Good Evening: Global asset prices took a fairly substantial hit today, as sovereign debt issues in Europe continued to ignite. Greece’s woes have been center stage for a while now, but Spain, Portugal, and Italy are starting to vie for the same sordid attention. How these sovereign debt problems get sorted out will be messy, and market participants in both equities and commodities spent Thursday elbowing each other in an attempt to reach the exits. Perhaps Bill Gross cried “Ring of Fire” too loudly in his latest Investment Outlook, since for all but the shorts, market losses don’t make for great theater. Investors may continue to get burned until these sovereign debt issues start to get resolved, and it seems unlikely the central banks will stand idly by without dousing the situation with liquidity at some point.
Despite declines in Asia and Europe overnight, U.S. stock index futures were holding in fairly well early this morning. Cisco’s earnings beat and sunny guidance probably helped on this score, but one company’s success couldn’t stem the tide of risk aversion that soon washed up in New York. Worse than expected jobless claims figures didn’t help the psychological backdrop, either, especially with a nonfarm payrolls report looming tomorrow. The other economic data released today had little impact, and equities opened 1% lower.
The selling quickly grew more urgent, leaving the major averages down 2% or more only sixty minutes into the session. Credit Default Swap prices for Greece and all the PIGS in Europe rose enough to make for disturbing headlines, boosting quotes for the U.S. dollar in the process. Oil and the precious metals were abandoned, as were the equities in those industries. At one point today, gold hit an air pocket (likely generated by sell-stop orders) and soon all the metals were the site of some pretty panicky selling. In addition, the companies that mine them have simply been crushed. While gold is now down more than 12% from its December high, many of the mining stocks are down between 20% and 40% over the same period. I used some of my dry powder to buy a bit of both today, but, alas, I was a bit early.
Unless one waited for the closing bell, every minute today also proved to be too early to buy U.S. stocks. The major averages went out on their lows, and the damage ranged from -2.6% (Dow) to -3.4% (Russell 2000). Friday should also prove volatile, but I have a plan for dealing with however Mr. Market reacts to the news out of the Labor Department. If the averages rally strongly after the jobs report, I’ll add to my hedges. If the news sits poorly with market participants and we get another whoosh to the downside, I’ll take some hedges off. While I could change my mind, my game plan for the last trading day before Super Bowl Sunday is to fade the initial reaction to the unemployment data. This is not a macro call, nor is it investment advice. It’s just a trade, and I’ll likely end the day with roughly the same positions I had going into it.
Away from stocks, Treasurys were the only asset class in the U.S. that enjoyed a decent bid. Securities across the coupon curve benefited from the carnage in equities and commodities, and yields fell between 7 and 10 basis points. Other U.S. credits, especially of the high yield variety, lagged. That Berkshire Hathaway lost its AAA rating from S&P seemed to set the tone for all corporate paper. The flight to perceived safety could also be seen when the U.S. dollar rose in response to the troubles in Europe. The greenback gained 0.8% to close at its highest level in six months. Judging by their market action of late, commodities are behaving as if the buck was on a 20% tear, but the actual gain in the dollar index has been a relatively modest 7.4% from the November lows. This data point was of no comfort to commodity longs on Thursday, and the CRB index fell 2.6%.
What’s the way forward for Greece? As we all learned during the 2007-2009 financial crisis, problems that begin in one sector (like subprime mortgages) can become very hard to contain. The Greek government has promised to ditch its profligate ways, and at least ECB president, Jean Claude Trichet, believes them. European equity investors, however, see the calls for Greek labor strikes and hear rumors of Greek debt default. They are not in the credulous mood they were for most of 2009 (see stories below).
Mr. Trichet’s confidence may soon be tested, if the London-based fixed income team from Credit Suisse is on the beam (see attached). They believe that any foothold Greece will find on the slippery slope of credit mistrust will involve budgetary discipline by the Greek government, shared sacrifice by the Greek populace, and some form of “official intervention” to see it all through. Strikes by various unions will frighten some investors, but the 24 to 48 hour duration of them indicates, at least to me, a mostly symbolic protest. Those facing a stint in rehab often put up at least some resistance. The jury is still out as to whether Greece and official Europe can come together and work things out, but CS believes there are some reasons for hope.
A reasonable expectation for hope is also an underlying theme of the other document you see attached. Contained therein are the remarks of John C. Dugan, the U.S. Comptroller of the Currency, before the American Securitization Forum held earlier this week. If your trigger finger currently hovers near the “delete” key because you have no desire to read a speech given by a financial regulator, please holster it. You will be pleasantly surprised that Mr. Dugan is both knowledgeable and thoughtful; he even has that rare, post-disaster gift of a balanced perspective. Done properly, says Mr. Dugan, securitizations can fulfill a vital and important role in credit creation. The banks can’t do it all, in his opinion, but it’s extremely important to get the underwriting right:
“Few can debate how much the core problem of terribly underwritten loans, especially residential mortgages, critically impaired the securitization market, precipitated the financial crisis, and resulted in the record number of foreclosures that are now working their way through the real economy. Indeed, one critical lesson from the crisis is that not even the most clever financial engineering – from synthetic securitizations to CDOs squared – can compensate for the devastating problems arising from terrible underwriting. Unfortunately, the maxim “garbage in – garbage out” that is often used in the context of IT systems turned out to be just as true for securitizations.”
Give Mr. Dugan a read. Not only will you start to find yourself involuntarily nodding your head in agreement, you’ll also find yourself wondering if he is willing to take on a bigger role some day. After Comptroller, perhaps “Keeper of the Currency” would suffice. Certainly the recent occupants of the corner office in the Eccles building seem to have forgotten this age-old tenet of central banking.
— Jack McHugh
Stocks, Commodities Plunge, Dollar Gains on Debt, Jobs Concerns
Treasuries Advance; 30-Year Bond Yields Fall Most Since October
Trichet Says ECB ‘Confident’ Greece Can Cut Deficit
European Stocks Fall Most in Two Months as Portugal, Spain Sink
CS Investment Themes – Greece
DuganRemarksatASF2010
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