Personally, I believe that the importance of the AAA rating is way overrated, particularly in the current circumstances.

S&P downgraded 9 Euro Zone countries on Friday 13th, including France – don’t you just love the date/timing – pure drama.

Indeed, Italy, Portugal, Cyprus and Spain were downgraded by 2 notches, with Austria, France, Malta, Slovakia and Slovenia by 1 notch – Cyprus (BB+) is also now in junk territory – so much for those Russians who used Cyprus – they will learn. In addition, S&P suggests that, in the event of a default, investors in Portuguese and/or Cyprus debt would recover between 30% – 50% of their assets, at the most.

The ratings agency reiterated its rating on Belgium, Estonia, Finland, Germany, Luxembourg, Ireland and Holland. All 16 countries have been removed from CreditWatch, suggesting that there will be no further downgrades in the near term. However, 14 of the countries (ex Germany and Slovakia, who regain their stable outlook rating), remain on negative outlook, which imply a 1 in 3 chance that their rating will be lowered in 2012/2013. Basically, of the Euro Zone, only Finland, Luxembourg, Holland and Germany have retained their AAA rating.

S&P stated that the “rating actions are primarily driven by our assessment that the policy initiatives that have been taken by the European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the Euro Zone”.

Greece’s credit rating is CC – forget Greece – I will be amazed if investors recover even 25% of par.

The downgrades were widely expected and were leaked during market hours on Friday. In addition, it is actually not as bad as it could have been – there was a risk of Holland and, more importantly, Germany would be downgraded, with France’s rating being cut by 2 notches. The markets took the news in its stride. Sure, there is likely to be some selling first thing on Monday, but I’m not sure that it will be widespread and/or prolonged.

LCH Clearnet raised the margin requirement on trading on (3.25 – 30 year) Italian debt FYI.

However, the more important issue is the (certain) ratings downgrade to the EFSF/ESM, now that there are only 4 remaining Euro Zone AAA countries and with the 2nd most important Euro Zone country (France) having lost its AAA rating. Oops. Monsieur Sarkozy start getting real.

Personally, I believe this could be the final nail in the coffin for Greece. Negotiations between Greece and its creditors collapsed on Friday – there is a serious chance that Greece will have to have to default and indeed, exit the Euro. Contagion issues then arise. However, the ECB’s 3 year LTRO has helped enormously (particularly in respect of yields on shorter Euro Zone dated debt) and, as you know, I expect the ECB to introduce QE in the 2nd Q – possibly even in the 1st Q. In addition, the question is – will the Euro Zone be better without Greece – personally, I seriously believe it.

A recent watering down of the “fiscal compact” (supported by Germany, who wants more flexibility !!! – this really represents double standards by Germany, yet again – Germany FYI has not met its Maastrict treaty commitments for the majority of the time, I would add) has not helped the case for the ECB introducing QE, but I remain convinced that its inevitable – I suppose the ECB could demand that countries stick to pre agreed fiscal targets, in return for them buying the relevant countries bonds.

With the Sovereigns downgraded, a number of Euro Zone banks are next. Having said that, I reiterate, I remain bullish the European financial sector – particularly for those who do not need to raise equity capital – given the ECB’s 3 year LTRO programme. Yes, I know you think I’m crazy, but……….;

Just imagine what would have happened if the ECB had not introduced its 3 year unlimited LTRO programme. Bloomberg reports that US money market funds reduced their lending to French banks by 97% (yes that’s 97% – no typo) in 2011. US, Japanese and Swiss banks have benefited from this shift. However, I repeat, the ECB’s UNLIMITED 3 year LTRO is a game changer. There is NO LIQUIDITY issue facing (virtually all) European banks – even INSOLVENT BANKS COULD WELL SURVIVE. By the way, French banks increased their use of ECB funding by 62% in the 4th QW 2011, according to the Banque de France.

In addition, the ECB policy is effective QE, by the back door, as banks (in particular those in trouble) play the short term (less than 3 year) carry trade – the really bust banks will play the longer term carry trade;

The Euro traded closed at US$1.2676, well below the E1.30+ in December 2011, but even this rate is questionable. My forecast of sub E1.20 looks good and getting better by the day.

The 2012 game is beginning – fortunately, as I expected. However, let me just add that 2012 is going to be a particularly difficult year to forecast – I will respond accordingly.

