Peter Tchir

Europe Wasn’t Destroyed in a Day

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Peter Tchir

Just like Rome wasn’t built in a day, the Eurozone won’t be destroyed in a day, but it is on a path that leads to eventual dismantling. What day will historians choose to pick as the day that the Euro died?

  • The day Greece or someone else first leaves the Euro
  • The elections of May 6th
  • The day Greece changed laws to retroactively add Collective Action Clauses and created a new class of bonds for the ECB
  • The day that Greek Private Sector Involvement was finished and new bonds traded at 20% of par

Personally, I think the Greek PSI was what proved the Eurozone was doomed. Greece restructured debt, made different rules for different holders, and yet, the new bonds trade at 20% of par. It’s like drink non-alcoholic beer, why put up with the better taste with no useful result at the end. So these elections, while important are merely another step on the path the Eurozone has been headed for months, if not years.

The markets will digest the elections as we illustrate in «The Paucity of Growth«. We are already seeing it play out. After an initial swoon in markets, they have rebounded, and already threaten to take out some post election shorts. Germany has said they will play nice with France. Merkel seems to have the trickiest job as she and her supporters lost support for their bailouts, and yet in Greece, the people who took the bailouts also lost power. It is funny that both the giver and receiver are viewed as having done the wrong thing. This will be important over time, but not this week.

This week we will see everyone play nice. Conciliatory words will be spoken. Growth will become the topic de jour. The markets will fall all over themselves once again on news of bank bailouts. The headlines we get in the early part of this week will once again be overwhelmingly designed to encourage people and the markets. Europe will have a new spirit of co-operation and will welcome fresh insights into the process. Growth, growth pacts, plans to grow, infrastructure growth, etc., will be talked about. There will be talk, and maybe even action on the bank recapitalization efforts. Good banks and bad banks will abound. Governments will promise money to banks at rates so low no sane investor would even consider. So I look for a continued bounce and am a bit net long in the TFMkts Best Ideas™.

Ultimately these plans will fail, and we will see fresh lows on the year for stocks, with the U.S. and Germany hit hardest (having outperformed by far too much already), because:

  • Germany in particular, but France and the Netherlands will have trouble justifying their contributions to the bail-out. They will be forced to turn to domestic issues to satisfy their electorate and this will become obvious to the market.
  • Growth isn’t easy to achieve. Once “growth” moves from a vague concept stage into something resembled a plan, investors will likely laugh at the attempts. It will be clear that most of the plans are unlikely of achieving long term growth above and beyond the cost of achieving it. That will not help the bond markets, and in turn will spill over into equities as they realize they were fooled by headlines and hype over reality, once again.
  • The good bank/bad bank concept is a loser to start with. The bank recapitalizations just enshrine zombie banks. By the time a bank is getting government gifts, the problems they have hidden are likely as large as the obvious ones. The managers don’t worry about lending, they worry about protecting their jobs and their income and hoping nothing else comes out. They hoard the new money in an effort to grow capital and in the hopes that the problems no one noticed go away before someone notices. Starting fresh banks would be ideal. Or letting some bad banks fail and then starting them fresh would be okay. Letting the existing banks get taxpayer money at uneconomic rates, does nothing for the citizens, or the country, and ultimately if there is any “winner” it will be the banks, but even that may take years to play out.

I remain slightly long having been significantly short at the start of last week. I will look to add to some areas that should benefit the most from another short squeeze – with Spanish stocks sticking out. I continue to avoid Spanish and Italian bonds as I think the fixed income markets will be less likely to be tricked by the headlines, and there really is no natural buyer. I am looking at adding Greek bonds now that the election is over and we have seen a bit of a sell-off. A treasury short looks appealing, and the economic data in the U.S. continues to support the idea that high yield bonds should perform decently (ie, paying the coupon without much price volatility in either direction).

Copyright © 2012 · Peter Tchir

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