Start the conversation
Comment on This Story
Or to contact Money Morning Customer Service, click here.
Everybody loves a rally.
After European leaders announced a plan to stem Eurozone and global panic over Greece's potential default and shore up capital at beleaguered banks, positive contagion is lifting stock markets from one end of the planet to the other.
What's not to love?
Well, the plan itself, for one thing. It's so full of holes that unless it's tightened-up, detailed, actually agreed to, financed and executed, it's nothing but an outline in the sand.
Don't get me wrong, it's a start. But, the question investors have to ask themselves is, if the plan isn't written in stone and if they've missed this rally, is now the time to jump back into equities?
The answer is yes and no.
Understanding where the risks are and how to position yourself to profit on the heels of this new global positivity requires looking at the European bailout plan as proposed, and measuring it against the realities constantly unfolding in the future.
Let's start with the plan and measure it against what you should be watching in the days, weeks, and months ahead.
The Devil's In the Details - Especially When There Are None
What has been proposed is a plan to ask private banks to "voluntarily" exchange some $300 billion (210 billion euros) of current Greek debt for new debt to be issued by Greece. The banks are being asked to take a 50% haircut. That means the debts they were owed will be cut in half. Instead of Greece owing $300 billion, the country will owe its creditors $150 billion (105 billion euros).
The two immediate issues here are:
- How many banks will voluntarily execute an exchange of Greece's obligations?
- How are they going to plug holes in their Tier 1 capital when they write down $150 billion of losses?
As of now, there is no answer to the first question. It remains to be seen how many banks will willingly eat Greece's bad cooking. Back in July, banks were asked to voluntarily take a 21% haircut on their Greek holdings. Practically none of them did.
The only thing that's different this time around is that if the banks exchange old bonds for new bonds, the new bonds "may" have some first-loss provisions that would offer some protection if Greece defaults.
Yet, even that is a dicey proposition, since there currently is no number in place for first-loss provision. In fact, there isn't even an explanation of how the first-loss provisions would be backstopped or who would pay up on the losses.
Also, first-loss provisions relate solely to who gets paid when in the case of a default. They have nothing to do with banks taking losses if the market price of newly issued bonds tumbles. That's especially troubling now, since accounting rules require banks to not only show unrealized losses, but to add capital to offset those losses, as well.
And that's just the first problem.
The second is that in order for Greece to potentially guarantee some portion of its new bonds, it's going to need at least $43 billion (30 billion euros).
So where will it get that money? Well, the plan implies the International Monetary Fund (IMF).
At this point it's important to understand that of Greece's $500 billion (350 billion euros) of outstanding debt, $300 billion is held by private banks and the remaining $200 billion (140 billion euros) is held by institutions. These institutions, which include the IMF, are NOT volunteering to take any losses on their holdings. They want to get back 100% of what they're owed. So, they are willing to pony up more backstop money against the losses banks could see, as long as in the final rinse they get back everything they've lent.
So where's the $150 billion in capital that's needed to shore up the banks that are supposedly going to take 50% haircuts going to come from? Probably the IMF, with new money added to its coffers by the Chinese. And that's the only way the Chinese are likely to participate in this high-stakes game of blind man's bluff.
Now the question of how much you should invest in this rally.
Pick Your Poison
As I said, the plan at this juncture is nothing more than a line in the sand. And the sand is shifting.
The markets have rallied hugely. If you've missed this major push north and want to get in, do it very gingerly. We could see markets rally through year-end based on the positive contagion from the perception that this plan is going to be detailed, financed and executed.
Buy with caution and use very tight stops. I would suggest 10% to 15% stops.
On the other hand, I would be equally at ease shorting this rally, also with tight stops.
As a trader, that would be my choice. I believe we've come too far, too fast. We've been rocketing higher on short-covering and hopes that the threat of European contagion would be addressed and conquered.
Well, it's been addressed, as in, "hello, my name is uncertainty."
And as far as conquering the systemic problems in Europe, we've still got a long way to go. This plan is nothing more than a liquidity backstop to a solvency problem.
The only way this situation will be fixed for good is if Europe's insolvent countries are afforded enough liquidity to grow their way out of their budget holes.
Good luck with that.
France, Europe's second-largest economy, in September saw a wide measure of its unemployment tick up by some 4.175 million people. The government has reduced gross domestic product (GDP) forecasts to 1.75%, but private economists are putting that number closer to 1%.
Germany has been slowing down, as have almost all other European countries.
And so many questions still linger.
What will required austerity measures do to future growth prospects? What social and political implications will the continent have to deal with as it tries to extend and pretend that it's not really one giant debtor-in possession? What will fuel growth if there's no bank capital to finance it? What will happen if structural recession is the new normal? And what will happen if we get sequential crises via Portugal, Italy, or some other debt-laden country?
For investors wanting to jump onto rallying markets, I say be careful. We're not out of the woods. And for investors thinking about fading this rally, I say give it a shot.
Just don't forget the devil is in the details and sand is not concrete.
News and Related Story Links:
- Money Morning:
The Market's Next 1,000-Point Move - Money Morning:
Bank Stocks Are Bad Investments - But Excellent Trading Opportunities - Money Morning:
Four Moves to Make Before Greece Defaults
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.
