The Fed Is Approaching the End Game… Are You Ready?

by Graham Summers

The financial world seems to think that because Greece accepted another bailout we’ll be off to the races in the markets.

Aside from how absolutely moronic this view is (how’d the first Greek bailout work out? And it was what 12 months ago?), we have to consider the backdrop against which this particular tragic-comedy is playing out.

The consensus view from the mainstream financial media and 99% of find managers is that liquidity and access to loose money from central banks will keep things afloat.

However, reality shows this not to be the case… at all. Consider for instance the impact of the Fed’s money pumps.

For starters, as a back of the envelope analysis, consider that in 2007 when the credit markets first jammed up, the Fed resorted to providing emergency money pumps of $30 billion or so.

By June 2008, the Fed had done this 14 times to the tune of $200+ billion. Then came the $700 billion bailout in November 2008.

So by the end of 2008, the Fed had put in nearly $1 trillion in capital to the markets. And this did absolutely nothing to avert the market collapse.

Then came QE 1, which put another $1.25 trillion into the markets. And even after QE 1 ended the Fed continued supplying the juice to the tune of $30 billion or so per month during options expiration weeks.

Then we get QE lite, which results in another $300 billion into the markets plus QE 2 which adds another $600 billion. So all in all, the Fed’s supplied a minimum of $4 TRILLION into the markets since 2008 (I’m not accounting for the trillions more in deal that have not been made public). And the S&P 500 is at roughly the same level as before the Bear Stearns collapse.

So on the surface of it, the Fed’s money spending appears to have accomplished something positive: they spent $4 trillion and the markets rallied bringing household net worth up 17% from its low in 2009.

However, when you dig deeper into the specific results of the Fed’s actions it becomes clear that not only is the Fed creating a giant Ponzi scheme in the financial markets, but that we’re getting close to a breaking point.

Consider that QE 1 provided $1.25 trillion in liquidity to the markets. From the date of its inception until its end, the S&P 500 roughly 540 points. Put another way, each $10 billion was worth 4.3 points on the S&P 500.

In comparison, QE lite and QE 2 put roughly $900 billion into the market (roughly 75% of QE 1) creating a 251-point rally in the S&P 500. In this case, every $10 billion in additional capital was worth 2.7 points on the S&P 500.

So $10 billion of Fed money today is worth just over half (62%) the market gains of $10 billion in Fed money back in 2009. Put another way, every new injection of $10 billion from the Fed is producing less and less results.

If we step back and look at this plainly, we will see that reality does not in any way match the view that the Fed’s liquidity will solve the financial world’s problems. In fact, we see that each Fed move is having a smaller and smaller impact on the financial markets. Extend this idea out a bit further and you find that we will reach a point at which the Fed will no longer have any control over the financial markets.

I believe that we are rapidly approaching that point. Indeed, the Fed has already hit a wall in the sense that the negative impact of its policies (inflation/ prices soaring) far outweigh any positive impact (stocks rallying).

At some point, and I cannot say when, the market will begin to realize that the Fed cannot backstop the entire financial system. When this happens, THEN the REAL Crisis will hit and it will make 2008 look like a picnic. The reason is quite simple: the next Crisis will be a Crisis of Faith pertaining to the US Federal Reserve.

For 80+ years, the US financial system has operated under the belief that the Federal Reserve could handle any problem. This belief was put to the ultimate test in 2008 when the Fed faced off against the biggest Financial Crisis of the last 80 years. And the ONLY thing that kept us from the brink was the belief the Fed could fix things.

It couldn’t. And we’re all beginning to see that now.

So when the next Crisis hits it will become clear the Fed CANNOT fix these issues (it never could but most people hoped regardless). And that’s when the real collapse will begin.

It’s coming. The fact Bernanke has admitted publicly that he’s clueless what’s going on is a MAJOR step towards the world realizing that he’s lost control.

Which is why if you’re not taking steps to prepare for what’s coming now, you need to start moving.

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Sector Relative Strength: Cyclicals Take the Lead

by Bespoke Investment Group

In the charts below we highlight the relative strength of the ten S&P 500 sectors compared to the S&P 500. For each chart, when the line is rising, it indicates the sector is outperforming the S&P 500 and vice versa when a sector's line is falling.

Over the last two weeks there has been a notable shift in the relative strength characteristics of the ten S&P 500 sectors. Whereas during the month of June we saw defensive sectors outperforming cyclicals, today cyclicals have moved into the leadership role. The relative strength of the Consumer Discretionary sector is now at new highs. Industrials and Materials have both hooked higher, and the Technology sector has broken its recent downtrend.

Defensive sectors, on the other hand, have all recently lagged. As noted in the individual charts, Consumer Staples, Health Care, Telecom Services, and Utilities have all seen their relative strength reverse multi-month uptrends. Finally, financials continue to sink ever further into the abyss of underperformance. What will it take to get this sector out of its rut?

