Thursday, 28 June 2012

Mind Of The Market II: All-Is-Well Syndrome, A Habit Of Misplaced Hope

In a chaotic world, a barrage of mirages can, sometimes, be confused for reality. In an environment of sustained negative developments and events, it seems somewhat paradoxical for misplaced hope to find an audience.

The second part in the Mind Of The Market series (Part I, here) will focus on recent elections in Greece and France, and the culture of all-is-well and misplaced hope that pervades market participant positioning. Paradoxically even as mainstream media resonates with negative undertones, participant actions paint another story.

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Greeks came, voted a second time, and all seemed well. Again. For a disaster seemed averted. Greeks avoided Tspirageddon and offered the reins to a pro-bailout coalition led by New Democracy and PASOK, to steer them through the new phase in a never-ending saga.

The flight of deposits that had begun from Greek coffers into banks in stronger EU countries (run-rate approx. EUR 800 mm per day) seemed like a costly hedge to those that prudently went through the process. Money started trickling back into Greek banks, post elections and 'clarity'.

All is well.

Or, is it?

When The Mouse Garnered More Attention Than The Elephant
June 17, 2012 was a big day for voters. While global media and market participants were transfixed on developments in Greece, fretting about the possible victory of Tspiras' Left; a potentially far more important election transpired in France. Surprisingly, few seemed to notice, or care.

30-day search volume, a rough proxy for 'mindspace':


There was a collective sigh of relief when Left-centric Alexis Tspiras' Syriza lost to Right-leaning opponents in Greece. Over at France, the Socialists, under Francois Hollande, managed to achieve an absolute majority. Unlike Greece, where New Democracy had to jostle with PASOK to put together a government, France achieved a significant Socialist-dominated leadership, unlikely to face major opposition in implementation of policy.

In another queer development, a Party promising anti-austerity was voted to power (France), and a Party promising anti-austerity was shown the door (Greece). 

The Promise Of The Impossible...

A quick summary of Francois Hollande's election campaign agenda is insightfully oxymoronic.
  • Anti-austerity and growth-stimulating platform 
  • Reduce French budget deficit to 3% next year (current deficit: 4.5%) and eliminating it by 2017, although no clear road-map was enunciated. The Finance Minister insisted that targets would be met 'without austerity'
  • Reduce retirement age from 62 to 60 years
  • Creation of 60,000 new teaching jobs over the next 5 years 
  • Raise minimum wage by more than inflation and make it tougher for businesses to lay off workers
New jobs shall be created, working hours slashed, wages raised, lay-offs are tougher, pro-spending policies figure prominently; and yet, budget deficit is expected to be on the way down. Market participants seem to be placing an inordinate amount of faith in Hollande's ability in pulling off this Supermanesque feat of reconciling mutually exclusive objectives.

Hollande's pro-spending/stimulus stance is more likely to increase deficits than to decrease it. Especially, when the levers that would contribute to slashing the deficit are weakly understood. The whispering debt meter is likely to grow louder with time.    
  
...Yet Hope Runs High: France, A 'Safe' Haven

A look at market participant attitudes towards France over June is illuminating. Despite the slew of dark clouds on the horizon, largely thanks to the political impossibilities propounded by Hollande, market participants gleefully lapped up new bond issues by France. Reuters news runs:
 
French bond yields hit record low at auction - Jun 7, 2012

French yields fall at debt auction, demand firm - Jun 21, 2012

Yield on France's 50-year bond, due in 2060, fell to 3.27%. This was down from 3.34% in Nov '10, when the EU crisis was less intense than the present day. In the first bond auction after Hollande's Socialists assumed power, market participants accumulated new French bond issues. Bid-to-cover (a measure of participant demand) ran at close to 2.5x.

Yields began touching new lows (bond prices and yields move in opposite directions) and new issue appetite was healthy. When little had changed for the better and with the path of least resistance still pointing to more pain.

Hope floats eternal.

All is well.   

Greece: The Lair Of Liars & Wonders Of Short-Term Memory



While slightly dated, the chart captures the pre- and post- Euro situation in Greece. The (susiciously) reducing deficits leading up to Euro adoption reversed post-adoption. Much of this could be attributed to the benefits of cheaper sources of financing (common currency). Debt piled on and Cindrella had a ball. Until the party ended.  

Rumbles From The Past: Greece, 1990s
Barring a brief interlude in the early 1990s, PASOK - a Party associated with unbridled populism, a love for spending and tolerance for corruption - was at the helm of affairs throughout much of the 1990s and early 2000s, a critical time as Greece proceeded to adopt the common currency. In 2004, Greece admitted that it had fudged accounts to gain access to the Euro. Of course, that PASOK had presided over Greece when this activity was underway was deemed unworthy of mention. 

Voters exhibit an odd sense of history. Few remember, or question, the true reasons for their present quagmire but selectively remember the PASOK-promoted pay rises that they were beneficiaries of. Self-interested, rational beings indeed. Unsurprisingly, now, this same group is expected to lend support to their decades-old rivals - New Democracy - in forming a government and in steering Greece through trying times.

The Greece stock market roared its approval on pre-election rumours of pro-bailout faction assuming power.

Inertia Of Lying
Ahead of the critical EU Summit over the next few days, the Greek Prime Minister miraculously goes down with an eye problem, while nausea incapacitates the Finance Minister. Replacements shall make their way to the Summit, requesting renewed assistance from the EU powers-that-be.

The health 'issues' are likely to recur, at appropriate moments in this dynamic drama.

But, all is well.

A Habit Of Misplaced Hope

Time to gauge the pulse of the market. One would be forgiven for thinking all was indeed, hale and well. For a major disaster (Euro-imperilling government in Greece) was averted. All was/is, of course, well with France.

Cross-asset class behaviour leading up to Greece and France elections:




Risk-off sentiment prevailed generally, as market participants dived for cover in US Treasuries and bought protection to hedge against events in Europe (widening European CDS). Risk-off posturing continued with equity markets around the globe sauntering flat-to-down. Commodities reflected the sentiment, with dual-personality Gold being bid, even as Oil and Copper were shunned.

Post elections?




Built-in pessimism morphed into hope. The unwind began, as participants cycled out of US Treasuries, European CDS tightened and equities were bid. Oil and Copper continued to signal something amiss but few paused to ponder. The most significant change manifested in Volatility, which compressed materially post the weekend election events, a sign of return to 'normalcy'.

To sum up, little has changed for the better in the weeks post-elections. If anything, woes of varied character and intensity continue to confound Spain, Italy, Greece, France and Germany. This union is in disunion; on banking union, fiscal union, political union. The form of the Euro-wide bailout fund, European Stability Mechanism (ESM), remains shrouded in indecision and no clear path exists. Meanwhile, voices for Euro-defection and bailout requests (classic Game Theory responses) have picked up.

Market participants learnt all about tail-risks in the aftermath of the subprime crisis and Lehman Brothers. Few years since, tail-risks do not seem like tails anymore. The Black Swan event now would be a miraculous cure to the world's ills, or, the more likely outcome; the emergence of a new Order.

Until then, all is well.   ?

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