Let’s Get Europe Out of the Way
I would love to be able to say that Europe is fixed. It isn’t and this particular summit was particularly disappointing. They announced some vague plan to plan a bank supervisor. I still don’t understand why people really think a bank supervisor would change anything. Just think about the Spanish bank bailout. Money was supposed to be available in July, then August, then September and as far as I can tell, not a single distribution has been made. This problem is even more complex than other ones, because Germany is part of the problem. Germany may be the land of luxury automobiles and industrial efficiency but it is also fertile ground for state sponsored Zombie Banks.
Spain is not asking for a bailout yet, and allegedly it wasn’t even discussed. I cannot tell whether it would be worse if it wasn’t discussed or that they are lying to us and it was discussed but no conclusion was reached.
Talk about various ways to manipulate the Greek debt problem. Plans range from further punishing the PSI bonds which I think would meet with incredible resistance and accomplishes nothing, to ways to get the ECB off the hook and dump losses on ESM. I am not sure there is any particularly good solution to the official sector problem because owning 10’s of billions of mismarked bonds and loans is a difficult problem to overcome.
Then there is news that France is in more frequent disagreement with Germany. That will make any longer term solution more difficult to achieve.
So why didn’t markets sell-off more? At this stage everyone still believe the ECB will intervene with OMT and the ESM will provide some form of PCL along the lines of the IMF’s programs (my ultimate goal is to write and entire paragraph with just acronyms).
One of these days, Europe will fail to catch the falling knife. Europe has let the situation deteriorate and then the EU cobbles together some sort of program that kicks the can for a little while. OMT and ESM should be the ultimate in can kicking, but every delay means that resistance will mount. If ESM gets immediately saddled with ECB GGB losses, how will the countries react? Will there be an immediate capital call? The ESM is supposed to be leveraged at 6.66 times and any losses that hit capital would limit how much it could currently borrow.
I see a likely scenario that the market starts to question the resolve of Europe and the dissent amongst all the various organizations and the countries rewards those who bet against Europe now. I would be selling Italian and Spanish bonds here or even short.
Moore’s law is that basically computing power doubles every 18 months or so. Without getting into specifics, or arguing about the details, it is clear that technology has been developing rapidly. What is also clear is that more and more of the computing power is wasted.
I certainly remember upgrading frequently because my computer wasn’t doing what I needed. It was slow for running some big calculations. Video games just weren’t fast enough. Eventually downloading videos and pictures became a problem. But now, if anything, I find screens too cluttered. Most of the time, my computer performs well enough that I don’t really need more power.
What am I going to do, watch videos in fast forward to test the download speeds? On Excel, I think I use version 2007 and the only features that I use that came with that version are the ones I’m forced to because I can’t figure out what they did with the old Excel 2000 commands. I cannot imagine a world without spreadsheets. They have come a long way from some very simplistic ones to Lotus 123, but the reality is that old ones work just fine.
The best analogy I can come up with is speakers. There are some impressive speakers out there. Some are incredibly expensive and can reproduce sounds with more accuracy than the human ear can perceive. What’s the point of that? There are speakers out there that audiophiles insist are worth it. Yet half the world (or so it seems) is quite content with little white ear buds.
It is possible that this quarter was a mere blip for companies like Microsoft, Intel, and Google, but maybe we are seeing saturation in the market where the incremental improvements that we can detect just aren’t enough to spur demand. The benefits might be there but if we can’t perceive them, we aren’t in a rush to pay for them. Ironically, as I write this, I wonder if it isn’t the internet service providers (wireless or otherwise) who will benefit. If new technology isn’t what we need to do more, maybe it is ever faster flow of information and access to more of it?
One of the best presentations I ever saw was given by Michael Milken at either Bankers Trust or Deutsche Bank High Yield Conference around 2000. It is relevant today for the same reasons it was then.
He asked a basic question, “if you had bought big technology company stocks in the 1970’s, how rich would you be?” This was at the height of the internet craze and Nasdaq was everyone’s favorite. The answer was that basically you wouldn’t be rich. Very few of the big tech companies in the 1970’s went on to be successful during the internet/tech rally. In fact there is a long list of companies that had gone bankrupt or sold off in pieces by that time.
His thesis, which he applied to big pharma at the time, remains valid. His argument was that the big pharma companies had a massive market cap, but spent very little on research. Yes they had big earnings, but you were paying a fair multiple for those and the research was the key. You could buy all the listed biotech companies for less than the cost of one of the big pharma companies, yet the amount being spent on research by those biotech companies was a massive multiple of what big pharma was spending. Yes, these companies were in the red so you couldn’t even attempt to put a P/E ratio or any other traditional metric on these companies, yet he was convinced that the big winners were to be found in the smaller, relatively unknown companies, that were trying to create the future.
That certainly worked in the past in regards to technology and I can’t help but wonder if we shouldn’t be spending more time looking for the next thing.
Just looking at mobile phone production, in the past 10 years we have seen Motorola rise and fall, Nokia go from European dominance with some traction in the U.S. to nothing, and Blackberry was one of the first words to become both a product name and a verb (I was so bored at the meeting, I was blackberrying people to pass the time). We all know what state that product is in.
If something can go wrong, it will. The level of complacence and the view that while things might eventually go bad, they won’t go bad anytime soon is very high. Even the bears, of which I’m one, are thinking 1,400 on S&P. Finding a real die-hard 10% correction type bear is almost impossible. With Europe once again risking the wrath of the markets and with the love affair of big market cap tech possibly being questioned, maybe there is more downside. I’m not there yet, but certainly more comfortable with the short than before.
Leveraged Loan LCDX Lessons
Say that 5 times fast. I am working on a more detailed report on this market, but I think it is worth giving a snippet here. In 2007, leveraged loans were all the rage. LCDX was created and immediately traded to spreads that seemed unbelievable. And they turned out to be unbelievable. The speed with which this “safe” product collapsed was astonishing. When EVERYONE thinks one way, and more importantly is positioned that way, bad things can happen in a hurry.
It is hard to see from this chart, but we went from trading about par, which seemed insane given the low spread and callable nature of the underlying, to a harsh a vicious sell-off down to 92. Remember, the underlying were senior secured floating rate bank loans. Should never have happened in theory, but it did. It got worse, and then went into total capitulation mode, which I haven’t shown here when one firm was allegedly being forced to unwind a massive long LCDX, short HY trade. Again, more on this another time, but worth thinking about after some of the shine got taken off of Apple and Google, and Intel and Microsoft eroded further.