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Crop futures a 'buy', says Morgan Stanley

by Agrimoney.com

The slide in agricultural commodities represents a "buying opportunity" rather than the beginning of a long-term decline, Morgan Stanley said, highlighting US data doubts, and the highest profitability for ethanol plans for more than a year,

The liquidation in agriculture commodities, which drove futures down 10% last month, and has shrunk speculators' net length in Chicago corn to its lowest level since August, was "premature", the bank said.

"We see the recent weakness in agriculture process as a buying opportunity rather than the start of a cyclical downtrend," Morgan Stanley analysts said in an investor briefing, adding that it was "not the time to abandon agriculture".

"We view the current weakness as transient."

'Export arbitrage'

The thesis was based in part on the prospect of lower futures prices sparking demand, meaning it was no longer being rationed to the extent that the US Department of Agriculture outlined in June's Wasde crop report, viewed as something of a bible among crop investors.

"On paper, the ethanol industry is seeing the best production margins since December of 2009, currently sitting at $0.22 a gallon," the report said.

Hog production margins had returned above breakeven, at $22.70 a head, potentially reducing prospects of a cut in herd size.

And, with US corn now cheaper by $0.22 a bushel excluding VAT in southern China, "the export arbitrage to China has opened".

"Given an admitted 10m-tonne deficit between production and demand in China this year, we do not rule out the possibility of further Chinese purchases to rebuild government strategic reserves," Morgan Stanley said.

'We are sceptical'

However, the bank also restated its scepticism in shock US corn estimates last week showing that American farmers sowed 1.7m acres more of the grain than had been expected, and that inventories left over from the last harvest were 380m bushels bigger than expected.

An estimate that North Dakota had lost 2.3m acres in overall crop sowings to poor weather appeared to contradict separate official data showing insurance claims for lost plantings against 6.3m acres.

The higher corn inventory number implied a slump in feed demand of 44% year on year, to the lowest in more than three decades, and appeared at odds with firm cash corn prices, which had reached their highest in more than five years in some areas amid an apparent battle to secure supplies.

"We continue to head anecdotal reports of conusmers - particularly destination ethanol plants - struggling to secure feedstock for delivery in August," the briefing said.

Price outlook

Morgan Stanley said it was "sceptical, and question the accuracy, of the USDA's estimates".

The bank added that it was "bullish" on corn and soybean prices, but foresaw wheat futures as "likely underperforming".

See the original article >>

Watch the Copper barometer ...

by Kimble Charting Solutions

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Team Bernanke's QE17: A Glimpse of America in 2015

By Martin Hutchinson

At the end of last month, the U.S. Federal Reserve brought down the curtain on its $600 billion "quantitative easing" initiative, a U.S. Treasury-bond-purchase program that investors liked to refer to as "QE2."

Fed Chairman Ben S. Bernanke has indicated that he does not intend to carry out a follow-up "QE3" program.

But here's the reality: The U.S. federal deficit is running at about $1.6 trillion, meaning we need to sell a lot of Treasury bonds to finance the shortfall. So if the Treasury-bond market gets a case of "indigestion" - meaning there aren't enough buyers to fulfill our massive financing needs - many folks believe that Bernanke will have to step in with the-much-talked-about "QE3" bond-buying program.

But Ben, please be forewarned: If you do this, our future is clear ...

A Glimpse of Our Future

The year is 2015, and it's late in the month of June. Central bank policymakers have been meeting for two days. Now it's late in the afternoon of that second day, and Bernanke's traditional press conference is set to start at any moment. Investors the world over have stopped everything to hear what the U.S Fed leader has to say.

Bernanke is still not the longest-serving Fed chairman: With only nine years under his belt, he has a decade to go before he'd have more service time than predecessor Alan Greenspan, or the legendary William McChesney Martin.

But as Fed chairmen go, Bernanke is uniquely powerful - perhaps even more so today than he was back in 2011. We all know that he won't change interest rates, which have now been held in a target range of 0.00% to 0.25% for nearly seven years. The real question - and the reason we're waiting for the press conference to start - is whether the former Princeton economist will indulge the financial markets with a further round of quantitative easing.

This round of Treasury bond purchases would be "QE17" - but these days, nobody's counting.

Wall Street is pleased with Bernanke; after all the Dow Jones Industrial Average has just passed 36,000, the target set for it by James K. Glassman and Kevin A. Hassett way back in 1999.

Since the U.S. stock market has trebled in value since 2011, a lot of people on Wall Street have made huge amounts of money. So, too, has the tech sector; the recent initial public offering (IPO) for Faceless.com - the "anti-social network" that allows you to block your personal data from being seen by friends, competitors and the Russian Mafia - was an enormous success. It now has a valuation of more than $200 billion.

The U.S. Economy Under QE17

Bernanke has told us that inflation isn't a problem. The latest report on the consumer price index (CPI) from the U.S. Bureau of Labor Statistics says that prices are up 0.8% for the month and 9.3% for the year, with "core" prices somewhat lower - pretty tolerable considering the economy's ongoing difficulties.



