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Nicola Marinellei, portfolio manager, Glendevon King Asset Management

Plenty of dark clouds still around


Nicola Marinelli (pictured), portfolio manager at Glendevon King Asset Management, on the ECB’s decision to cut interest rates, the ongoing difficulties in Greece and potential problems in Italy…

Exactly when the major equity markets were expected to officially enter a bear market, they posted one of the strongest months ever and credit markets followed suit. Then the widely announced and expected European Grand Plan was finally announced with a lot uncertainties and lack of details. Anyway it was well received by the markets, most probably because it was the proof that policy makers had shifted from the denial period to officially understanding the gravity of the situation.
Regarding the plan for Greece, we do not think that a 50% or 60% haircut that does not involve the ECB and other public or supranational authorities is enough to stabilize the debt/GDP path; and by the way the official target is to put it at 120% by 2020 – just remember that the Maastricht criteria is for 60% now!
We fail to understand how a stable long-term solution to excessive debt can be achieved by adding to or swapping the existing stock; and also we fail to understand all the proposed financial-engineering solutions for the EFSF: if it is going to be like a CDO, who buys the big super-senior tranche (estimated at 800+bio euro); if it is going to issue guarantees, given that for example Germany apparently has capped its involvement to around 200 bio euro, who is standing behind those guarantees? In plain English, someone has to foot the bill somehow and we feel that the stronger northern Eurozone countries no longer have the stomach to do this. We said in the past that one of the biggest risk was the social unrest in Greece (it has probably played a huge part in the referendum decision), but also that the political environment in the stronger countries can increasingly oppose further spending for southern Europe.
Now the referendum seems to have been dropped, but can we be sure that it will not become a request from the social parties that have held strikes and protests so far? It would be only natural that the people want to get the opportunity to express their opinion about such important matters, bypassing their untrusted and unloved politicians.
The G20 of Cannes will be very important to try to produce (another) comprehensive solution, but unless it is clear who is going to pay for it and how much, the good mood in the markets will not last long, given that also thanks to the sovereign situation, there are other clouds on the horizon. The only long-term solution is a tighter fiscal and political union: raise the hands those who think it has any chance of happening now or in the next, say, 10 years.
The other clouds that are gathering over us are 1) the increase in defaults (or similar events) of Investment Grade companies (We have noticed that the ECB has made a change in direction, with Draghi sounding more dovish than Trichet; whilst it is a welcome change, given the low inflation environment and no pressure from wages, a cycle of easing is not going to help massively, as we can see from the experiences in US, UK and Japan of course. At least it seems that the ECB can have a slightly more pragmatic approach in the future.
In our opinion now the major problem Europe is facing, the elephant in the room, is Italy. The yield on its government bonds are higher by the week and, more worryingly, its curve has flattened with underperformance of the short-term vs the long-term bonds: it signals a major loss of confidence. This is going on with the ECB buying program in the background and some attempts from the Berlusconi government to patch more fiscal consolidation without great success (the Letter of Intent to Europe and other (recently Dexia and MF Global); 2) there is a recession looming in many countries in Europe and possibly in US too according to recent macro-economic figures; 3) in case of a deep recession and/or other external shock some countries can easily lose their AAA rating (for example France and UK); 4) the yields and spreads on the Italian (and other European countries) government debt have risen to euro-area highs notwithstanding the ECB buying program; 5) the EFSF had to cancel/postpone its 3bio euro 10yr bond (already reduced from 5bio and 15yr maturity), without any sign of Chinese/Qatari/SWFs real interest.
Equity markets have been very bullish in October mostly thanks to the fact that corporate results have not been that bad generally over the quarter (more true in US than in Europe); but how are they going to look if some of the clouds cited above start pouring rain over us? There is also the political risk of early elections. In our opinion Italy cannot be saved if things get out of control, therefore it is the real test for all the markets."

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