VOLATILITY WILL RULE.

The great news (or in your case, unfortunate news) is that my Internet problems, here in Goa, seem to be sorted out. Will need a few days to get back up to date though.

Have a great weekend. I am.

Today, I have no idea what their business model is.

Despite having missed 2011′s declining earnings per share for the biggest U.S. banks, they are forecasting an even bigger profit surge for 2012, according to Bloomberg:

“The six largest lenders, including JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC) and Goldman Sachs Group Inc. (GS), may post an average profit increase of 57 percent this year, according to 184 analysts’ estimates compiled by Bloomberg. A year ago, analysts predicted profit at the banks would climb 32 percent in 2011. Instead, earnings per share probably fell 18 percent as the economic recovery analysts counted on never took hold.

Improved trading results, more investment-banking deals, expense-cutting measures and lower credit costs will lead to the increase in earnings that didn’t materialize last year, analysts say. That may provide a boost to stock prices after financials were the worst-performing industry in the U.S. in 2011.”

Exactly how does one forecast improved trading results? “I really feel these guys are not only going to have a better trading environment in 2012, but they are going to get better insight, cleaner executions and be a whole lot luckier than they were in 2011” said no one at all.

Its not just the Bank Analysts who stunk up the joint. Wall Street Market Strategists did not do much better, as this WSJ graphic shows:

The takeaway is you better have your own approach for investing and trading, rather than relying on 3rd party guesses . . .

>
Sources:
Bank Earnings Jump 57% in Analyst Forecasts
Michael J. Moore and Dawn Kopecki
Bloomberg, Jan 3, 2012  
http://www.bloomberg.com/news/2012-01-04/bank-earnings-increase-57-in-analyst-forecasts-which-proved-wrong-in-2011.html

Street Wary on Its Random Walk
Strategists, on Average, See 6.1% Rise in S&P 500 for 2012 as Worries Abound on Europe, Earnings
STEVEN RUSSOLILLO
WSJ, JANUARY 4, 2012
http://online.wsj.com/article/SB10001424052970204368104577139023088982182.html

Well, you heard it first from Sarkozy – basically he is trying to defuse the impact of the impending French ratings downgrade, likely imminently. Remember that S&P suggested a possible 2 notch downgrade for France. A downgrade is considered a near terminal event for Sarkozy’s Presidential reelection hopes. The current favourite to replace Sarkozy is Francois Hollande, leader of the French Socialist Party, who may add a further complication to the recent Euro Zone “fiscal  compact”.

Other euro Zone countries will be downgraded, including Germany, if S&P carries out their threat Fitch joined S&P and Moody’s in threatening a downgrade for a number of Euro Zone countries, warning of a “significant economic downturn” in the region;

It looks as if Commerzbank needs a 2nd state bail out since 2008, according to German political sources, though Government officials have denied the story – the EBA suggests that Commerzbank will need E5bn. The EBA has ordered European banks to raise E115bn by June next year which, whilst not enough, will still prove to be a struggle. European banks continue to reduce leverage – current estimates suggest that the need to reduce their balance sheets by at least E2tr;

Moody’s have downgraded 8 Spanish banks, citing the weakening economy and the bad debts remaining with Spanish banks. MS suggest that, on a mark to market basis, loan losses (particularly property loans) will require an additional E100bn+ of capital for Spanish banks, as opposed to the EBA’s requirement of E26bn. The new Spanish PM proposes a bad bank solution – well great, but where’s the money coming from;

Given that Euro Zone banks hold between 20% – 30% of their assets in Government bonds, compared with 7% – 8% for US/UK banks (source MS), I cant see European banks buying further Euro Zone bonds – bad news given the significant Euro Zone Sovereign financing requirements, particularly in the 1st/2nd Q 2012.