Admittedly, the BLS no longer has the credibility it used to enjoy. Perhaps that has something to do with the fact that, back in 2013, U.S. President Barack Obama chose an aide to former Illinois Gov. Rod Blagojevich to run it. Private consultants are rumored to have estimated the actual annual U.S. inflation rate at somewhere between 160% and 170%, but their report was suppressed under the Patriot Act as damaging to U.S. national security.

There is a lot of grumbling about unemployment, but both the Fed and the Obama administration firmly maintain that high unemployment is inevitable for at least a decade after a financial crash like the one we lived through back in 2008.

The official unemployment rate is only 10.2%. But the real problem is that the work-force participation rate has sunk from its level of 65% before the crash to its current level of 48%. That means there are an extra 40 million "discouraged" long-term unemployed workers who are not included in the official statistics. On the whole, however, those jobless folks may actually be better off than they realize: With gasoline at $22 a gallon they couldn't afford to commute to work anyway.

When General Motors Co. (NYSE: GM) moved its entire operation to China in April, it caused quite a scandal - not surprising, given that U.S. taxpayers had bailed it out for a second time. (Besides, we warned you back in 2009 that this would happen.)

But since the carmaker could borrow in U.S. dollars at 4% and invest in the land of the strong renminbi (the yuan has risen only 40% against the dollar this year - much less than last year - because China's currency is being held down by its government), GM's CEO said it would be madness not to do so.

Making cars in the United States made no sense anymore anyway, since it was impossible for GM to meet the new U.S. fuel economy standards. GM's departure meant more unemployment, but the capital-gains tax on the Faceless owners' IPO gains would help pay for that, at least at the federal level.

One welcome development has been the rise in U.S. housing prices since they bottomed out in 2011 - the S&P/Case-Shiller Home Price Index is up 80% since then. Of course, it's very regional: With unemployment so high, foreclosures are still abundant in many areas. But the Las Vegas housing market, in particular, has been strong, as gambling by the newly rich from Wall Street and Silicon Valley has become one of the few bright spots in the otherwise-moribund U.S. economy.

Another bright spot is foreign trade. Imports have gone up far less than exports, since foreign exporters won't accept payment in dollars anymore. Only those lucky people with holdings of gold - steady today at $27,000 per ounce - or export businesses of their own can buy foreign luxury goods. With GM having moved to China, Ford Motor Co. (NYSE: F) is enjoying a booming resurgence - although there is an argument that Ford's success in meeting the fleet fuel economy standards by selling millions of its Ford Stallion-brand bicycles is in some way cheating!

Ah, Bernanke's on TV now. Yes, he's announcing another round of quantitative easing - not a bad idea, since the U.S. budget deficit is now more than $5 trillion and another nasty debt-ceiling debate is in the offing. Of course interest rates will stay at zero - the Fed must worry about unemployment, after all. And we can stop worrying about inflation; Bernanke says the recent rise to 9% is only temporary!

Chalk it all up to a sign of the times - and a look at life in America under QE17.

[Bio Note: In a recent interview, investing icon Jim Rogers made this sage observation: "Whenever there's a catastrophe, there are also massive opportunities."

In this case, Rogers was referring specifically to the Japanese earthquake and nuclear disaster. But that powerful bit of wisdom is just as true for the uncertainty U.S. investors now face.

If you loathe uncertainty - and what investor doesn't - take a look at our affiliated newsletter, "The Money Map Report." Each month, our gurus scan the globe in search of the best strategies, profit opportunities, and defensive investments.

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What is the Greek Debt Crisis, and What Does it Mean for Investors?

By Kerri Shannon

With Greece on the brink of default - and hanging over the global economy like a financial sword of Damocles - investors the world over are asking themselves the very same question, day after day: Just what is the Greek debt crisis, and what does it mean to me?

It means a lot.

In fact, the Greek debt crisis could prove to be the first in a series of sovereign-debt defaults that could even infect the U.S. economy, tipping it into a "double-dip" recession and reprising the bear market of 2009.

In short, this crisis is one you need to watch and understand.

Given the stakes, we decided to work with our panel of global-investing experts and put together this Money Morning special report: "What is the Greek Debt Crisis, and What Does it Mean for Investors?"

Our goal was to provide you with answers to some of the key questions about the Greek debt crisis - how it started, what's actually taking place, how it could affect the U.S. economy, and how we expect it to play out.

And with the help of experts Keith Fitz-Gerald, Shah Gilani and Martin Hutchinson, we also answer the most important debt-crisis question of all: "What should you do about it?"

Question: What is the Greek Debt Crisis?

The Greek debt crisis is an expensive lesson in the importance of fiscal discipline - that comes with a multi-billion-dollar price tag.

Due to decades of overspending, Greece is currently receiving a bailout package of $159 billion (110 billion euros) from European governments and the International Monetary Fund (IMF) to meet payment obligations. Greece received its first installment in May 2010, and needs its next $17.3 billion (12 billion euros) loan by mid-July or it won't be able to pay wages or pensions at the end of the month.

