The T Report: Manziers and Puffy Shirts
What Does Seinfeld Have to Do with Anything?
Not much, but I figured everyone could use a smile on this slow Friday, and the Manzier (or Bro if you prefer) somehow fit my mood. I am neither a bull nor a bear right now. I have a lot of thoughts bubbling, but I’m struggling to put them into a coherent strategy right now. I’m evaluating my core position and trying to figure out what to look at going forward.
A Bull Market In Spain!
Don’t laugh, but the IBEX is up 27% since the July 24th low. I wish I could say I caught the bottom, but I was adding there and being long Spain and Italy has been a core part of my position. I felt they had priced in extremely dire cases that were unlikely to occur and that they had lots of upside. I am now virtually out of these positions as I sold into strength yesterday and this morning.
I am really torn on the decision to sell and may add back. These markets still seem cheap and yesterday, Dow Jones published an interview that Blackrock was dipping its toe back into Spanish and Italian bonds. They had decent timing and conviction in 2011 when they waded into Italian bonds, and given how everyone seems to talk about how underweight they are (if they have any exposure at all) I’m wondering if this is still the early stages of this rally. With so much negativity, and people making it such a point of pride not to be invested in Spain and Italy, I keep coming back to the idea that it is too early to take profits here, especially in the bond and CDS side.
Banks
Outside of Spain and Italy we have consistently liked banks. JPM has been our favorite in the U.S. and we have largely relied on index exposure for Spanish and Italian banks since they make up so much of that. Barclay’s has also been on our list as having been overly beaten up on LIBOR when in fact they look at least a little like whistle-blowers.
Banks like Unicredit are up almost 40% from their recent lows. The scary thing is that they still look cheap. If money is going to find its way back to Italian bond markets and the EU is really going to make one more big push, then this scary bank still looks attractive. The fact that I’m cringing as I type that, knowing the derision it will be met with, gives me a bit more comfort that it isn’t a bad idea. It would be extremely high beta, for all these banks in the PIIGS region, and I have tiny exposure through what is left of my broad market positions, but I am thinking about adding these. I’m hoping for a pullback. I scared of a sell off. At same time, many of these banks seem to offer the best opportunity as they remain heavily shorted, underweighted, despised (if that is an investment status) and the “system” is potentially about to implement another round of policies that will likely directly and indirectly benefit them.
JP Morgan has been another good one. I never looked at it until after the May 10th conference call that added whale to the Wall Street bestiary. It is above the close from that day and has approached $38 and paid a dividend. There were a few days you could pick it up under $31. With all the work we did (as best as possible given limited disclosure of their derivatives and other positions), we treated this as relatively low beta. But here I just can’t get comfortable with it. I had started moving into some higher beta names like MS but got out of those yesterday and am struggling not to short the sector.
I like JPM in particular because I thought it had been overly beaten up on the whale trade. I think the LIBOR scandal, while bad, will result in fewer successful lawsuits than some anticipate. Without a doubt there will be regulatory action and fines, but not the massive class action payments.
So I fought those trends, and believed that housing in the U.S. is stabilizing. I guess you could call it “bottoming” but I’m not even that optimistic. I just think it can start clearing in and around current prices, but that is enough for banks to start booking some decent income and will drive funds into the down and dirty areas of busted MBS to find bonds with great risk reward.
So why am I getting wishy washy on domestic banks? First and foremost, price. I think the banks have bounced enough that they reflect a lot of good news out of Europe and the U.S. mortgage market. While I don’t think big lawsuits will be victorious, banks don’t seem to be pricing much risk in here, and with the headline risk remaining high from the regulatory scrutiny, I see some potential downside.
This lack of volume on all trading products is also a concern. I don’t think the low volume is as bad for the broad market as some people claim, but I do think it is bad for bank earnings. Volumes are atrocious. The ability to generate bid/offer or commission revenue is low. M&A may be attempting to pick up the slack, but the Facebook IPO has hurt the investment banking IPO business.
So as a whole, I just can’t get that comfortable being focused on banks, particularly domestic ones.
