Do Androids Shop With Electric Money?

By: Michael Ashton | Tue, Nov 27, 2012
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"Cyber Monday" sounds like something dreamed up by Philip K. Dick for his book "Do Androids Dream of Electric Sheep?" (which later, of course, became the basis for the movie Blade Runner). So, how did it go?

Who cares?

The amount of time, money, and energy spent figuring out how "Black Friday" and "Cyber Monday" is going is all out of proportion to the amount of money actually being made by retailers those days. To be sure, this is an important selling season, and these are some of the most important days in that season. But it's still a small number. Today eBay gained 4.9% and gained 1.6% in a market that was flat-to-lower all day (the S&P ended -0.20%).

Having said that, the frenzy seemed to be less intense than in years past, perhaps because the global economy (and the markets) face very real challenges in the next month, quarter, and year. On Friday, the tiny European nation of Cyprus asked for, and received, a financial bailout, according to government officials there (although denied by the EC). It's good to be small - allegedly, their bailout could be as much as 100% of Cypriot GDP, but that's only about $28bln. According to the story, the bailout includes "unpleasant measures."

Not half as unpleasant, I'll wager, as what would have happened if Cyprus had been forced to leave the Euro. As small as Cyprus is, it's a cinch that no one would let that be the first domino. The first domino will fall when everyone has lost the capacity, or the will, to force the unmatched puzzle pieces to artificially jam together in an apparently cohesive unit. This denouement may still be some time away. As my friend Andy F wrote in his daily (FX markets) commentary today, "German Chancellor Merkel has been very clear that Greece will not fail, regardless of the fact that it already has."

Now tonight, supposedly, we can again temporarily put aside the fears of a Greek exit from the Euro as the IMF and European finance ministers reached a deal on the (revised) terms of the Greek bailout. ECB President Draghi said that the agreement "will certainly reduce the uncertainty and strengthen confidence in Europe and in Greece," and we will doubtless be told that repeatedly over the next few days.

Here is the full text of the Eurogroup statement on Greece, if you are curious, but in the interest of summarizing, I present here just the beginnings of the paragraphs, except for one paragraph worth quoting in full, and you can judge how much important content there is and how much progress was made in this meeting:

The Eurogroup recalls that...

The Eurogroup in particular welcomes...

The Eurogroup noted with satisfaction that...

The Eurogroup again commended the authorities...

The Eurogroup noted that the outlook for the sustainability of Greek government debt has worsened...

The Eurogroup considered that...

The Eurogroup was informed that Greece is considering certain debt reduction measures in the near future, which may involve public debt tender purchases of the various categories of sovereign obligations. If this is the route chosen, no tender or exchange prices are expected to be no higher than those at the close on Friday, 23 November 2012.

The Eurogroup considers that, in recapitalizing Greek banks...

Against this background and after having been reassured of the authorities' resolve to carry the fiscal and structural reform momentum forward and with a positive outcome of the possible debt buy-back operation, the euro area Member States would be prepared to consider the following initiatives:

  • A lowering by 100 bps of the interest rate charged to Greece...
  • A lowering by 10 bps of the guarantee fee costs paid by Greece...
  • An extension of the maturities of the bilateral and EFSF loans by 15 years and a deferral of interest payments of Greece on EFSF loans by 10 years...
  • A commitment by Member States to pass on to Greece's segregated account, an amount equivalent to the income on the SMP portfolio accruing to their national central bank as from budget year 2013.

The Eurogroup stresses, however...

The Eurogroup is confident that...

As was stated by the Eurogroup on 21 February 2012...

The Eurogroup concludes that the necessary elements are now in place for Member States to launch the relevant national procedures required for the approval of the next EFSF disbursement...

The Eurogroup expects to be in a position to formally decide on the disbursement by 13 December...

To my mind, the interesting part was the "Eurogroup was informed that Greece is considering" part, where what Greece is considering is "certain debt reduction measures" in which debt that is trading at, say, 34 cents on the dollar would be paid 34 cents on the dollar. Now, I am no expert on international bond law, but since the last "rescue" deal resulted in Greece taking on more debt, in terms of notional, in exchange for lower current interest rates, it seems like it may eventually dawn on the Greeks that if the Germans and Finns and French really want to keep the Euro inviolate, they might consider actually writing down some of the debt burden.

I have no idea how such a deal would work mechanically, and clearly it would have to be coercive (since if Greece is offering to buy all bonds at $0.35, they clearly will trade a tiny bit above that since there's a chance they may be worth more). But I have long scratched my head about why the Greeks were so keen to stay in the Euro at the cost of extended deflationary economic depression in Greece. Could leaving the Euro really make things dramatically worse? Maybe before, when there was hope that the bailout deal would improve conditions, it was worth a smidge of obsequiousness. But nothing between the first loan request in April 2010 and the bailout/restructuring in February 2012 has had any effect at all on the suffering in Greece (and many people think it has exacerbated it). The chart below (source: Bloomberg) shows the Greek Unemployment Rate.

Greek Unemployment Rate

Moreover, as we recently pointed out in our Quarterly Inflation Outlook to our clients, the effect of having one rigid currency rather than 17 has been that inflation experiences have diverged dramatically rather than, as between nations which freely float a currency, tending to equalize. In the first 10 months of 2012, inflation has risen 0.1% in Germany, 0.8% in the Netherlands, and 0.8% in Finland (collectively representing a third of Euro GDP) while in Italy it has declined 1.2%, it is -1.3% in Portugal and -1.3% in Greece (collectively adding up to a quarter of Euro GDP). Interestingly, in France inflation has fallen -0.4%, as it has begun to migrate PIIGS-ward. The chart below (Source: Eurostat, Bloomberg) shows the acceleration in inflation for these countries (and Austria, -0.1%) versus their 10-year bond yields. The logarithmic function fit to those points shows an R2 of 0.73, which actually gets better if Greece is removed.

European Inflation

Clearly, the weaker countries are being forced into deflation as an alternate leveling mechanism because they cannot float their own currency lower. Why Greece, Portugal, and Italy would want to allow this to happen (rather than leaving the currency union) is beyond us, and if the trend continues then Finland and the Netherlands will be none too pleased as well for the opposite reason.

But for today, we can all pop champagne corks and celebrate the "Grexit has been averted again!" all the while ignoring the fact that the countries themselves have not voted on the "agreement" and Greece is at least tacitly threatening to take matters into its own hands unless the deal is pretty good.

This is not to say that last week's U.S. equity rally had anything, really, to do with optimism about the European circumstances, our own fiscal cliff, or Japan's election. Immediately after our own election, intelligent taxpayers began to try and realize gains in 2012 so that the potentially drastically-higher tax rates to be imposed next year will occur on profits realized from a higher tax basis. But as I noted at the time, that by itself is not a net negative for the market, since sellers will rotate into other names that they consider bargains at lower prices. So, while Apple plunged from $700 in late September to nearly $500 in mid-November, it is back to $589 today as some investors (including some who sold in September and have waited the requisite 30 days) have leapt back in with delight. It has also helped that a number of companies have paid large cash dividends in 2012 to beat the tax hikes, making the index dividend yield look artificially higher (and therefore the market look cheaper) than it really is.

There are other reasons to be skeptical about the medium-term trajectory of the market, of course, and I am not sanguine about the opportunities which the equity market offers at the moment. I think the key thing to keep in mind is that we are on the cusp of December, and "holiday style trading volumes" have been happening earlier and earlier every year it seems. Today's volume was on less than 600mm shares, and fully one-third of that was in the last fifteen minutes of trading. Expect volatility to continue, but don't get married to the price action.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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