Nor does it end there: The European Commission has said Greece will need an extra $166 billion (115 billion euros) through the middle of 2014.

Through the involvement of other countries and financial institutions, this is no longer simply a "Greek" debt crisis - it's becoming a global one. Similar problems plague Portugal, Spain, Italy and Ireland. With the debt contagion spreading, other worldwide players - including the United States - might not escape unscathed.

Q: How Did Greece Get Into This Mess?

Greece certainly didn't create this epic mess all by itself - it had help. Aiding and abetting Greece's own miscues were budgetary machinations by Goldman Sachs Group Inc. (NYSE: GS), a failure by the Eurozone to hold countries accountable for their finances, and credit default swaps that bet against Greece meeting its debt obligations.

But ultimately Greece is to blame.

"Greece lied to get into the European Union [EU]," said Money Morning's Shah Gilani, a former hedge-fund manager who's an expert at "reading" global-capital-movement trends. "After they were in, they used world markets to borrow from investors who bought their bonds, knowing that the EU/IMF would bail them out when it came time to repay. It was a calculated gamble to keep stuffing themselves and raising their GDP/per capita productivity to levels equal to Germany and France. [Greece] doesn't have the productive means to grow to anywhere near the per capita income of the French or Germans. It has olive oil and tourism, what else?"

Under an agreement called the Maastricht Treaty, to adopt the euro as their currency countries had to cap annual budget deficits at 3% of gross domestic product (GDP), and total government debt had to remain at or below 60% of GDP. To appear compliant, Greece failed to book billions of dollars of military expenses, and Goldman Sachs arranged a currency-swap deal in 2001 that effectively cut the country's deficit.

After Eurozone acceptance, Greece violated the terms of the Maastricht Treaty from 2001 to 2006, running excessive budget deficits in each of those years.

Greece's financial mismanagement had been ongoing for decades. Many problems started when the country joined the EU in 1981 - during the administration of then-Prime Minister Andreas Papandreou (father of current Prime Minister George Papandreou).

"Instead of steering the Greek economy to reap the enormous potential benefits of its premature EU membership, the internationally sophisticated Papandreou manipulated the EU system of slush funds so as to keep a gigantic stream of resources flowing to the bloated Greek public sector," said Money Morning Contributing Editor Martin Hutchinson, a former global merchant banker who in the past has helped some European nations restructure their finances. "The result was an economy focused almost entirely on the public sector and tourism (which also benefited from innumerable EU grants), with the populace enjoying living standards far in excess of their ability to pay their way."

The bottom line: Greece spent years borrowing from Europe without offering any real returns to the global economy, creating a country of citizens living well beyond their means.

Q: Will the Bailouts Really Halt a Default?

While European leaders continue to discuss a second round of bailout plans, Gilani said Greece could avoid default - if lenders remain willing to help.

"There won't be any big victims if Greece gets bailed out and their debts rolled out another 30 years," said Gilani. "Were any of the big U.S. banks victims of their own fraud in the subprime smackdown? No. They got bailed out and liquefied. The same could happen to Greece and theoretically there may not be any big victims. As long as there are fingers in the dykes we'll muddle through."

But the country's low economic productivity means Greece will require infusions of external financing every year for years to come. Greece's economy is set to shrink by an additional 3.8% to 4% this year after contracting 4.5% in 2010. Plus, the bailouts have let Greece believe it can lean on the EU to fix its problems.

Many experts, including Money Morning Chief Investment Strategist Keith Fitz-Gerald, believe Greece should be forced to face up to its lack of fiscal discipline - meaning the bailouts should end. But if that happens, the fallout - and the pain - will be widespread.

The bottom line: The risk of default is much greater than the headlines would have you believe. And if there is a default, the U.S. economy won't escape the fallout.

Q: What Does This Mean for the Euro?

One of the lessons we've learned from the Greek debt crisis is that the Eurozone is not as strong or stable as most believed. Eurozone members attempted a monetary union without united fiscal policy. Now it must strengthen membership standards to prevent future crises.

"If the EU wishes to make the euro work, it must demonstrate that the fiscal rules of euro membership have teeth," said Hutchinson.

That's been tried before - to no avail.

The euro's stability was based on a pact among members to keep their finances in order. In 1996, countries voted on imposing fines on countries that didn't adhere to the Eurozone's standards. But that motion was struck down and no "punishment" ever came about.

The bottom line: Greece isn't the only euro "bad boy." Other countries also have failed to meet the Eurozone standards at least once; but certainly none as extreme and frequent as Greece. In fact, the Eurozone as a whole has never met the 60% of GDP government target. And Eurozone policies weren't enforced.

Q: What's Next in the Greek Debt Crisis?

As you're no doubt beginning to see, the question "what is the Greek debt crisis?" may actually be too narrow a query.

