It took us a year to figure out there was no solution to current crisis but to transfer the “toxic” assets from the private to the public sector, i.e. for the Fed to buy them. It has taken a year for Europe to do the same – although one could argue it has actually taken them longer, since the Greek problem has been known at least since 2004, according to Eurostat.
So we used our bazooka: $700 billion at first, we are now at $1.8 trillion and counting. How much will these assets recover in value over time is difficult to say. What we can say is that we have averted a collapse. The pundits claim it is simply postponed; as long as there is no meaningful progress on the budget deficit, I tend to agree. But I’ll take one crisis at a time. For now, we bought time.
I do not know how big the European bazooka will ultimately be. The initial one is the European equivalent of TARP. It is operated by the European Financial Stability Fund – the EFSF – which was set up in May 2010, at the time of the emerging crisis. It has the ability to issue $600 billion in bonds and has capital of $1 trillion. Sounds good, even though it’s old news.
Well, not so good to start with. Of the $1 trillion in capital, only some $110 billion has been paid in. The balance is callable on the 17 euro area member states – the EAMS. In other words, at this point this callable capital is European sovereign guarantees. The question du jour, obviously, is the solvency of these guarantees. We have the full faith of the US government. They have the full faith and credit of 17 EAMS, most of which are lying through their teeth. In any event, Merkel and Sarkozy are flexing their "trust-me" muscles. Trichet is skeptical, but what does he care – on November 1 it becomes Mario Draghi’s problem. And Super Mario should know: He joined Goldman Sachs in early 2002, just as the firm was lead manager of Greek bonds, and left in 2005, a few months after the Eurostat report.
There is another issue. I doubt $600 billion will do it. The plan that is currently debated extends to countries with no imminent default risk, simply financial difficulties. Picture the US. When the Fed helps, it helps every state. Same there, from now on. Since our numbers are comparable to theirs in terms of GDP, debt and deficits – actually, slightly worse here than there, except for GDP per capita -- they should get into the trillion-dollar club ... unless you believe that the European financial system is in better shape, or more transparent than ours to include insurance companies.
But as I already said, one crisis at a time. The current one seems stabilized; witness the euro/dollar September futures, which went from a panic low of 1.3992 on Monday to an intraday high of 1.4394 today (as of 15:30 EST). In the meantime, while the European CDS are still at crisis level, they have come down significantly. European banking stocks rallied – my favorite, Barclays (BCS) went from an intraday low of $13.275 to a current intraday high of 15.99, a 20% move. That’s what I like about this job. On July 19 at around 11:00, I took my chance and bought the August 13 calls. I had spotted what looked like an abnormal decoupling between the euro/dollar and the S&P, and the euro was right.
So what do we do now? We follow the trend, with an eye on the euro/dollar September futures. Look at the spike and reversal below, at around 15:00 EST. The ink is not dry yet.
Sure, Washington is still a pain, but this is 2012 election posturing at its worse. We may even not increase the debt ceiling in time, but no party wants to engage in a Pyrrhic victory. This too will pass. In the three days since the euro got out of the short term way, it has all been about earnings. We went from an intraday low of 1296 to the current intraday high of 1347, a 4% increase. If I just take Google (GOOG), Apple (AAPL) and IBM (IBM), the increase in market cap is a total of $45 billion, or 6%. That’s fast but as I have said before, in the absence of a financial crisis, what takes the market up is liquidity and shorts. We are even ignoring China’s PMI, published overnight at 48.9 in July down from 50.1 in June.
I will follow the trend as long as the reaction to the news is positive, with a stop on the euro futures at 1.4260. Stocks do not all bottom at the same time, and some recover faster than others. One sector thought here: While Europe may be on the mend, don’t forget that Q3 is usually a slow period, which will probably prove worse this year – the Electrolux effect. Also, I expect the dollar to recover when we pass the debt ceiling. So I focus on domestic companies, with a few exceptions. I am still in front of Autodesk (ADSK), earnings to be released on Aug. 11 amc; this is my Japan reconstruction play down 10% in July and 20% since May. I continue to like United Rentals (URI) as the market seems to realize that the increase in capex was necessary due to the increase in fleet utilization rate; now that it is over for the year, H2 will again see free cash flow generation. I bought the dip this morning in Ecolab (ECL) as I like its business and the merger with Nalco (NLC), which I luckily stuck to despite my cautious outlook. And I continue to own Federal Agricultural Mortgage (AGM), Sallie Mae (SLM) and my recently acquired Barclays, which I will try and ride to $17 and take it from there. My only pain is Ingersoll-Rand (IR), down 8% on its earnings. I do not see anything wrong there, whether in terms of cash flow, debt, share buy-back or business. Yes, the president of the residential solutions department has been replaced, but it only accounts for 15% of revenues. At 13 times guidance, I sold half for good measure but I suspect I will be buying back soon.
Now, on Europe and banks in general, let me be clear: I don’t trust them, period. As far as the ECB is concerned, being old enough to remember when it was created in 1998, one thing puzzles me. Its first president was the highly respected and stern Dutchman, Wim Duisenberg. Nothing wrong there. Its second president, Jean-Claude Trichet, before taking office, had to be cleared from charges regarding his supervision of the largest French bank, Credit Lyonnais, as it near collapsed in 2003. This took three years. Now we have Mario Draghi. Last I looked, he is governor of the Bank of Italy. And if the Goldman story is correct, he knew a lot about Greece at the wrong time. The fox in the henhouse?