With almost certain credit downgrades, the future for the EFSF/ESM looks bleak – bad news for bank recaps from that source, though the recent move by the ECB to offer 3 year loans in unlimited amounts will help roll over the maturing debt of EU banks;

With so many Euro Zone countries likely to lose their AAA rating, AA may well be the future AAA equivalent – the market will have discounted much of the likely downgrades though;

The Head of the Bundesbank, Mr Weidmann, has repeated his opposition to ECB purchases of peripheral Euro Zone bonds. He remarked that it was Euro Zone county’s responsibility to resolve the crisis, rather than the ECB. However, the incoming French representative hinted very strongly indeed (at the EU Parliament) that he will be in favour of monetary easing, including more aggressive bond buying. The German’s will be outvoted.
The ECB bought just E600mn of peripheral bonds last week, well below
market estimates. Traders report that the ECB is buying Italian bonds
today.
Fitch repeated that ECB bond buying and/or financing the EFSF/ESM is
the only solution – clearly right in my view and, I continue to
believe, the inevitable ultimate conclusion of this debate.
A number of analysts suggest that this saga will go on for a further
year – I do not. Personally, the Euro/Euro Zone wont survive for
another 3/6 months let alone a year if it carries on as is, suggesting
that the Euro Zone politicians/ECB will have to rethink.
Italian bond yields rose to near 7.0% yesterday;

Swiss authorities cut 2012 GDP forecasts to +0.5%, from +0.9%
previously and +1.8% for 2011. The higher Swissy and weaker demand
from the EU are the main issues. Deflation is also forecast for next
year – the estimate is -0.3%, as opposed to +0.3% previously;
French November harmonised CPI was +0.3% MoM or +2.7% YoY;

Inflation is expected to fall sharply next year – to around 3.0% by
the end of the 1st Q/ beginning of the 2nd Q. Around that time, the
BoE is very likely to increase its QE programme – current forecasts
suggest a further £125bn, increasing the aggregate size to £400bn.
UK November CPI came in at +0.2% MoM or +4.8% YoY, basically in line
with expectations;

Summary

European markets closed at their lows yesterday, though US markets
were off their lows. The Euro continues to decline as does Gold.
Interestingly, the VIX closed well off its highs yesterday.
European markets are marginally higher at present, but cant see any
reason to go long.

“The function of a ratings agency is to visit the field at the end of the battle and shoot the wounded.”

-John Heimann, Spring 1998
(former U.S. Comptroller of the Currency and later vice chairman of Merrill Lynch and chairman of the Financial Stability Forum)

Sourced from Brookings

Old joke about Analysts:

You do not need them in a Bull market, and you do not want them in a Bear market.

>

I was thinking about that in light of the S&P’s mass EU downgrade threat.

As always, the Credit Rating Agencies are quite late to the party. And consider that the European Central Bank, whose balance sheets are festooned with bonds from all of these countries, is somehow still AAA.

My bottom line about the rating agencies is they are worthless to investors.

Consider how the market actually reacts to these outlook and ratings downgrades. As an example, think about the downgrade of US debt from AAA to AA+, as the chart below reveals:

>

Spot the Down Grade!

click for larger graphic

Source: Stockcharts

>

As a reminder, the S&P downgrade was August 5th; US Treasuries have actually rallied since, then, sending rates appreciably lower, and making US borrowing costs less expensive. (Thank you sir, may I have another?)

Equity markets wobbled for a few months, then resumed what they were doing previously (going sideways).  Last I checked, the Euro was practically flat year to date.

Given the various downgrades, they seem to make a lot more heat than light. They do not seem to matter as much as we think to the markets they are actually rating — namely, debt. Its somewhat ironic that a downgrade of debt seems to have more impact in the equity markets.

Which leads us to telling question: Do the ratings agencies matter anymore? Have investors figured out that they are corrupted, conflicted, unable to honestly discharge their duties?

Or is it simply that they suck at what they do? Recall the downgrades of Enron, Worldcom, Lehman, AIG, and many others. It seems the markets force them to act, that Traders are issuing the call long before the analysts at Moody’s or S&P actually  downgrade a corporate or sovereign ratings.

We may not need the judgment of honest analysts in a bull market, or want them in a bear market, but it seems the answer to our headline question: When it comes to the ratings agencies themselves, investors seem to have little if any use for them anytime.

Source:
Over Rated,
Bloomberg Businessweek,
Nov/Dec 2011

Apparently, there is no such corresponding code of honor amongst commodity trading firms.

I refer of course to the debacle that is MF Global. How on earth could $633 million in customer accounts simply disappear?

As it turns out, quite legally.

The regulations governing these customer accounts are 25 plus years old, according to a few insiders I spoke with. They gave the firms an ability to hypothecate (lend) client money, so long as it was only used to legally purchase investment grade sovereign debt.

So that was what MF Global did.

