European bond markets remain a mess.
The dynamics that have been driving Bunds higher at the expense of not only the peripherals but of other core markets too are simply not healthy. From a trading perspective, it makes sense to be long Bunds against more or less anything else with a € sign in the name. But who, in his or her right mind, would seriously consider committing money which is being managed in a fiduciary capacity to a market that is at any one time no more than a breath away from negative total return?
Sunday brings the referendum in Italy and with it a deluge of speculation as to what a ‘no’ vote might mean for the country, its banking system and the future of the grand European project. At the end of the day, Italy will be faced with very much the same dilemma as Greece, namely that its economy is locked into a currency corset which it entered into at an illusory exchange rate – what machismo was attached to so critically overvaluing the lira in 1999 at 1,936.27/€ will always remain a mystery – and that it set out into this brave new world with one hand tied behind its back.
It had always been assumed by the Brussels grandees that if Georgia and Tennessee could live in currency union with California and Massachusetts, then Greece and Italy could do the same with ease vis-a-vis Germany and Holland. The issue of absent fiscal union, though widely discussed in the Street was, like many an uncomfortable issue concerning the EU, neatly swept under the carpet and those who persistently questioned the situation were dismissed as moaning Minnies who didn’t grasp that the political will was much stronger than the economic reality.
So far, so good
I have worked with some of the most pro-euro economists on the Street, from Cyril Beuzit, now returned to academia, to Holger Schmieding who battles on as chief economist for the house of Berenberg, who have spent 25 years castigating me for my scepticism. Fact is that, one way or the other, they have so far been as right as I have been wrong. On the other hand, there is the one about the chap who falls off the top of the Empire State Building and, as he sails past the second floor windows, thinks to himself “so far, so good”.
That said, a no vote in Italy on Sunday could just as easily prove to be a sort of “Y2K” moment that is anticipated with hand wringing and teeth grinding but which passes without any further repercussions. Both the Brexit referendum and the Trump election have proven market fears to have been hugely exaggerated – or at least in the short term.
Spanish bonds remain 50bp cheap to Italy and nearly 200bp cheap to Portugal. Spain might have some impressive growth dynamics but unemployment, according to the Eurostat methodology, is still at 19.3% whereas in its western neighbour it is “only” 10.8%. In Italy it is 10.7%. How can Spain, with that albatross hanging around its neck, be trading so much better than its garlic-belt peers slightly escapes me. I do believe that in the really, really long term Spain is better positioned than Italy but over the next five years its position and outlook is in no way superior. As I suggested at the back-end of last week, the obvious trade going into the weekend has to be long the cheap dog’s breakfast and short the expensive one.
Trump rally
Meanwhile yesterday, the Trump rally finally lost a bit of its momentum. From the pre-election low the S&P had rallied – trough to peak – by 128 points or 6.15%, making copious new historic highs along the way and a technical correction was long overdue. Losing 0.5% in a day isn’t much and chart technicians will be busily digging out their Fibonacci retracement tables. The first 23.6% retracement from the pre-election low to the recent high should theoretically see the index trade back to 2,184.32 points. I’m not much of a mathematician and my understanding of Fibonacci more or less begins and ends with snail shells but the magnitude of the recent rally certainly calls for a consolidating pull-back and picking a target defined by technical chart points is probably as good as any.
The month is drawing to a close. Nearly 40% of the overall stock returns have so far been made this month and the temptation to lock in some of the profits ahead of month-end have taken hold again can barely be questioned before the uncertainty over the repercussions of the expected December tightening move. Look for lower equities, a lower dollar and firmer bond prices over the next couple of days.
The doors of Trump Tower continue to revolve as one hopeful after the other pays homage to the future commander-in-chief. The latest is General David Petraeus, highly decorated military man and former head of the CIA whose sparkling career was brought to an end by an extra-marital affair. He is the most recent of the three top candidates for secretary of state. Interesting.
Comparisons with the composition of the Reagan administration are already being drawn with a president way out of his depth but surrounded by a strong and competent “kitchen cabinet”. The fly in the ointment is, however, that the US is no longer the sole dominant economic power of Reagan’s day – Mao had barely been dead for five years and we’d only just risen above playing ping-pong with the Chinese – and with a current debt/GDP ratio of at or around 100%, fiscal and budgetary flexibility is much easier to talk than to execute. Reagan’s inauguration was met with the release of the Tehran hostages. I wonder whether Vladimir “put-me-in” Putin might have something similar in mind by way of an olive branch for next January. Can you see that? I can’t. It is, nevertheless, quite possible that the Kremlin is scheming as to how it can drive another wee wedge between Washington and not Brussels but Berlin. Maybe Petraeus could be the man of the moment.
Finally, OPEC. Blah, blah, blah, blah, blah. Buy, sell, buy, sell…. Next!