CDS
The one trade that I continue to like is selling protection or CDS. More non-traditional credit investors have been shorting these markets. They look “cheap” which really just means they have been burnt short everything else, so how much can you lose shorting something at 105 bps. I think the weak short base remains high, and the core buyers just aren’t there. PM’s don’t want or need hedges, especially when the hedge eats up more than they make owning the underlying. Banks, already under pressure to make loans, are under massive revenue pressure with the drop in trading volumes. The temptation to run more credit exposure is high, which means they will hedge less.
Not every credit investor can (or will) trade CDS. That means it hasn’t been picked over in the same way the “go go” liquid bonds have. It hasn’t worked great, but it hasn’t been a bad trade.
My conviction that CDS can continue to tighten is the main thing stopping me from being more bearish risk assets. If CDS can perform, the broad market and banks will benefit, so I am trying to square this view with my others.
Fixed Income
Along with CDS, I think “spread” products can do well on a spread basis, but not outright. I think muni’s and investment grade, and particularly bank bonds, can tighten, but I would not own them without a rate hedge.
HY bonds should do okay. There is too much rate risk and too much yield to call paper for the broad indices to have big gains, but they shouldn’t go down too much. Specific bond and credit selection will be the key to outperformance here. I still like the leveraged loan market and demand remains high as CLO’s continue to print, and the senior secured nature (of the better deals) protects on the downside.
“Safe haven” bonds which already have sold off hard remain susceptible to further weakness. I think any bond that had a “currency” angle is most likely to experience a large sell-off. Germany, Netherlands, and France are prime candidates to short along with EFSF bonds.
The Dirtiest Shirt
America may not be wearing Seinfeld’s famous “puffy shirt” but as far as I can tell, we now have the dirtiest shirt from an investing perspective. We are back to the highs on almost nothing good happening domestically. Data has stabilized, but at very mixed levels. When we broke 1,400 in Q1 you could at least argue that our own jobs data played a role. Now, the move is almost exclusively based on Europe. While I have argued that a fix in Europe will translate into better economic data in the U.S., that won’t be immediate and at these prices is at least partially, if not fully priced in.
If the next big move really depends on the Europe, then invest in Europe. We won’t see much of the benefit.
I have never believed that that QE3 is as critical to the bull case as the bears have believed, but it is at least a part of the view (especially with weak regional fed manufacturing data) and seems more likely to disappoint than not. My invitation to Jackson Hole still hasn’t arrived, but I don’t think we will hear anything terribly exciting. If anything, look for plans for a more “targeted” approach. For the Fed to hint at a plan that really works to get money into the hands of homeowners and small businesses since they are allegedly the ones who want cheap money and can’t get it. I’m not sure how the market would react to anything that indicates the Fed is taking a more limited view on what they can do. It would be ironic, and completely par for the course, if a limited approach hurt the market but actually helped the economy.
I just don’t see the domestic growth and with a strong dollar, it isn’t going to be as easy to export our way to prosperity. It is especially hard to export our way, when all our main customers, including China and the entire EU are also planning on exporting their way to prosperity.
I have this feeling that by the end of September, the U.S. political process will be the laughingstock of the world. The arguments seem more polarized than ever, the rhetoric more heated than ever, and the willingness to play fast and loose with the truth seems have hit a new levels too. So with a contentious campaign about to get in full swing, a Republican ticket that in some ways seems like dual presidents rather than the more traditional prez/vp ticket, I don’t see anything getting accomplished and think in fact, the divisions will become larger. The chance that the market gets distressing headlines from the campaign trail is very high. So, regardless of who I hope wins, I don’t see the campaign itself being helpful for the market, especially at the levels we are currently at.
Where Does that Leave Me?
Small longs in Europe, particularly European banks (tiny longs). Longs in Spanish and Italian debt and in CDS (long credit risk by selling protection), particularly in banks and domestically.
Willing to buy domestic banks on weakness and short broader markets on strength and I have started finally buying some US puts. I’ve been able to purchase September S&P 1,375 strike puts for less than when I first started looking at the 1,350’s as vol has moved in my direction, time to maturity has decreased, and the S&P has moved higher.
I remain convinced Europe will launch some new initiatives but that September 12th German court ruling on ESM will make people nervous as we head there.
E-mail: tchir@tfmarketadvisors.com
Twitter: @TFMkts