Franco – German Divergence

The European debt crisis is straining the Paris-Berlin axis, the pillar of EMU. French banks are heavily exposed to Italian debt, with some estimates putting public and private sector exposure at more than $400 bln at the end of H1 (without taking into account insurance, hedges, etc). The French government is not in nearly as good a fiscal position as Germany. The French 10-year premium over Germany stands at a record 145 bp today. It finished last year near 40 bp

Ignore Egan-Jones at Your Peril

If you are still inclined to give Greece the benefit of the doubt, I suggest you study the works of Egan-Jones, a credit rating company located in Haverford, Pennsylvania. Contrary to most other rating companies, Egan-Jones does not receive any compensation from bond issuers (a huge conflict of interest in the world of credit rating agencies) and, unlike most of its competitors who haven’t exactly covered themselves in glory in recent years, Egan-Jones has a formidable track record (see it here).

Sean Egan, co-head of Egan-Jones, predicts the eventual haircut on Greece to be close to 90%. He has done his homework and believes that Greece can support no more than €40 billion of debt through tax revenues. That amounts to only 10-15% of outstanding Greek sovereign debt. Sean put his case forward brilliantly in an interview in Barron’s earlier this year

Disappearing Diversification

One challenge investors and portfolio managers is achieving diversification. Impressionistic views gained from every day experience is confirmed by a number of academic studies. Diversification in the international capital markets is becoming increasingly difficult. Bond markets have long been highly correlated. Equity markets have become increasingly so. Foreign exchange was embraced by some money managers as a way to regain diversification, long thought to be a key aspect of modern portfolio theory.

The foreign exchange market itself is becoming more correlated

Chart of the day: what is the high yield bond spread telling us?

I see this as a macro call. High yield is attractive if you think that the economy will rebound. if not, the extremely low high yield default rate will rise considerably, as will yields

On the IMF’s warning of a European sovereign debt and bank meltdown

Last night, I posted a video of Robert Shapiro warning that the EU needed to address its banking crisis promptly and thoroughly. I agree 100%. I also mentioned a New York Times piece I wrote on Wednesday. I had anticipated my NY Times article would be out today. It is not and won’t be coming until next week. So I am going to do a partial quote here in conjunction with some other commentary

Gold and the Three McBears

Now the market must contend with three macro bears: 1) how much and how Asia slows; 2) the Eurozone debt crisis; and 3) the slowing U.S. economy and employment/political problem. Continued volatility and 1101, 1101, 1101 on the S&P500!

Finally, we warned last week gold could take a big swan dive and $1,700 was where the “river meets the waterfall.” The chart below shows the yellow metal hasn’t been below its 200-day moving average in more than 2 1/2 years. The power of the rally has been stunning. We now think gold is set to test its 200-day moving average at $1,527, which is the level we will take a shot at getting long again

Bianco: An 1100 S&P would look expensive if we have a recession

Economists are telling us that the economy is decelerating rather quickly. What does that mean for stocks, in either a recession or no-recession scenario? Jim Bianco was on Bloomberg Television yesterday with some insightful comments about stock valuations and economic cycles

Ireland: Is austerity enough or will we see haircuts?

It is high time politicians in Berlin to started to recognise that fiscal austerity is not the be all and end all of the policy issues they now face. Ireland is applying fiscal austerity, but this alone may well not be enough. A better distribution of the pain needs to be found. As the IMF itself notes in its latest staff report: ”there is a strong sense that burden-sharing between taxpayers and creditors for the cost of supporting the banks has been unfair”

Janjuah thinks stocks aren’t cheap enough

Economic policy has become more important than ever in the investment world. And the degree of policy uncertainty only increases as bailout and deficit fatigue battle it out with liquidity uber alles and financial repression as the policy response of the day. Gold/Bonds has been a good play in that environment. Will it continue to be? Bob Janjuah says it will

Connect the Carry Trades

So, our friends, a few questions. Which rates are the result of financial repression, capital flows, and/or stellar credit risk? And what is the best carry trade, assuming you can borrow close to the sovereign

Chart of the Day: Guess what the best performing asset market is

Here is a chart of the relative performance of various asset classes over the past year. One asset class outperforms the others… by a wide margin

Herbert Hoover: On Bank Liquidity and Solvency, 1931

This is excerpted from the American Presidency Project at UCSB. Hoover writes the following letter to George L. Harrison, Federal Reserve Board of New York, on financial and economic problems on 5 Oct