs has approached it from the standpoint of the Taylor Rule, the deficiencies of output relative to their own particular index.

We look at it a little bit differently at PIMCO, we look at it from the standpoint of the amount of debt that’s required to produce a dollar’s worth of GDP growth. And up until 12-18 months ago in terms of our existing economy, that was about $4 of debt for $1 of GDP growth.

This $1-trillion dollars to our way produces $250-billion of GDP; that’s just under two percent real growth. That`s good, that produces in our opinion about 1-million jobs, but we need more than that.

KH: Is it enough to avoid the mini-depression you were talking about last month when I joined you for an interview out there at Newport Beach?

BG: We think so, you know yesterday’s move by the Fed were in recognition of this recessionary economy that could have resembled a small depression unless credit markets and risk taking were revived. And in fact the Fed labelled their policies ‘credit easing’ and you mentioned the obvious intent to lower mortgage rates to homeowners and lower credit card rates, auto loans, commercial rates as well so, you know, its very much of a positive push. We have sense that the $1.8-trillion balance sheet that the Fed has, that’s now growing to $3-trillion, probably will have to grow to $5-trillion and $6-trillion in order to keep us on a trend line that produces positive as opposed to negative growth.

Because QE measures may not yet be sufficient to completely overcome the problems facing the banking system in terms debt reduction the outlook continues to be tilting towards deflation.  As long as the need to deleverage balance sheets exceeds the availability of credit, assets could continue to deflate. Therefore, our sense is that the Feds first QE move is preliminary, and primes the pump for more QE in the next 6-12 months.

So, is the Fed’s move a signal that we are at an inflationary or deflationary inflection point for the moment? Watch the debate unfold between Hugh Hendry, and Liam Halligan. Then you decide…

We like to err on the side of reason and validity.

At the moment the political will to carry out this process fully, and further, faces significant opposition, especially to the idea of bailing out Wall Street and the US banking system, and is hobbled by the public outcry against the AIG bonuses debacle, and government has done as much as it can to suitably convince constituents of what it needs to do, for now. Today, the US Treasury announces a $1-trillion ‘public-private investment programme’ to absorb the toxic assets into what amounts to a ‘bad bank.’ One of the big issues is the competence of those in the private sector (which is meant to be a checks and balances component) to price these assets. Another issue remains whether or not this will get banks to release their chokehold on credit and resume business as usual in the lending business. The White House is expected to follow up this week with its comprehensive financial plan. This administration’s public relations programme has reached a crescendo; 60 Minutes, Jay Leno. Will they be able to finally stop talking and actually get down to work on it?

Does Geithner have the political ammunition to take further measures? Geithner must convince the market and constituents that this move will complement the Fed’s quantitative easing.

From today’s Globe and Mail: Nobel Prize-winning economist and Princeton University professor Paul Krugman blasted the strategy as a rehash of former treasury secretary Henry Paulson’s discredited solution to the banking crisis, first proposed six months ago. “It’s not new; it’s just another version of an idea that keeps coming up and keeps being refuted,” Prof. Krugman wrote over the weekend on his New York Times blog.

“It’s just horrifying that [U.S. President Barack] Obama – and yes, the buck stops there – has decided to base his financial plan on the fantasy that a bit of financial hocus-pocus will turn the clock back to 2006.”

The only way out of the banking crisis is for the government to offer a sweeping guarantee of problem debts and to seize control of banks with too few assets to cover their debts, Prof. Krugman argued.

The current crisis, he argued, isn’t just a panic, but a fundamental realignment of a financial system that foolishly bet big that house prices and consumer debt would continue rising forever.

For these reasons, QE and other measures will be a gradual process and could work, but only if taxpayers are willing to be saddled with the burden.

Tags: Balance Sheet, Balance Sheets, Ben Bernanke, Bill Gross, Bnp Paribas, Cdos, Collapse, Covenants, Debt Reduction, Debtors, Distressed Assets, Domestic Currency, End Result, Feds, Gap, Gold, Gold Bullion, Hugh Hendry, Last Autumn, Last September, Lehman Brothers, Lows, Market Assets, Mortgage Backed Securities, Nuclear Option, Printing Money, Printing Press, Qe, Redeker, Stocks Bonds, Stop Gap, Strong Dollar, Treasury Yields, Us Treasury Bonds, Vimeo
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