Moody's Investors Inc. (NYSE: MCO) just cut Portugal's debt rating to below-investment-grade status ("junk" in the parlance of Wall Street). And that move roiled the bonds of Spain and Italy, two other high-debt nations that have been the focus of major solvency worries. Ireland is also causing lots of sleepless nights for debt-holders.

"The real problem is that Greece is only the first domino," Gilani said. "In order to support the rest of the ailing peripheral Eurozone countries, the European Central Bank, all the European banks, the IMF, the U.S. and China are going to have to come to the rescue. Unless there is some new model for achieving solvency with liquidity that comes from the Chicago School of Impossible Economics, the euro is toast and the whole experiment of European Union will be tested from the corners and its center."

Hutchinson said Portugal and Ireland are productive enough to solve their problems through austerity, although there's no guarantee. Italy will be a tight squeeze. In an ideal world, Spain would get a badly needed new government - one that would put in place the measures needed to avoid default. And Greece would be booted out of the Eurozone, he said.

The bottom line: The Greek debt crisis is more of a Eurozone debt crisis.

Q: Could the Greek Debt Crisis ‘Infect' the U.S. Economy?

Let's just cut to the chase here: The answer is a resounding "yes."

Greek's debt problems have an excellent chance of going global, not just because of an economic ripple effect, but because other countries like the United States are also getting carried away with high debt loads.

"What's happening in Europe is already happening here," said Gilani. "So, it's not so much a problem of infestation, it's more a matter of manifest destiny."

All of this is widely known. But the largely untold "rest of the story" is this: If the European banking sector implodes, the U.S. financial system could take an unqualified beating.

Big U.S. banks have been lending generously to banks across Europe. Close to 29% of their lending books during the past two years have gone to their heavyweight European counterparts. While they have pulled back considerably as a result of recent turmoil, U.S. banks are widely believed to have $41 billion of direct exposure to Greece.

The amount of exposure to the rest of Europe is not easily quantifiable. And this U.S. financial system link doesn't end there: U.S. money-market funds have a hefty European exposure, too.

The bottom line: The U.S. Federal Reserve and other regulators are right now reviewing "contingency plans" in case the widening European debt crisis fires off another run on the $2.7 trillion money-fund sector - a situation we saw back in 2008. But insiders admit that it may be a lot tougher to craft an effective response this time around.

Q: As an Investor, What Should I Do?

Although it's not clear how the Greek debt crisis will play out, you should run through a "Greece safety" checklist to avoid exposure to the heart of the crisis and increase holdings in safer and more protective investments.

Our experts suggest taking the following steps:

• Stay away from European banks - they're on the hook for $100 billion.
• Avoid southern European debt, as well as U.S. Treasuries and Japanese government bonds - they're no safe haven.
• Don't ignore Europe entirely - there are some worthy German and Swedish non-bank stocks.
• Look to energy-related investments, commodities and precious metals, all of which have bullish long-term outlooks.
• Use protective stops.

One final note: If you have comments about this report, or additional questions about the Greek debt crisis, feel free to e-mail Money Morning at mailbag@moneymappress.com. Make sure, in the subject line, to use the phrase: "What is the Greek debt crisis?"

[Bio Note: In a recent interview, investing icon Jim Rogers made this sage observation: "Whenever there's a catastrophe, there are also massive opportunities."

In this case, Rogers was referring specifically to the Japanese earthquake and nuclear disaster. But that powerful bit of wisdom is just as true for the Greek debt crisis.

In this special Money Morning report, we give you some solid investing guidelines that will help you navigate the Greek debt crisis. But perhaps you'd like more - including some specific investment recommendations.

If that's the case, you should take a look at our affiliated newsletter, "The Money Map Report." Each month, our gurus scan the globe in search of the best strategies, profit opportunities, and defensive investments. The Greek debt crisis has been - and will continue to be - a major theme behind many of our best ideas.

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A sign to respect??

by Kimble Charting Solutions

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Down the road?

by Kimble Charting Solutions

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Not a Short Covering Rally

by Bespoke Investment Solutions

It has been difficult to listen to so many market commentators call the gains we've seen since last Monday nothing but a short covering rally. The worst part is that the claim is made with no data backing it up. We ran our decile analysis on the S&P 500 to see what the actual numbers show.

To run the analysis, we broke the S&P 500 into deciles (10 groups with 50 stocks each) based on a stock's short interest as a percentage of float. We then calculate the average percentage change of the stocks in each decile from the close on June 24th through today.

The average stock in the S&P 500 is up 5.4% since June 24th. As shown below, the 50 stocks that have the highest amounts of short interest have averaged a gain of just 5.2%. The stocks in the second most heavily shorted decile are only up an average of 4.9%. With the top two deciles of the most heavily shorted stocks both underperforming the overall market, it's hard to call this a short squeeze rally.

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A List of Reasons Why Greece & Portugal Are Worse Off Than Central/South America During the Argentienian Debt Crisis

by ReggieMiddleton

Greece and fellow members of the PIIGS group of distressed sovereign states are considerably worse off than those tumulted by the Argentenian debt crisis of the '90s. Here's why...