As originally conceived, client monies were only supposed to purchase US Treasuries. However, so as to not offend trading partners (and other reasons), the regs were written so as to include any “investment grade sovereign” in the rules. Hence, AA rated European sovereign debt, despite the obvious fact that in 2011 they are obviously not the equivalent of US Treasuries, technically qualify. Whether this violates the obvious spirit and intent of the law will be for a judge to decide.

Of course, this raises another question: If the corrupt and compromised rating agencies had actually done their jobs — downgrade European junk to what it really was — would MF Global been able to empty client accounts? I suspect not.

Regardless, consider the Con Man’s Lament: The past half century of boiler rooms, accounting scandals, pump & dumps, backdated options, corrupted analysts, IPO spinning, derivative debacles, etc., have all come about for this simple reason: Brokerage firms cannot simply reach into client accounts and take the money for firm use.

This wasn’t a face-in-hand moment — Hey, why didn’t we think of that? — amongst equity criminals. Rather, it was a well understood rule that was enforced without question. “Borrow” money from a client account without their knowledge, go to jail for grand theft.

Consider:

• If the weasels at Stratton Oakmont or any other ’90s boiler room thought they could merely empty client accounts, they would have. Instead, they had to concoct enormous Pump & Dump schemes to dupe willing rubes out of the money.

• If Merrill Lynch could have merely grabbed billions from Orange County, rather than create an elaborate derivatives scheme that ultimately bankrupted the county, don’t you think they would have done that?

• Instead of the IPO spinning to capture assets and revenues that most of the major bulge bracket firms did int he boom times of the late 90s, wouldn’t it have been easier to merely leverage up client accounts?  Heads we win, tails you lose?

• Would any of the major accounting firms had to do such absurd audits of firms like WorldCom or Tyco? They worked hand in hand with Wall Street to help capture money. (But steal? Never!)

• Consider the side pockets developed by Enron with the help of McKinsey & Co. If there was a way to simply take client money, why would anyone bother going through all that trouble?

• Even the convoluted Lehman’s Repo 105 was a way to hide $50 billion per quarter from investigators and regulators. Had they been able to tap client monies, who knows how their saga might have ended.

Now, that may not sound like much, but it is worth considering. Neccessity being the mother of invention forced the very worst enterprises on the equity side to engage in all manner of deception and duplicity by morally compromised, ethically challenged bad actors. They had to do this, because they could not merely grab monies from client accounts.

It was a point of pride amongst equity con men that they did not merely steal. They cajoled, wheedled, scammed, and cheated, but they never stole.

Hey, what kind of people do you think we are?

Moody’s threatens to downgrade ALL Euro zone countries – hey, that includes Germany does it not. Off course it does. I really wonder what officials in the German Finance Ministry think of that – a bit of a shock – well, possibly stronger emotions than that, I suspect. However, why the surprise – in my view Moody’s is just reflecting the reality of the situation.

French newspaper reports (La Tribune) suggest that S&P may downgrade the country’s outlook to negative in the next few weeks – personally, I do not believe that France will be able to maintain it’s AAA rating, so no surprise. French unemployment rose to the highest since December 2009. Looks increasingly as if Sarkozy is “French toast” in next years Presidential elections – no great loss, but the likely winner (a socialist) – who knows what he will be up to. Basically, more
uncertainty – just hope (likely) that the euro zone issues will be sorted out before that – making it more difficult for the potential Socialist candidate to complicate the process.

The far more important point is that Germany is finally recognising that it is not financially immune. The other big issue is whether Germany comes up with a credible solution re the Euro Zone and, by default (maybe not the right word to use, given the current situation) for themselves.

I am in Goa, India at present and last night had dinner with 2
delightful people with strong German connections. I was, in
particular, impressed by their honesty, openness and desire to find a
solution. The even better news is that a mutual friend has been
promoted – good news – must travel to Berlin. Congrats Mr M. Whilst
the Internet/electricity does not work in Goa, it’s quite amazing what
you pick up over here.

By the way, don’t mention the Greeks – it’s as I suspected, including
the passion in the statements, when explaining the German point of
view – I suspect that is a view held by many of us.

