Steen's Chronicle: A Full blown poltical crisis - Macro digest on Cyprus, UK Budget and the FOMC

Macro Update: Cyprus, UK budget and the FOMC

Non-Independent Investment Research

Not a boring week for sure! Let's dig into it. First, my thoughts:

Cyprus  

A few facts in a news stream that is based on feeling, emotions and sometimes pure rubbish comments:

1. Any help from Russia can't be in the shape of a loan - a loan will make debt to GDP too high for the IMF and Germany. So if Russia is not handing over money free of charge as a gift, it is not part of any "deal".
2. The amount of natural gas constantly being brought forward is not quantified enough to be paid for. See this link.
   
3. As of last Friday, the ECB deemed some Cypriot banks insolvent as they wanted to close the Emergency Liquid Assistance (ELA) to protect the integrity of the banking system. The ELA is the ECB's last recourse for Euro zone banks that find themselves unable to raise funding in the open market through bond issuance. (Clickhere to read Deutsche Bank's explanation of why this is.)  The ECB will support the ELA through to the open on Tuesday.
4. The longer the bank holiday, the more likely Cypriot banks will see a bank run - so the time dimension works both ways, needing time to find a solution but also increasing the ultimate odds of people wanting to take their money out when the banks finally open. I personally do not believe any solution to Cyprus will create enough credibility to stop this. This has been a mess since Saturday morning and more so now with Russia involved.
5. The German election almost per definition means Angela Merkel can't back down as she has done in 2008, 2009, 2010 and 2011. She was hailed over the weekend for making Cyprus pay part of the price for the bailout. In an election year (September 22, 2013), she can't come back and ask for "more money".

Conclusion

Cyprus needs to find more than EUR 5 billion of capital or the ELA is closed from Tuesday. Ignoring the EU Group and running to Moscow hardly sets perfect conditions for getting concessions. To me, this is becoming a Lehman moment both in terms of political significance but also to constitute the top of market. It's time to wear a hard helmet as it looks more and more like Cyprus is small enough to be made an example of. The change from economic to political crisis is now for everyone to see.

UK Budget

I rarely say this, but I was impressed by Chancellor George Osborne's delivery of the budget. A budget slow on progress and high on desperation, but he sold it well. The bottom line was, however, as expected.

Bank of England remit will be changed, keeping the 2% target, which has not been reached in six years now, and adding extra thresholds. What an imagination! Copying everything the US Federal Reserve has done so "succesfully". To me, this is confirmation of "monetary activism" as Osborne himself called it - or in my words: currency manipulations. GBP is a sell on this.  Budget tax cuts for business to follow loss of AAA credit rating

FOMC

Very small changes to status. Economic outlook upgraded to "moderate economic growth" from "economic activity paused".

At the press conference, Helicopter Ben acknowledged that the success of QE was uncertain and an overall threat to financial stability through a reach for yield. Of course, Bernanke calls it "manageable" in the context, but then again he famously did not see any sign of froth in the US housing market in 2005. (Promise me you see this media clip from Bernanke!)

Some hawks could interpret the minute changes to this text as indicating the FOMC is debating more actively to, if not stop, QE then at least reduce it:  "... In determining the size, pace, and composition of its assets purchases, the Committee will, as always, continue to take appropriate account of the likely efficacy and costs of such purchases, as well as as the extent of progress towards its economic objectives."

The latter part of this sentence is the interesting part and leads to some quarters seeing a reduction in size and scope - and most importantly, the belief in QE. It has to be said, you really have to look for it to find it.

Strategy

Two of the chart people I trust the most, Andrew Baptiste of TAG618 and our own John Hardy, are both looking for exhaustion on this move. John has written an excellent historic piece, titled How do massive stock market rallies end, which is a must read. Drew, who famously forecast the 666-00 S&P low in 2008 when he was at Morgan Stanley, is now running a top of market chart company of his own. Having been long, he is now calling for an end to this cycle. This link gives you an appetiser from Drew, who is not only an outstanding chartist, but also a perfect gentleman.

My point?

Market perception and market reality have been separated for a long time; for most of 2012 and certainly in 2013. In economic terms, only three month into the year the outlook is grim if not outright terrible in terms of growth and employment. This combined with an almost outrageous believe in the no alternative to stocks, the nonsense of the great rotation (it can't happen - one sells, then one buys right!), and the lower of forward earnings guidance indicate that my two friends, Drew and John, could be timing their end of rally/bearish calls well.

I remain with my All-weather portfolio for 70 percent of my capital, but in the Alpha Allocation I bought some May 2013 S&P Puts 1400 for 4.20 - if for nothing else than to protect the good start to 2013. 

This market may just about have proved wrong the famous John Maynard Keynes quote: '"The market can stay irrational longer than you can stay solvent." This week could be the ultimate test.

Safe travels,

 

Med venlig hilsen  |  Best regards
Steen Jakobsen  |  Chief Economist

 

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