CNBC reports: In Europe, an 'Argentinean Re-Run': Fund Manager

The situation facing European countries like Greece and Portugal is directly comparable to the economic crisis which hit Latin America in the late 1990s, Andy Brough, co-head of Schroders’ Pan European Small and Mid Cap team, told CNBC Wednesday. 

"I get the feeling we're having an Argentinean re-run," Brough said. "In Europe, they've tried everything to sustain the system but it's unsustainable."

Argentina, together with the region's largest country Brazil and with Uruguay, suffered a sustained economic crisis last decade after building up a huge debt pile.

Argentina in particular continued to borrow heavily from the International Monetary Fund (IMF) without repaying its debts.

Tell me about it! For those who don't know the consequences of said actions I recommend you reference How the US Has Perfected the Use of Economic Imperialism Through the European Union!

"In the end the populace is going to say we didn't go into the euro for this," the Schroders fund manager said.

Fernando de la Rúa, then president of Argentina, had to flee the country in a helicopter after the unrest grew. While the political situation in Greece and Portugal is not yet that serious, there have been widespread protests on the streets of Athensagainst austerity measures demanded by the ECB and IMF as part of a second bailout of Greece. 

It may be even more difficult for Greece and the banks supporting it to recover from its economic problems than it was for Argentina and Brazil, according to Brough.

"If you look back then, we didn't have the transparency we do now, so all the banks that were funding Latin America could smooth over what was going on," he said. "Now, everyone is in the spotlight so it's much harder for banks to smooth it over."

"The middle class in Argentina couldn't just withdraw their money, whereas the middle class in Greece or Portugal can take it out and buy anything that isn't the euro," Brough added.

In Argentina, the government slapped a $250 a week limit on withdrawals from its banks to halt massive pulling out of savings.

I would be remiss in failing to mention that we made this comparison in explicit detail this time last year - A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina.

In order to assess the impact of sovereign debt restructuring on the market prices of the sovereign bonds that undergo restructuring (haircut in the principal amount or maturity extension), we retrieved price data of the Argentinean bonds that underwent restructuring in 2005. The sovereign debt restructuring in case of Argentina was a combination of maturity extension and principal haircut. Argentina defaulted on its international debt in November 2001 after a failed attempt to restructure the debt. The markets priced in the risk of a substantial haircut around this time and the bond prices plummeted sharply. We at BoomBustBlog are in the habit of taking market prices seriously, and have factored historical market reactions into our analysis in calculating prospective price action in distressed and soon to be Sovereign debt. Before moving on, it is highly recommended that readers review our haircut analysis for Greece (“With the Euro Disintegrating, You Can Calculate Your Haircuts Here”) and our more likely to occur restructuring analysis for the same (What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates).

The restructuring of the Argentina debt in default was occurred in 2005 when the government offered new bonds in exchange of old securities. The government gave the option of either accepting A) a par bond with no haircut in the principal amount but substantially lower coupon and longer maturity or accept B) a discount bond with a haircut in principal amount to the extent of 66.3% but relatively better coupon rate and shorter maturity than in case of Par bond. If the bondholder accepted A), for each unit of bond, one unit of Par bond will be allotted. If the bondholder accepted B), for each unit of bond, 0.33 unit of Discount Bond will be allotted. The loss to the creditor, which is decline in the NPV of the cash flows, was nearly the same in both cases as the lower principal amount in Option B was offset by better coupon rate and shorter maturity. The price of the par bond in the market and the price of the discount bond multiplied by the exchange ratio (real price to the bond holder) were largely the same when they were listed in the market in 2005.

The IMF estimated the average haircut (decline in the net present value of the bond) was on an average 75% and the market priced in most of this haircut before the actual restructuring in Feb 2005. The prices of the bond in default declined nearly 65% between Feb 2001 and Feb 2005.

One should keep these figures in mind, for in the blog post "How Greece Killed Its Own Banks!"I ran through a much, much more optimistic scenario that wiped out ALL of the equity of the big Greek banks. Remember, the Greek government stuffed these banks to the gills with Greek bonds in order to created the perception of a market for them. As excerpeted...

Well, the answer is…. Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)…

image001

The same hypothetical leveraged positions expressed as a percentage gain or loss…

image003

When I first started writing this post this morning, the only other bond markets getting hit were Portugal’s. After the aforementioned downgraded, I would assume we can expect significantly more activity. As you can, those holding these bonds on a leveraged basis (basically any bank that holds the bonds) has gotten literally toasted. We have discovered several entities that are flushed with sovereign debt and I am turning significantly more bearish against them. Subscribers, please reference the following:

• • Sovereign Contagion Model - Retail (961.43 kB 2010-05-04 12:32:46)
  • Sovereign Contagion Model - Pro & Institutional
• Euro Bank Soveregn Debt Exposure Final -Retail
  • Euro Bank Soveregn Debt Exposure Final - Pro & Institutional
• Sovereign Debt Exposure of European Insurers and Reinsurers (Empty 2010-05-19 01:56:52)

To date, my work both free and particularly the subscription work, has shown significant returns. I am quite confident that the thesis behind the Pan-European Sovereign Debt Crisis research is still quite valid and has a very long run ahead of it. Let’s look at one of the main Greek bank shorts that we went bearish on in January:

nbg since research

NBG since research

Now, referencing the bond price charts below as well as the spreadsheet data containing sovereign debt restructuring in Argentina, we get...