Interesting viewpoint. I live in the next country who will join the EU (Croatia) but, thanks God will NOT see the Euro as a currency for a couple of decades at least (IF it lasts that long). The "plan" glued together in Brussels is, in opinion, a 2-year band-aid and perhaps even 2 years is too long. Nothing has been done to attack the underlying problems within the Eurozone (hence my band-aid analogy). The "hot air" spouted by EZ leaders in Brussels is NOT a cure, merely an act of "kicking the can into orbit". Many of them probably won't be around in 2 years, so why worry…….
Halleluia! Someone is FINALLY speaking sense. Thank you so much for such a keen analysis!
The whole debt deal appears to me to be a house of cards on an uneven, shaky table in the middle of an Arizona dust storm. The Germans and French are earnestly trying to help, and I don't doubt their resolve. But the Greeks don't think like the Northern Europeans and don't care. My Greek friends tell me that the Greeks will take this money and be in the same bad situation when the money runs out in time. Greeks are skilled in hiding their money and not paying taxes. So the money will run out in due time.
Well written. Thanks.
I would ask this. When is a plan not really a plan?
When it's a plan to to create a plan to create a plan. The whole thing is a farce. But there'll be dozens more high level meeetings…and I understand the food and wine are really good at those get togethers. So much Euro togetherness. Might as well enjoy themselves as the preside over the demise of their doomed experiment.
I have been following with fascination all of the ecomomic commentaries and forecasts Re; Eurozone sovereign debt and US government budgetary problems and as a non-stockmarket player { but a businessman} the only conclusions I can reach are
1}The Eurozone will not colapse under Greece's { and other's } sovereign debt
2}The US dollar will not { in the foreseeable future} cease to be the currency reserve of the world
and both commercial and ecomonic blocks will eventually { who know's when} rise from the ashes { so to speak} and the reason is very simple.. the global economy can NOT survive without either.. the emerging economies of the world { china, india, Brazil etc.} can not survive { economically} without these trading partners… so, even though all have indicated a reluctance to enter the game with the liquidity for both blocs… this is a massive bluff to get preferential terms on the cash they are going to have to pony up… nobody should be cap in hand to these countries… we know it… they know it.. they have to cough up sooner or later
Look at the alternatives.. in europe and the US… 70% unemployment… double digit inflation.. homelessness… food riots .. etc …etc…if the people haven't overthrown their own governments by this time.. there is is only one possible scenario… the strong will take from the weak.. { I seem to remember somebody a very long time ago prphesising this scenario !!!}
What intrigues me the most is where have the huge sums of money gone that have been won and lost on the markets and dumped by governments? It can't have disappeared off the face of the earth.. so who has it?… the only certainty is that with all of these government bail-outs and quantative easing… the bill will most certainly alnd at the common working man's door by way of taxation… the behaviour of those who control the markets has been nothing short of criminal and immoral and until there is universal regulation, these vultures will continue to feed off the masses.
I agree wholeheartedly with George Soros.. the economic crisis that the world is in today, starkly emphasises that the capitalist system is just as flawed { if not more} than the communist system…. and neither will survive
Dear Shah Gilani. Although we are from different political outlooks, I congratulate you to the wisdom displayed in your article. Fact is: The Banks will loose big time with the Greek bonds, The Question is,
which Banks because Government Bonds are mostly bought for their Interest by Banks to insure certain earnings to pay their dividends with. Question is however, how many Banks worldwide, have invested in Greek Bonds and are "voluntarily" required, as you so quainly put it, to have a 50% Haircut???
Investors don't bother to ask that question, Shareholders should, because it is their money that is taken away, and Shah Gilani,d it is their dividend, that may be cut. But Glory Halleluja, The Investors drive the market up by X percent, while they suffer in effect the 50% Haircut. Say Halleluhja, Shah Gilani, you see
idiots scramble in, to loose more money, and once the money is gone… Who cares, there is another sucker born every day, this is the Philosophy of the Snake Oil Merchant. Thanks again for an illuminating article.
European contagion is a basic certainty without a way out for Italy- France- Germany and Spain and cast in stone agreements from banks and institutions and this will never happen. Except if Markets trust Wall Street, France, Germany, the ECB and China to work together in agreed harmony for the best interests of the EU. This tactic of delay was enforced by France and Germany and will hold a few weeks now bailouts are no longer acceptable. The public has seen and felt the obscene fraud and corruption in Government, Institutions, Corporations, Banks and Insurers. And Markets are feeling the effects and seeing the protests all over the World.
FANTASTICK !!! THANKYOU !
Socialism is the root cause of the problems in Europe. Governments buy votes by telling voters they can have wonderful social programs and someone else (ie. the Rich, big business, etc.) will pay for it.
Many millions of Canadians and Americans are demanding that Canada and the USA adopt the European economic and social model, and refuse to even think about the consequences.
Those millions of North Americans are not stupid. They are just mis-informed and un-informed.
It's time to make the study of economics and business mandatory core subjects in all schools in North America so that in the future people will know enough to elect better political leaders.
Why not have a look to the Brady's plan for Brazil default in the 90's ?
Where there is money, there is greed, and corruption.
Wait and see what happens in the USA, they are living beyond their means.