Whilst we are on the subject of the peripherals. Andy Lees of UBS (one
of the best analysts around) reported that Italians were the richest
(individually), certainly in Europe(probably excluding
Luxembourg/Monaco). It’s the Government, that is indebted – though I
will continue to maintain that Italy has bumbled along with that level
of debt for decades, a large part of their economy (GDP) is, how shall
I put it, unrecognised (grey economy), the country has a primary
surplus, and likely to have a budget surplus before other Euro Zone
countries. Indeed, I have added to my 10 year Italian bonds.

Mrs M is apparently not too far off from my assessment of her, though
has a sense of humour. Personally, I was told that – based on an
amusing joke that Merkel shared with Cameron. Actually it was quite
funny. However, I suspect that my observation that she may need more
“clued up advisers” – well it did not go amiss – my interpretation
though.

Had power cuts/ no Internet 4 times before 1.30pm local time (UK
Market opening – so important for me) yesterday. How can India develop
with such poor systems/infrastructure. The frightening issue, is that
no one objects – it’s par for the course they say. Indeed, it’s
likely to get worse, given that India is not allowing utilities to
raise tariffs, even though coal prices have soared. Same issue in
China – it’s the old game of trying to keep down inflation/avoid
politically unpopular utility price increases.

Heard that Germany is to propose more details re the EFSF by end
December – whoops – how do you make a “dead duck” fly? Well
politicians are hot air specialists, but even that’s not good enough.
I’m now nervous, though need to check on market expectations. As far
as I’m concerned, the Dutch Finance Minister said it all – basically,
it close to a waste of time – my non diplomatic interpretation of his
comments.

Rumours of a downgrade to France’s outlook will also weigh on the EFSF.

Schaeuble apparently stated that the Euro Zone would pursue an
alternative path (with the IMF), also suggesting the “dead duck” EFSF
scenario. I really hope that I am wrong, but……..

The ECB announced yesterday that it had bought E8.5th of Italian and
Spanish bonds (most likely), still far too low. However, in total the
ECB has bought E203.5th – a huge amount, but totally ineffective,
given the tepid and spasmodic buying. Bond yields of the PIIGS remain
at near record levels. However, they are the ECB – what else can you
expect.

OK so a decent Market rally yesterday – not unexpected given that
markets were grossly oversold. Too much in one day – likely. However,
in spite of all the silly rumours of massive financing by the IMF for
Italy – total rubbish. – E600 bn is way beyond the IMF’s resources – I
believe the Market is getting the sense that there will be some
positive movement within the Euro Zone – personally, so do I.

US markets closed slightly off their highs – profit taking, but
nothing serious. Asian markets have continued to perform today, in
spite of lower Australian GDP forecasts(likely to be reduced further)
and weaker employment in Japan. Likely modest positive follow through
in Europe.

Importantly, the Euro is picking up – good for markets, though still
around US1.3365 – though drifting at present – blast.

US economic data was marginally better -Chicago Fed, though Fitch
downgraded the US outlook to negative (still AAA though). Lack of a
policy to reduce debt (US15tr) was the reason cited – no great
surprise. I really wonder what would happen to the US dollar, if it
were not the sole global reserve currency. I suspect we all know.

I understand from a brief report, that Stephen Roach, a passionate fan
of China, in spite of being a serial bear, is becoming more cautious
on China – need to read his comments. Anyone got them – please forward
if you do. In my view, Mr Roach is one of the most clued up people on
China ( with clearly excellent high level connections), even though I
have disagreed with him. His views MUST be taken into account

Can the rally last – key question.

The answer I suspect, (ex other issues), is whether by and/or at the
9th Dec EU Summit, the Euro Zone (Germany and, i suppose, France, for
the time being) can finally come up with a credible plan.

Sorry, but not enough info yet, but, I’m still leaning towards giving
the guys the benefit of doubt. Today’s Euro Zone Finance Minister’
meeting will shed some light and an Italian bond auction will be
closely watched.

Extraordinary statement for me, but I feel that Euro Zone politicians
(in particular, Germans) have understood that they need to deliver
and, in addition, have a greater sense of urgency.

The real problem is that I’m unsure (do you blame me) as to whether
they are financially clued up enough.

However, I will, as usual, stick my neck out and suggest that it will
be better than current very low expectations and therefore positive -
I just hope that expectations do not rise.

Still believe in the views re the Euro Zone expressed in my last note,
even though there are a number of sceptics amongst you.

Crossing my fingers that the electricity/ Internet continues to work -
unlikely to do me any good though.