Price of the bond that went under restructuring and was exchanged for the Par bond in 2005

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Price of the bond that went under restructuring and was exchanged for the Discount bond

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With this quick historical primer still fresh in our heads, let's revisit our Greek, Spanish, and Italian banking analyses (the green sidebar to the right), many of which are trying to push the 400% mark in terms of returns if one purchased OTM options at the time of the research release. It may be worthwhile to review the Sovereign debt exposure of Insurers and Reinsurers as well.

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Some Technicals on the Market

by the trader

With the market having climbed quite a lot during the past 10 days, it is time to reconsider the bullish short term bounce we argued would happen. Markets reached oversold levels, with a overly pessimistic sentiment. It got to an extreme, and reversed with the first Greek vote. With the relatively low volume melt up we have seen, we see limited upside short term, and would be tacking chips off the table. A break above resistance levels, should be surprising, and would most probably be a false break out, if it were to happen. With VIX once again having collapsed, we think picking up cheap vol for the report season/autumn is a good trade. Below some further thoughts by Technical Take.

I define the price cycle as the path that prices take from low to high and back again, and I use investor sentiment to help me characterize where we are in the cycle. For example, if prices are at their highs, then most likely investors are bullish; conversely, if markets are getting slammed, then investors are probably bearish. The use of investor sentiment isn’t so unique that I have any great insight, but it is how I use that data to help generate an edge.

As you know, investors were extremely bearish several weeks ago, and this is typically a bull signal. As you can see, the “dumb money” indicator, which is a weekly chart of the SP500, is shown in figure 1. This was a bull signal, and as if right on cue, the markets lifted 5%. Holy grail? No, no, no.

Figure 1. SP500/ weekly

Now look at the same figure, but this time I put a slow stochastic indicator (in black), which can be found in any normal charting package, on top of the “dumb money” indicator. (See figure 2.) I don’t see much difference. Do you? Once again, there is nothing special about the sentiment indicators.

Figure 2. SP500/ weekly

However, let’s get back to the price cycle. Investors are likely to get more bullish this week such that the “dumb money” indicator is going to cross above the bottom blue line (in figure 1). So let’s set up the question to ask this way: 1) investor sentiment turns bearish and the “dumb money” indicator is below the blue line; 2) prices rise and the indicator crosses the blue line; 3) at this point, how often does the indicator go on to become extremely bullish and how often does the indicator rollover crossing back below the bottom blue line?

This is important because if the indicator always go onto become extremely bullish (i.e., crosses above the upper blue line) then we would know that extremes in investor sentiment always lead to higher prices. But this isn’t always the case. Referring back to figure 1, since 1990, there have been 46 times the indicator went from below the bottom blue line (i.e. sentiment is bearish, bull signal) and crossed above it. In 24 of those instances the indicator ended up crossing the upper blue line (i.e., sentiment is bullish, bear signal in theory). As expected, 23 out of 24 trades were winners.

There are 22 times the indicator just rollsover without extremes in bullish ever taking place. Or to put it another way, extremes in bearish sentiment don’t always lead to extremes in bullish sentiment, and in fact, it only happens about 50% of the time. So what happens when the “dumb money” indicator rolls over? 15 out of the 22 trades turn out to be losers.

So what’s next for the markets? We have a 50% chance of going on to new highs, which in all likelihood would be expressed by extremes in bullish sentiment. That leaves a 50% chance of the market rolling over, and about a 33% chance of seeing prices trade below the lows of a couple of weeks ago.

What is my opinion? It doesn’t really matter what I think, but I will to venture to take an educated guess. Despite the extremes seen in the “dumb money” indicator there was a lack of consensus amongst all of the sentiment indicators (i.e., dumb money and smart money) at the recent lows; since 2004, the best, sustainable price moves occur when the sentiment indicators are in alignment. In addition, my research shows and the most I can go out on a limb is this: that the lows from a couple of weeks ago should provide support for prices. If they don’t, then it is look out below.

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EU Attacks (US) Rating Agencies

by the trader

The best Defense is a good Offense. The EU is firing an attack on the bias among the “all US” rating agencies. 

According to Baroso, Merkel and other politicians, the agencies just don’t understand how good Europe Peripheral countries are. Reuters reports;

BRUSSELS (Reuters) – Europe issued a full-throated assault on credit ratings agencies on Wednesday, saying there were signs of bias against the European Union after Moody’s downgraded Portugal’s debt to “junk” status.

