The T Report: The Axis of Weeble is Definitely Wobbling

Posted by on May 14, 2012 in Uncategorized | No Comments


Weebles wobbling, spinning tops running out of energy, running out of room to kick the can, whatever analogy you want to use, the world seems like an incredibly dangerous place.

Greece is going to leave the Euro. That is now pretty much everyone’s expectation. I continue to believe that although they are highly likely to leave, it isn’t for a few more months, and that there will be some real effort from the Troika, led by the ECB to resolve this situation. This isn’t about helping Greece. This is about saving what is left of Europe. What does a new currency really do for Greece? It sounds exciting and the conventional wisdom is that it lets them inflate their way out of their problem. I think all it will do is inflate them into a “Mad Max” world. How is Greece going to be able to afford gas and food if they revert to the Drachma on short notice? Greece doesn’t export enough to get a huge immediate benefit. Yes, it will be cheaper to produce in Greece, but very little is set up to take advantage of that right now.

But it is the ECB and the rest of Europe that need to worry. Greece needs further debt cuts even more than it needs a new currency. Not only would the ECB’s and IMF’s existing holdings be converted to the new currency, Greece may decide to default outright. The ECB and IMF are both staring at massive losses. If Greece goes to the Drachma and doesn’t change the debt to Drachma, then they will have killed themselves. That just isn’t possible. So switching to drachma, and then possibly even defaulting is what is necessary. How will the ECB and IMF deal with it? The ECB might have to make a capital call. That would send tremors through the system. The IMF will deal with it, but expect talk about countries pulling out of the firewall. There is talk about having the EFSF make the ECB whole. That’s not even taking money from one pocket and shifting it to another, it’s the same damn pocket. The market will not like that.

Shorting Germany, preferably bunds, is my favorite way to play this (with French bonds a close second). I think the next leg if it occurs wipes out the myth of Germany as “safe haven”. If Greece goes, losses to the Troika will be real and any attempt to paint over them will be too obvious. The staggering size of the commitments that will ultimately flow onto the shoulders of Germany and France will end the idea that somehow their credit is somehow better. The guarantees matter, and these bonds will be affected.

I still expect some “surprise” headlines bringing all the people involved to some form of resolution, that won’t obviously fix everything, but will buy time. Notice Draghi has not once said anything about this, and really he seems far and away the most competent person at the ECB.

Then back here, we can focus more on JP Morgan. Since 2007, JPM had a loss in one quarter only. They lost 9 cents in Q4 2008. The just made 1.70 in Q1 of this year. Citi had 9 quarters of losses in that period. Their worst quarter was -23.80 per share compared to a tiny 1.11 per share in Q1. MS had 6 quarters of losses, with the biggest being 3.61 AND they lost money in 2 quarters last year. Yes, $2 billion is a big number. It may have grown, it may turn out smaller. In any case, it is unlikely JPM will have a loss this quarter. This group and the overall risk management of the firm is part of why they have done so well relative to their peers. If you want to focus on the fact that $2 billion is a huge number to a normal person, that is fine, but you may be getting more angry than you should. The reality is that JPM, with $2.3 trillion in assets is huge, and every business they are in is big, and P&L swings will be large in $ terms, but seem completely reasonable in percentage terms.

Yes, regulatory scrutiny will intensify, but this is a problem at all big banks. The specific risk of this trade has been overdone. Unfortunately it is hard to tell how much of the price move is specific to one aspect or the other, so I can’t quite get comfortable with the situation in terms of getting long JPM, but will be looking at outperformance trades.

Futures have already had a wild ride, and I would expect that to continue throughout the day. MAIN is out to 169 +12 bps on the day. XOVER is at 718 +36 bps on the day. It is ugly, with minimal liquidity – even the best market makers are back to making 1 bp markets in MAIN. IG18 is opening at 112, which is 3.5 bps wider, and HY18 is at 94 3/8, so down about 5/8. The moves in XOVER and HY relative to MAIN and IG seem more normal than Friday, when we saw almost amazing outperformance in the HY space (where JPM is allegedly short).

Spain and Italy are under attack again. Ten year yields have hit 6.26% and 5.70% respectively while CDS is at 640 and 480 respectively. Scary numbers, though Spanish 10 year may be getting to the point where we see some ECB intervention in the secondary markets.

So with problems across the globe and the mood so dim, I can’t help but think we are set up for a rally on the back of any scrap of good news. I don’t see Greece hitting the breaking point just yet, and the market will digest the JPM loss as it thinks more rationally, and Spain and Italy are not so heinous that they should respond well to any ECB intervention.