On t’Mark – tin hats, Band-Aids, US psyche hurt, ECB’s peashooter, UK riots

OK, tin hats on; Dora Band-Aids at the ready?  What do you mean we’re out of them?  Oh, the ECB used the last one last night.  What about the Wiggles ones instead?  The Fed used those all up in April!  It will be a dark and ugly day in our markets, and governments/central banks are out of Band-Aids.

 

I’ll start you will this thought: Geithner announces that he is not resigning, Dow plunges 635pts.  Enough said!

 

I will try to skip the hyperbole and give you the facts as they are.  However, what is it with the US administration’s response to the S&P downgrade?  What a disgrace!  Geithner announcing that it is a “really terrible judgement” and even Obama’s comments “No matter what some agency may say, we have always been and always will be a triple-A country.”  As the President spoke the market plunged further; soothing words indeed!

 

A more mature, rational and calming attitude would be to say, we can’t control what the rating agencies do but we will work hard to get our AAA rating back through balancing the budget by controlling spending, raising taxes and creating a stable regulatory environment that business and the economy can flourish in.

 

Speaking last night to the American missus, apparently the US psyche can’t handle not being the best at everything, so the downgrade would have really hurt.  I guess sometimes the truth hurts, but there is no need to have the messenger hung, drawn and quartered.

 

In that regard I saw Congress is planning to probe S&P’s decision.  Please, just grow up and sort out the underlying, fundamental issue – reduce the deficit and future debt burden.

 

In that regard I watched CNBC US Squawk Box and was saddened to see the normal level-headed, Joe Kernen launching an uncharacteristic vitriolic attack on S&P.  Just deal with the downgrade – it’s really not a big deal – and move on; we have bigger issues to deal with and while we continue with the S&P debate we are wasting energy.

 

The US markets were down LARGE.  Unfortunately the volume was also heavy and we closed on the lows of the day.  In addition, US stock futures have traded lower after the close of the physical stock indices.  So that does not bode well for tomorrow’s trading, even though we still have to get through today’s.

 

I also think that it is massively instructive to see the differences in response to S&P’s downgrade from the equity and bond markets.  Each time there is a crisis the equity markets appears to be surprised and fixed income markets say, well that what we’ve been trying to tell you!

 

If all the downgrade does is focus dozy equity investors on the real issue of sovereign debt levels at unsustainable levels and a slowing US economy, then it has done its job.  We cannot continue to play the pass the debt parcel game; the music has stopped and sovereign governments are left holding the ticking parcel. 

 

So you know the response of equities but what happened to bonds?  US Treasuries rallied across the curve!  Despite the downgrade, investors weren’t spooked and sought safe-haven assets – hence gold hitting another high at US$1,710 – and drove down yields: 2yr UST at 0.26% (-2bp); 5yr UST at 1.08% (-17bp); 10yr UST at 2.34% (-22bp); and 30yr UST at 3.67% (-18bp).

 

What that is telling you is that the bond markets think that we are entering into a slower growth, low inflation and low interest rate environment.  I’m sure that will be a fact reiterated in the Fed’s statement on Wednesday.  Also will we get a hint of QEIII today or at Jackson Hole?  Not that it would help anything but sentiment.

 

That is not to say the world of credit didn’t react.  After the rout in financial shares, their respective 5yr CDS got hammered, and we are almost starting to get into systemic concerns:  BAML at 310 (+105bp); Citi at 220 (+58bp); Goldman at 217 (+51bp); JPMorgan at 143 (+32bp); Morgan Stanley at 260 (+61bp); and Wells Fargo at 143 (+32bp).

 

Those moves were despite S&P stating that there would not be any immediate rating action on the banks flowing on from the US downgrade.  Interestingly the US 5yr CDS did not move; unchanged at 57!

 

And that brings me onto the key “real” impact of this equity market correction: confidence.  I dread to think how the confidence indicators will get hammered and businesses and consumers will go into their shells and become even more defensive and cautious.  And that will not help bottom line growth.  We have already seen a plethora of economists downgrade US and other countries Q3 and Q4 growth estimates; are there more to come?

 

Phew, so that’s the US dealt with; time to move onto Europe.  The ECB loaded up the bazooka, or maybe that should be the peashooter, and started to buy Italian and Spanish 5yr bonds.  As you would expect, the market stood back and watched.  It had the desired impact:  Italian 10yr yields tightened 80bp to 5.29% and Spanish 10yr bonds dropped 88bp to 5.17%.

 

It allowed investors who wanted to get out to get out at “good prices”.  I wonder how long before the bond vigilantes will test the ECB’s resolve.  They have certainly been given the ammunition by German finance spokesman’s comments that it rejects the idea of increasing the size of the EFSF and that it “misses the point” by not addressing the problems in these countries.

 

And let’s not forget France, which traded at record wides of 160 (+15bp) on fears that it will be the next nation to lose its AAA status.  I think that would be a fair assessment, once the dominos of Italy and Spain fall then France will topple too.

 

The ECB and the European governments are as usual late to the game; unfortunately they are still playing snap with Grandma, when the markets are going all-in for the final hand of winner takes all of Texas Hold Em.

 

I’m not going to even bother with US earnings today; there seems little point when the macro tsunami is riding rough shot over corporate specific news.

 

Equities were mugged and left for dead.  After another volatile day, US equities closed down 5.6-6.9%.  Despite the ECB’s best actions, Europe was also hammered and closed down 2.4-5.0%.

 

Financials were hit hard:  BAML crashed 20.3%; JPMorgan slumped 9.4%, Citi plunged 16.4%; Wells Fargo plummeted 9.04; AIG fell 10.0%, Goldman dropped 6.0%, Morgan Stanley slipped 14.5%; AmEx stumbled 8.8%; and BoNY fell 9.7%.

 

BAML was not helped by news that AIG is suing the company, along with a host of other prominent financial institutions, as it seeks to recover US10bn of losses on RMBS.

 

Offshore credit was dire.  The European IG closed 4bp wider at 140.  The US IG finally succumbed and closed 12bp wider at 115.  The Aussie iTraxx closed 3bp tighter at 135/139; but we will give those gains back and then some today.

 

Sovereign CDS was relatively calm: Greece 1,600 (-113bp); Spain 350 (-55bp); Portugal 870 (-57bp); Italy 34 (-43bp); France 160 (+15bp); Germany 79 (+5bp); UK 80 (+3bp); and Ireland 750 (-33bp).  The senior financials index got slammed and closed 6bp wider at 217 and the subordinated financials index closed 20bp wider at 384.

 

And finally the riots in London are spreading, as social unrest in the UK is taking off.  Opportunistic looters are realising that police cannot attend all the crime scenes and as such are ransacking shops in locations such as: Peckham, Ladbroke Grove, Ealing, Croydon, Catford, East Dulwich, Bethnal Green, Lewisham, Clapham, Hackney, Birmingham and Leeds.

 

Tin hats on, heads down, don’t answer the phone or the door.

 

Have a good day.

 

Regards,

 

Mark.

 

Still Australia’s Favourite Independent Credit Strategist (Insto 2010 and 2009)

CFO Magazine: Credit Analyst of the Year (2008)