European Commission President Jose Manuel Barroso said Moody’s decision to lower Portugal by four notches and maintain a negative outlook was fuelling speculation in financial markets. Europe was looking at getting away from its reliance on the mainly U.S.-based ratings companies and weighing possibilities for legal redress, he added.

His view was seconded by Germany’s finance minister, Wolfgang Schaeuble, who said Portugal’s downgrade was totally unjustified in present circumstances, when the country was taking steps to put its finances in order.

“Yesterday’s decisions by one rating agency do not provide more clarity. They rather add another speculative element to the situation,” Barroso told reporters, adding that the agencies were not immune to “mistakes and exaggerations.”

“It seems strange that there is not a single rating agency coming from Europe. It shows there may be some bias in the markets when it comes to the evaluation of the specific issues of Europe,” he said, stating publicly a view that many senior EU officials have pushed privately for some time.

Schaeuble said limits should be put on what he called the ratings agencies’ “oligopoly.

“Portugal is … not only completely on course but even ahead of the curve, so there really is no factual justification for such an assessment at this early point,” he said.

“We must break the oligopoly of the rating agencies.”

It is not the first time during the sovereign debt crisis that the EU has taken the major agencies — Moody’s, Standard &Poor’s and Fitch — to task, but the message this time was delivered with a much greater sense of frustration.

Barroso’s comments followed German Chancellor Angela Merkel’s brushing aside on Tuesday of a warning from S&P, the largest agency, that it would view the current French plan for a partial rollover of maturing Greek debt as a default.

Such a move would narrow the options available to EU leaders to tackle the crisis and could greatly exacerbate the situation.

Merkel suggested the EU had depended for too long on the opinion of outside, private-sector agencies and said Europe had its own institutions that it needed to put its trust in.

“It is important that the troika (EU, IMF and European Central Bank) do not allow their ability to make judgments to be taken away,” she said. “I trust above all the judgment of these three institutions.”

TIGHTER RULES

Last year, the EU introduced rules that require the agencies to spell out how they come to rating decisions, such as a downgrade of Portugal. Barroso said further steps were in the works and would be outlined by the end of this year.

“We plan measures to improve methodology and transparency of rating of sovereign debt, to reduce excessive reliance by financial institutions on credit rating, to further reduce conflicts of interest and introduce more competition,” he said.

“We are for instance looking at civil liability by the agencies,” he said.

EU officials have frequently criticized the ratings agencies for being American, although in fact only Moody’s and S&P are U.S.-based — Fitch has headquarters in both London and New York and is majority owned by a firm based in Paris.

There are moves afoot to have a Europe-based agency, although Barroso said no decision had been taken.

“I know that there are some possible developments regarding the possible creation of rating agencies originating in Europe said, without elaborating.

Before new laws are introduced, and policymakers don’t expect them to be in place until the middle of next year at the earliest, there is little the European Commission or other parties can do to influence the agencies’ decisions.

A pan-EU markets watchdog based in Paris has the power, however, to intervene if it sees failings in their work. It could withdraw their license to issue ratings, although such drastic step is unlikely.

Under assault from several corners of Europe, ratings agencies have begun to push back against the criticism.

The head of S&P in Germany defended his company’s work this week, saying: “It cannot be that S&P puts its more than 150 years of creditworthiness, credibility and predictability on the line to enable politically motivated push-ups,” he said, referring to the political desire to prop up Greece.

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Who Framed Greece?

by the trader

While the Troika is trying to figure out how to save the ever more desperate Greek people, Der Spiegel gives some color on who brought the country to ruin. Welcome to the Papps and the Elite that brought Greece down.

The latest tranche of loans from the EU and the IMF has helped buy debt-ridden Greece some time. But the Greeks will find it hard to get back on their feet. Their country has been ruined by three political dynasties, which created a bloated system of cronyism that is hard to change.

 

The queue of hungry people snaked across the courtyard and into the street at the homeless shelter behind Omonoia Square in Athens last Thursday, just as it does every day at lunchtime. The retired, the unemployed, mothers with children, immigrants; they were all waiting patiently for church members to press something to eat into their hands.
Georgios Levedogiannis, 38, managed to get his hands on some peas with root vegetables and potatoes, along with three hunks of bread and a few cups of yoghurt. Levedogiannis has been coming here regularly for nine months. “I have to, in order to survive,” he says.

Levedogiannis worked in security at Athens Airport for seven years. He wasn’t rich, but he got by — until his bosses fired him in 2009. At the moment, his poverty is not yet visible. Levedogiannis wears a clean shirt, smart blue slacks and a new-looking bag slung around his waist. He clearly makes an effort. But there are tears in the man’s eyes as he says: “If I had work, I wouldn’t do this to myself.” He says he has “zero” money and that he sleeps at the Red Cross, eats at the church and dreams of a different time, a time where there was still work. “If you don’t have connections, no one will take you,” he explains. “And it’s only getting worse.”

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