Friday, 15 June 2012

GREEK ELECTION PREVIEW FOR INVESTORS

Whenever there is a big "binary" event, preparation is vital.  This happens in two different ways:  1. Advance positioning.  These are specific trades to be done before the event occurs -- deciding on asset allocation, sector allocation, and possibly protection against unlikely (but possible) outcomes.  2.Tactical preparation.  The analysis must be done in advance, but the trades will occur after an initial outcome is announced.
The idea behind advance positioning is that you must not wait!  Whatever happens will move the market so much that you cannot possibly adjust.  This is often true in binary events like FDA decisions about new drugs, but it is not very true of events related to global macro.
On Wednesday night I listened (oh so briefly) with astonishment to the assembled punditry explaining why it was foolish to be "going long into the weekend" where the Greeks might exit the Euro.  The question we raised in our office was why was it not equally foolish to be short?
I guess we now have the answer, after two days of rebound.  Those who were so confident on Wednesday night have missed a big rebound.  It is not that I predicted the two-day trading move (although our Felix model caught it quite well).  What bothered me was the false, TV-inspired confidence of those "explaining"  the market on Wednesday.  As regular readers know, I believe that investors should be expecting a long-term solution in Europe.  This is a long-term prediction of a process of gradual compromise and negotiation, which you can check out here.
Tactical Positioning
If you do not think about problems in advance, you will be paralyzed at the wrong times.  My Wisconsin friends always talked about the "deer in the headlights" and the idea has caught on.
Here are some thoughts for advance planning.  This illustrates what I am doing.  You may feel free to disagree, but you had better have good reasons and be ready for some fancy footwork.
Greece is unlikely to exit the Euro
The reason is simple:  It does not really help any nation, whether inside Europe or outside.  This means that everyone will be trying to avoid this outcome.  Here is an excellent discussion from a great source, Credit Suisse’s Head of Global Research, Giles Keating.  In contrast to other pundits, please note that his background includes the analysis of politics as well as economics.



Keating believes that it would take a total breakdown for a return to the Drachma, and that much of the negative sentiment is built in.
An Eventual Solution -- regardless of the initial decision
I like the thoughtful analysis from William De Vijlder, the chief investment officer at BNP Paribas Investment Partners (via Barry Critchley and FP Street).
“I am confident that a lasting solution will be found,” said De Vijlder, who spends his time when in  Europe between Brussels and Paris, in an interview in Toronto on Wednesday. De Vijlder, who has a Ph.D. in economics, bases his confidence on three main factors:
• There is knowledge of what needs to be done.
• There is the political will; and,
• It can be done.
The full article does a nice job of explaining each point.
The Market has Underestimated the Spain Plan
The market reaction is unsurprising, since the acid test is some sort of comprehensive plan.  Few in the financial punditry see the advantage of incremental improvement.  Here are some great points from one of our favorite sources, Peter Tchir of TF Market Advisors (via Financial Post).
I do not want to quote the entire (excellent) article, so here are my favorite points.  You really should read it all.
  • The plan will restore health of Spanish banks: A healthy banking system is necessary for a healthy economy, and official European investments will support investor investments in the medium- to long-term. “Over the next five years, this can pay off,” Tchir argues, and the rumored five-year moratorium on bailout repayments will give this time to happen. “I think [European lenders] will make decent investments, and investors will calm down,” adding that this could be a significant positive for Spain in the crisis.
  • Subordination of debt isn’t such a big deal: Thus, the risk of investments fleeing Spanish bonds because they are now subordinated to the preferred status of European lenders “is being overly hyped right now,” Tchir argues, though qualifying that investors shouldn’t be completely ignoring it. He believes that a much of this fear is rooted in the idea that Spain will actually be out €100 billion and misconceptions about where European cash is actually being invested.
  • Gives Europe time to get its act together: A reported 15-year repayment plan on loans to the FROB at just 3% interest means that Spanish banks are likely to remain afloat for a while as European leaders make more sweeping changes to the economic and political structure of the euro area.
Investment Summary
Your general takeaway should be that there will be an eventual solution, perhaps of the "muddle through" variety.
The worst case would be an election result with no clear winner and doubt about the ability to form a coalition.  The better cases would include a more probable path to a coalition.
In any case I expect plenty of skepticism and negative reaction -- the prevailing sentiment.  There will be time to react, even for investors who have been cautious before the decision.
Here is a key precept for Monday:
Do not worry about a market reaction of 1 or 2%.  The stakes are much larger. 
A satisfactory solution could spark a major rally, since there are ripple effects for the US economy and corporate earnings.
An unsatisfactory solution will also require more analysis from many experts.

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