Dear all,
Following last month's Christmas special and despite a somewhat desultory January (as the month usually tends to be as we adjust to the new year and new tempo) there has been a sustained improvement in the wider markets. What was meant to be a short recap of my thoughts below on where we stand in the global economy and the European credit space has spiralled into a much denser picture that touches on the complex underpinning of the ongoing Sovereign issue in the eurozone and whether this mini-recovery as spurred on somewhat by the LTRO (Long term refinance option) by the ECB can in fact take on a more permanent picture and lift us collectively out of this market uncertainty.
I've opted to retain that initial dense stream to reflect in part that the picture remains very myriad, conditional and complex but even so these glimmers of recovery should not be ignored and instead value-seeking opportunities remain as compelling as ever. For the astute market observer must realise the beyond the gloom and doom there remains, as always, the sprouts that will redefine the next & ongoing market cycle.
Additionally, the current low rate environment is excellent if you are planning to get a mortgage, but what about all that cash festering away in a bank account, yielding almost naught. Some ideas on where to place your cash, at 5+% yield. In the current environment, with rates likely to be stuck here for 2-3 years, wealth creation can be a lot more simple through intelligent bond investing.
Enjoy the below and until next time have an excellent month as always ideas, questions and feedback always welcome.
Sincerely,
Thank you for listening; Stay Hungry Stay Foolish
Z.i.L
From the Desk of Zachary I. Latif
What a difference, a year makes! 2012 started with a convincing rally which has at least for now, batted away questions on sustainability of the PIIGS within the € project and while any bullish stance should be tempered, it is difficult to see a halt to the current recovery. The LTRO was mentioned in the last piece as a potential game changer, and the increased liquidity through this 3 year funding program has been a major catalyst for the recent risk asset rally. The "Black Swan" event of a complete market shut down with bank failures and a euro break-up were easy to visualise late in 2011; but the fact that the ECB has decided to embrace fiscal support and set off on a 3 year bank funding mission, has at least taken the unthinkable off the table.
With liquidity no longer a concern, capital raising remains the biggest challenge for European banks (the EBA has told banks to raise $150bn by Jun'12), yet for the discerning investor, this can represent the most interesting opportunity. Given how distressed secondary levels had become on Bank paper (across all spectrums: unsecured, covered and asset backed); the easiest way for banks to improve capital ratios is to launch buy backs (tenders) for these products. Its the perfect zero sum game, normally the premium over current secondary levels make it attractive for investors to tender their bonds to the originating bank, while for the bank its an easy get fix toimprove their core Tier 1 ratio. Even National Bank of Greece launched a tender on their covered bond issuance, almost 15 points higher than trading levels at the time. I suspect a number of peripheral banks, with pressing capital short falls, will continue this theme in the next few months andidentifying secondary paper which remain lucrative to tender back will be an interesting short term trade.
Finally the perfect storm for a sustained rally would not be complete without the Fed coming out with a statementprolongimg super low interest rates for at least another year and a half. Great for long term loans and perhaps even stimulating fixed investments, but bad for deposit holders. And this is where I think the opportunity within credit becomes so interesting for any discerning investor. One of my greatest bug bears has been the number of "unsophisticated" investors within equity markets (in spite of the greater volatility relative to credit), but now with interest rates so low, surely it is time for a number of smaller investors to start investing in high coupon investment grade credit. Without taking significant risk, yields of 4-7% are very achievable on benchmark liquid name,and surely that's a more interesting proposition than 1.5% at Natwest Advantage Current Account. If one were of the more discerning character,financials have very interesting risk-return profile. One of my favourites, Lloyds 7.5884% ECN note, currently trading at 85 cash price, implying a yield of around 10%. The risks associated with ECN's has reduced substantially over the last few months, and expect Lloyds to call this well before maturity date; so yield level can be a lot more compelling.
Or why not look at Sovereign debt? We discussed how Italian Government yields had hit a peak of 7% last year, and currently at 6%, with the threat of implosion now a mere dot in the horizon and a Greek debt deal nearing completion tomorrow evening, can this not equally be a nice coupon trade, while at the same time, a very compelling story to continue to grind in.
My dark horse favourite is Ireland, their response to the sovereign crisis has been the most credible (Michael Lewis's attempt notwithstanding) and the current sovereign/ financial rally is fully justified, given the fact that their medium term debt sustainability is credible. They have been the most active in announcing (and more importantly implementing) austerity measures, their economy remains significantly more competitive to other peripheral (or even main stream) European nations and with 10 year yields around 10%, this will continue to grind tighter based on positive economic growth this year. House price correction remains a concern but there is a lot to like about the Celtic Tigers.
Fundamentally I remain bullish going into the short term, it feels a lot like early 2009 soon after Lehman's collapse when the US announced TARP and other liquidity measures, which led to a furious rally in risk assets. This time, the ECB has reluctantly taken the mantle and while one can argue the systemic risks remain, the liquidity measures announced will once again lead to a sustained (and since this is Europe, I suspect slightly more subdued) rally. Its time to pile into risk.
