Monday 20 June 2011

Very Disappointing Fear Indicator

I was hoping for this fear indicator to come down. But I was wrong. It rose to the highest level since Aug 2010. So far, stock markets haven't fallen by 20 - 25% like it did in May 2010 so I'm expecting another sell down after this week of rebound.

I was hoping that a rebound would come after 6 consecutive weeks of sell down. After all, the Greek situation is almost going to be resolved via a bailout. Lehman's meltdown is still fresh on the minds of regulators. It's either a rollover of the same debt to prevent banks from being hit in their capital, or a wholesale bailout by ECB. ECB has to accept Greek debt as collaterals even if the debts are rolled over otherwise the country will grind to a standstill. Anything less than that will result in French and German banks taking a hit in their capital and becoming insolvent. In the end, ECB will have to bail out the German and French banks otherwise it will be a systemic failure of the banking system again, only this time it is of a much larger magnitude.

For the Greek government, agreeing to a harsh austerity plan will mean more riots on the streets and a deeper recession. There seem to be no light at the end of the tunnel. A bailout will mean kicking the can further down the road. If they decide to default, it will mean no more borrowing from the bond markets. It will mean bankruptcy like Russia in 1998 and Argentina in 2002. They won't be able to borrow again until all debts are settled, or IMF - ECB agree to forgiveness. But forgiveness doesn't come cheap. Greece will have to privatise a lot of national assets to become foreign owned. So remaining in the EU and defaulting on their debt is not palatable either. Damn if they accept the austerity measure, damn if they choose bankruptcy.

Let's explore Greece breaking away from the EU. It will almost certainly mean the meltdown of French - German banks. It will start a contagion that will affect American, Swiss and British banks too. It will be Lehman crisis all over again. It means the Greeks will have to turn back to Drachmas, which will almost certainly crash after reversion. It will mean a default of their current bonds. Nobody will buy Greek bonds in Drachmas. It will mean hyper-inflation and perhaps a Zimbabwe-like hyper-inflation. ECB will count the massive costs because Euro confidence will be hit. Euro will crash.

So the third option will not only kill Greece, but the EU too. It is unpalatable to both.

The best option is to accept a watered-down austerity measure and allow for voluntary roll-over of the same debt. Greece can take a longer time to balance its fiscal books. The world will calm down again. It will happen because collateral damage is far too big to stomach.

But what's causing the fear indicator to rise? I am worried that there are unknown factors. Perhaps the debt ceiling in the US will not be raised, although I am quite sure this won't happen. Perhaps QE2's end will push the US economy over a cliff. This is possible although I find it strange that QE should be such an issue when it didn't even flow into the money supply of the US in the first place. With the end of QE2, interest rates could rise and UST plummets. Unless the bears think a recession will occur and buy up those USTs. Investors should be putting money in equities and commodities because no other sector, not in the least cash will give them higher than inflation returns. The earnings yield gap is still super wide, with PE at 12x, or 8% yield, and 5y UST at around 2.5%, the gap is around 5.5%. It makes far more sense to invest in equities than Treasuries or USTs.

Another possibility is China's bubble has burst and the news hasn't reached us yet. The property bubble could be far worse than expected. I am staying clear for now. This rebound doesn't look sustainable.

I think we could see a sell down soon before we see a strong rebound. I don't think this is the peak but next year could be it.

2.536%

VALUE: 283.000 USD