Posts filed under “Derivatives”

CDS, Market Turmoil, Asset Allocation

CDS, Market Turmoil, Asset Allocation
David R. Kotok
November 12, 2011


Let us consider this week’s credit default swap (CDS) debacle in the following manner. People purchased CDS with the understanding that they had a type of insurance policy against the default of a sovereign debtor. Now they have learned that what they thought they had is something they do not have. The European Greek debt deal and the International Swaps and Derivatives Association, (ISDA) have clarified that.

What do they do? They must realign their positions. First, they have to face the reality that they were misinformed or misadvised. They must accept that their position has changed. Second, they must take action.

The spike in yields on sovereign debt of Italy was attributable, only in part, to the Italian political turmoil we are witnessing. The other aspect dealt with CDS on Italian debt. Those holders thought they had one type of CDS protection. They realized from the events in Greece that they had something else.

This is true of other sovereign CDS as well, and this change has roiled the markets. Interest rates have risen as bond prices have fallen. The cost of finance for Italy has gone up to levels that are deemed unsustainable. This is what one would expect with CDS realignment.

Does that mean the world is ending? No. In fact, there is a considerable possibility that the current stock market rally has the outlook correctly discounted, after this turmoil runs its course. If you examine Italy’s budgetary characteristics, you realize the country is headed for a primary surplus in 2013. “Primary surplus means after you deduct interest payments.”

Will Italy be able to complete the plan? Will they be able to implement it? What is going to happen? What about other exogenous shocks? All these questions are fair and they are additive to the uncertainty premium.

Italy may have a difficult issue when it attempts to roll its present debt, and that debt roll of maturities is coming up very quickly. However, with the help of the European Central Bank (ECB) Italy is likely to have some market access and be able to roll that debt on the heels of budgetary action

How will it roll? What will the yields be? These and more questions await answers.

Another crunch is coming up on for the debt roll of Greece. That is why the referendum threat dates were December 4 and December 11: the second half of December is when Greece must roll billions of euro-denominated debt. The authorities in Europe know they need sufficient structure in place so that this debt can roll without market access by Greece. Greece has been shut out of market access. The market believes it is an insolvent sovereign. In addition, there are the continuing operational demands for cash by the Greek government. This money will be provided with institutional lending, through one of the forms we presently see discussed.

Does this mix of European debt roll condemn the US to a recession? We think not.

The United States is not in recession. It is in a very slow-growth environment. Uncertainties are very high and uncertainty premiums are large, but decisions about US portfolios are based upon whether you are betting on recession, or slow growth.

If it is slow growth, stocks are inexpensive and markets are headed higher. That is the position of Cumberland Advisors. If a double-dip recession is coming, then stocks are headed lower and you should not own them.

The course of action to take in global portfolios is a different matter. In our global multi-asset class, we have taken our precious metal positions to 6% of the total deployment. That is very, very high and it is a considerable overweight for us. Precious metals are a tiny weight in global asset allocation under normal circumstances. We use several ETFs to reach that position, and they reflect an amalgamation of precious metal exposure.

We have this precious metal weight very high because, we are able to see a monetary policy transmission effect that reaches into precious metals. That supports our view that precious metals are likely to be priced higher in US dollar terms in the future. There is a considerable time lag between central bank actions and monetary effects and resultant higher precious metal prices; we measure that somewhere between nine and eighteen months.

We do not find the same relationship with commodities. Commodities are driven by other extensive factors in addition to liquidity flows from the creation of credit. Central bank balance sheet expansion has a weak link to commodities in this current environment, where central banks are attempting to provide as much liquidity as possible to avoid systemic meltdown.

When it comes to global stock markets, our international positions in Europe are far below the 24% weight that Europe holds in the benchmark index. Our exposure is limited to Germany, France, the Netherlands, and a broader-based international ETF. For Europe as a whole, we are very much underweight. In our international models, that weight is 11%, with all of it in Northern Europe.

In our global multi-asset class, we have only 3% exposure to the Eurozone stock markets. So clearly, we have a bias against Europe and in favor of other locations around the world, as well as other asset classes. In our global multi-asset class, we have 6%, or twice the exposure, in precious metals than we do in the stock markets of the Eurozone. That is a remarkable statement to make. It reflects the high degree of uncertainty given the times we are experiencing.


David R. Kotok, Chairman and Chief Investment Officer

Category: Bailouts, Derivatives, Think Tank

Can Litigation Bring Down Wall Street?

Click to watch video:

Can litigation bring down Wall Street?
FT. com

Category: Derivatives, Legal, Video

Ex-Product Sketch

The following is from Macro Man, an American fund manager living abroad: ~~~ As we approach month-end, after what has been one of the most eventful months of TMM’s careers, we thought we’d expand upon our somewhat mischievous obituary yesterday. In all seriousness, TMM have argued for some time that the Sovereign CDS market is…Read More

Category: Derivatives, Think Tank

Today’s WTF Video: AIG Debuts Reputation Insurance

Category: Bailouts, Derivatives, Video

Not with a Bang, but a Whimper: BofA’s Death Rattle

Not with a Bang, but a Whimper: Bank of America’s Death Rattle By William K. Black Wednesday, October 19, 2011 ~~~ Bob Ivry, Hugh Son and Christine Harper have written an article that needs to be read by everyone interested in the financial crisis. The article (available here) is entitled: BofA Said to Split Regulators…Read More

Category: Derivatives, Federal Reserve, Regulation, Think Tank

Fed & BofA Dump Billions in Losses onto Taxpayers

Posted on October 18, 2011 by WashingtonsBlog The Federal Reserve and Bank of America Initiate a Coup to Dump Billions of Dollars of Losses on the American Taxpayer Bloomberg reports that Bank of America is dumping derivatives onto a subsidiary which is insured by the government – i.e. taxpayers. Yves Smith notes: If you have…Read More

Category: Bailouts, Derivatives, Federal Reserve, Think Tank

Derivative Concentration Threaten Global Economy

Derivatives Ownership Even More Concentrated Than Ever As I noted in 2009, 5 banks held 80% of America’s derivatives risk. Since then, the percent of derivatives held by the top 5 banks has only increased. As Tyler Durden notes: The latest quarterly report from the Office Of the Currency Comptroller is out [shows] that the…Read More

Category: Derivatives

Meltdown: Secret History of the Global Financial Collapse

I haven’t seen this yet, but some people have call this a “great documentary” that explains the FINANCIAL MELTDOWN.

Part I

Parts II, III and IV after the jump

Read More

Category: Bailouts, Derivatives, Video

Spiegel: The Destructive Power of the Financial Markets

Nasty article in Der Spiegel, Out of Control: The Destructive Power of the Financial Markets, which helps explain what’s behind the financial transactions tax that was recently introduced by Angela Merkel  and Nicolas Sarkozy.  The article opens, The enemy looks friendly and unpretentious. With his scuffed shoes and thinning gray hair, John Taylor resembles an…Read More

Category: Bailouts, Derivatives, Regulation, Trading

Bank of America Credit Spread: FUGLY

This is pretty damned FUGLY: Click for larger graphic > click for larger chart Mark Gongloff explains the pain: “In the credit-default swap market, spreads are wider across the board, meaning people are paying up for protection. The Markit investment-grade corporate debt index is 3 basis points wider. The index of European sovereign debt is…Read More

Category: Bailouts, Credit, Derivatives