Friendly Takeover

By: Michael Ashton | Wed, Dec 7, 2011
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And now, for a couple of days, every wiggle in the market will have something to do with the European summit. Rumors and statements and denials are already flying thick and fast. None of it sounds like it is something that is likely to immediately precede a "Grand Plan" to save Europe.

S&P put the EU on Creditwatch negative. I thought we sorta already knew that was going on when 15 of the 17 Eurozone members were on the watch list, but the EU being broader than the EZ I suppose doesn't make that outcome automatic.

The ECB, said officials who are not part of the ECB but have "knowledge of policy makers' deliberations", is considering new ways to stimulate lending by the effectively-bankrupt institutions they call "banks". Among the methods reportedly being considered is the possibility that the ECB might loosen collateral criteria so they can take junkier junk from the banks for cash. Other brilliant ideas (although probably none so brilliant as this one) are also being tossed about.

There was a report late in the day, shortly before the stock market closed, that the G-20 might get a new $600bln IMF lending problem. There was apparently little thought of where that money might come from, since the IMF was also saying that it "may need more cash resources to help finance a newly created lending facility." It's hard to pony up $600bln when you're looking for the last $120bln. In any event, the IMF promptly denied the rumor that they're readying new money.

The rumors seem more promising than the concrete news relating to Europe. For example, it is the case that Merkel and Sarkozy have called for Eurozone countries to have common corporate tax rates. This sounds like a great idea if they converge on a low rate like Ireland's, but one suspects - since France is known to be annoyed at Ireland's naked ploy to attract business - that the intent is to have tax rates converge higher. That seems like a fertile ground for disagreement. But the bigger issue is that the Big One-and-a-Half (Germany and France) have proposed, essentially, that all Eurozone countries agree to have their fiscal budgets approved by Berlin and Paris. France, which is hardly in a position to make any demands right now, is on the podium mainly because Sarkozy is Merkel's buddy and because if Germany makes this proposal alone it looks like the sovereign equivalent of a "friendly" takeover of one corporation by another.

There are only two pieces of good news there. (1) A continent basically managed by Berlin would have a chance of making things work and becoming another great power, instead of the mish-mash of conflicting interests that mark a decision-by-committee approach. (2) At least it wasn't a proposal for a hostile takeover.

It is early yet but I give the France/Germany proposal about a 5% chance of being accepted by other European nations. I initially wrote "1%" and then I remembered to correct for overconfidence bias. But it's a long shot however you want to call it.

That doesn't mean there won't be warm fuzzies coming out of the summit, although I am skeptical there as well. But I have to say I am absolutely terrified to be short stocks even though (a) they're overvalued by quite a bit unless profit margins have permanently widened and (b) I have trouble thinking of a way out of the European crisis that doesn't end with at least a couple of key defaults or restructurings and/or a long period of sub-par growth. Partly, that's the "don't do anything in December that you can't live with until January" effect, but partly a concern that either the politicians will come up with something seemingly-positive to say along with big smiles, or the market will simply react positively to whatever they have to say.

The fact that I am terrified to be short probably means it is time to do so, but meanwhile I am merely less-long than my neutral position. But I am also still short a small amount of bonds via TBF. Our firm's four-asset model is completely out of stocks and TIPS (with a real yield of -0.05% on the 10y) and therefore overweight cash and commodity indices.



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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