Archive for April, 2011

Greek Drama

There has been a lot of talk lately about restructuring Greek sovereign debt. Greece failed to meet its deficit reduction target for 2010; its debt on a Maastricht basis stands at 143% of GDP; its austerity programme saw the national economy shrink by more than 6% over the course of 2010; unemployment has risen to 15%. The country’s credit ratings are low and still sinking. Most alarmingly, Greek bonds have sold off to the point where two year yields have reached 24% – 10% higher than where they were a month ago. Some kind of sovereign default must be round the corner.

And yet … Greece’s underlying problems would not be solved by debt restructuring – problems it has already begun to address. Yes, a budget deficit of 10.5% is abysmal, but that’s down by almost 5% on the year: a fiscal consolidation not even close to being matched by any other country in Europe. The Greek government has also embraced a programme of privatisation and land sales to bring down its debt burden. All this is being accomplished in the teeth of fierce opposition from trades unions and large swathes of the public.

Beyond Greece too, what would a restructuring accomplish? Nobody knows for certain what the effect would be on the balance sheet of the financial system, including the ECB, and on Greece’s existing sovereign creditors, but it would be far from benign. And once the precedent of a restructuring was set, surely Ireland would be next in line to be pushed over the cliff (2010 deficit: 32.4% of GDP). Perhaps Portugal might follow.

At that point, the harbingers of Euro-doom could be proved right: we might witness the collapse of the single currency zone. The global fallout from that would likely make Lehman Bros look like a picnic. Which is why – to take one example – China has been piling into European investments, including government bonds. The world does not want another crisis, and a sovereign collapse in the eurozone could be just the catalyst to make it happen.

These remain uncertain times. The recent election in Finland serves as a reminder of the unpopularity of bailing out bankrupt states. And Greece has serious problems.

We should be careful, however, not to write off the possibility that Greece, and the other countries in crisis, find time and support enough to muddle through without resorting to default. It is also possible to envisage a “minor” restructuring of Greece’s debt – such as an extension of maturities and / or capitalisation of interest for a few years, arranged so as to have a neutral effect on the value of the instruments concerned – that could be helpful to the Greeks without sparking serious contagion (though the risks would be high).

In other words, the bears may have their day again soon: but on the other hand, Greek debt could present the bond market opportunity of the decade.

28/04/2011 at 3:36 pm

Sell Signals

One of this week’s biggest stories was the announcement of the Glencore IPO.

The company is hardly a household name, but has been a giant in the commodities world for years. Its business model is unusual – it is involved in extraction, distribution and trading, both directly and indirectly through financial investments and supply contracts. It has also proved highly lucrative, generating turnover / net profit of US$145bn / $3.8bn in 2010 from US$80bn of assets (company fact sheet).

One obvious question to ask is: does the sale of this company to the public mean the experts who work for it think the commodity market is about to peak?

Recent history offers some interesting precedents.

In March 2007, news broke of the sale of Blackstone, a private equity giant and major beneficiary of the cheap debt financing available in previous years. The IPO was completed in June that year – six days after the first rating agency subprime downgrades that kicked off the world financial crisis.

As debt markets began to seize up, Blackstone shares fell sharply from their offer price of $31, closing the year at $22.13. They are trading at around $18.50 this afternoon.

A similar signal on a smaller scale came from the sale of Foxtons, the UK estate agent, the same year. Founder Jon Hunt offloaded the company (to private equity, funnily enough) in May, netting £390m. Property prices peaked less than 9 months later.

So, by these yardsticks, commodities have another 3-9 months before imploding.

But there is, perhaps, a more pertinent parallel from a decade earlier.

In June 1998, Goldman Sachs announced its intention to go public in a limited IPO (of 10-15% of the company – similar to Glencore’s planned 15-20%). Plans were delayed, however, as stock markets corrected in the face of the Russian default. It wasn’t until 3 May 1999 that the sale went ahead. The S&P 500 peaked just over 11 months later – almost two years since plans were made.

We ought not to read too much into these parallels, or into Glencore’s decision. But it’s not likely they’d be selling if they thought their market was absurdly undervalued.

15/04/2011 at 3:19 pm

Local Difficulties

The first quarter of this year – remarkably, when we consider the upheaval experienced in many parts of the world – saw reasonably strong returns to equity. With the exception of Japan, all the major markets are up at the moment: the US and Eurozone markets are about 6% higher on the year to date.

The UK, on the other hand, has managed less than half that. This could reflect a number of things: the release of GDP data showing an unexpected contraction at the end of last year, fears over the impact of fiscal consolidation, concerns over inflation – there are always reasons not buy. The question for UK investors is whether the underperformance can be written off as passing volatility, a bump in the road – or whether it might indicate more serious problems.

One important measure which has showed a decline is consumer confidence. Again, this could prove transitory. When the indicator first fell it was suggested that it was a response to worries over higher fuel prices, which had been receiving a lot of media attention. These two elements – inflation and media negativity – are still very much with us.

Meanwhile, over at the Bank of England, where they expect prices to stop rising of their own accord any time now, workers were finding it difficult to manage on incomes which have been frozen under the government’s cost cutting programme. In a delicious return to the policies of the 1970s, the Governor’s response was to impose a price cap on food.

Elsewhere in government, the prime minister has been sending mixed signals on his commitment to austerity in the face of military action in Libya which the country can’t afford.

And outside Britain, of course, commodity prices continue to increase. PPI data out this morning show the cost of raw materials rising at 15% per year – and that can’t be blamed on the currency as trade weighted sterling has hardly budged since the beginning of 2009.

There are reasons to be hopeful too. We are not insulated from the rest of the world and will benefit from continued global recovery. Away from the confidence data, surveys such as the purchasing manager series suggest that business conditions are robust and that last quarter will have seen an unequivocal return to growth.

Perhaps our troubled start to the year will soon become a distant memory. In the meantime, the Bank would do well to observe the deleterious connection between inflation and confidence and expand its focus beyond the price of its employees’ sandwiches.

08/04/2011 at 2:37 pm 2 comments

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