Up Or Down?

After weeks of positive sentiment across all equity markets, Friday saw a pullback. Let's be fair, you cannot be all running at the same time and see no pullback. But its interesting to see what the media and experts say were the reasons for the pullback.



a) China was making news all week, and on Friday the Shanghai Composite rattled world markets with a sudden 5% drop on inflation fears and the threat of tightening by the government. Is this a surprise? Of course not. What is more important is sentiment is still good and the pullback is just a breather. When you run for sometime, you have to pullback even if there were no bad news.

b) US municipal bonds took a huge hit and could be flashing danger signals for further problems to come. Muni prices have plunged as concerns about municipal debt and default continue to grow. So far this has been a back burner issue as everyone has assumed that the Federal government would bail out the states and municipalities, but with QE2 and a new House of Representatives in town, confidence in this outcome seems to be on the wane. So when did the rest of the markets really care about US housekeeping issues?



c) U.S. policy makers had a bad time at the G-20 meeting and while they were getting beaten up there for QE2 and devaluing the dollarIn Seoul, President Obama failed to get a much ballyhooed trade agreement with Korea, and the U.S. delegation took heat from countries like China, Brazil and Germany for devaluing the dollar at their expense. Later in the week, the Chinese again expressed their displeasure with current affairs as Commerce Minister Chen Deming said they didn’t support quantitative easing and espoused on the risks of growing more global bubbles. These are policy concerns, not liquidity driven issues.

d) While investor sentiment remains at extreme bullish levels. However in the U.S., insiders didn’t share the same optimism and set records for selling at a 12-1 ratio, perhaps sensing an interim stock market top. This is a concern.

e) In reality, US data has turned slightly more upbeat, reflected in higher US yields.



f) As the USD recovered, commodity markets have fallen back to earth with a thud, causing some to say the commodity bubble has burst, that's bull. A weaker USD caused a rally in commodity price, a slight rebound in USD would do the same in reverse, and since when we have a commodity bubble???

g) Debt worries are widespread in the Euro zone, the market is currently fixated on the Irish situation. Rumors are currently circulating that EU talks are underway that will lead to a financial rescue plan for Ireland as early as next week. Ireland’s Finance Ministry stated it had made no application for emergency funding from the EU and the European Commission said it has not received an aid request from Ireland. They are going through the motions. The Ireland issue is much smaller than the Greek's crisis, and the ECB have to do likewise and bail them, so what.

Being bombarded by various news and opinions can make one confused on market direction. Like I said before, all markets are running for quite some time, they have to pause even if there were no bad news. What's irksome is the business channels and media have to write "something" to explain the markets' pullback. As you can see, there are a plethora of reasons if you want a reason to sell.

I do not see any of the given reasons as anything new, we all know that. What is real is we are in for a low interest rate environment. The USD is moving down on QE2 and rebounding every now and then but the downtrend is there, which will move commodity prices higher and support US equity prices as well.

Elsewhere in emerging markets we are on a tear, or rather just starting. Its not a long drawn correction, its a blip. Thing should move up this week.

This Irish Joke Is not So Funny

Ireland's finance minister is shocked to discover that Irish banks actually need $43bn in new capital. As mentioned in my talk, the Greece situation is just one of many, its now the turn of the PIIGS - Portugal, Ireland, Italy, Greece and Spain. No matter how you look at it, Italy and Spain are really too big to fail - if things start turning bad there, help will be swift, so those two countries are not a big issue. Now its Ireland's turn. $43bn is very big to Ireland. Ireland’s banks need $43 billion in new capital after “appalling” lending decisions left the country’s financial system on the brink of collapse.



“Our worst fears have been surpassed,” Finance Minister Brian Lenihan said in the parliament in Dublin yesterday. “Irish banking made appalling lending decisions that will cost the taxpayer dearly for years to come.”

The Irish government, which has already nationalised one bank, Anglo Irish, is now widely expected to end up as the majority owner of every big bank in the country, except Bank of Ireland. Can you imagine the Malaysian government having to bailout half of the banks in Malaysia and ending up owning majority stakes in them, that's pretty bad.

Even Bank of Ireland, which must raise €2.66bn as part of the regulator’s capital demands, is expected to end up with the government as a near-40 per cent shareholder, compared with 16 per cent today.

The agency aims to cleanse banks of toxic loans, the legacy of plunging real-estate prices and the country’s deepest ever recession. In all, it will buy loans with a book value of 80 billion euros ($107 billion), about half the size of the economy.



The information that has emerged from the banks in the course of the NAMA process is truly shocking. The black hole, equivalent to about 20 per cent of gross domestic product, is far bigger than expected. It emerged after the country’s new bad bank, the National Asset Management Agency, announced the acquisition of €16bn ($21.5bn) of mostly real estate loans, setting it on the road to become Ireland’s biggest property owner. But NAMA paid only €8.5bn for the loans, applying a bigger discount than expected – a reflection of their poor quality.

The regulator’s capital shortfall calculation is based on a requirement that banks increase their capital ratios – to 7 per cent for tier one equity, and 8 per cent for core tier one by the end of the year – as Ireland seeks to insulate its banks from the impact of ongoing loan losses.

Dublin-based Allied Irish needs to raise 7.4 billion euros to meet the capital targets, while cross-town rival Bank of Ireland will need 2.66 billion euros. Anglo Irish Bank Corp., nationalized last year, may need as much 18.3 billion euros. Customer-owned lenders Irish Nationwide and EBS will need 2.6 billion euros and 875 million euros, respectively.

“The regulator is taking the bank system by the scruff of the neck,” said James Forbes, senior equity strategist at Irish Life Investment Managers in Dublin. “Allied Irish has a lot of work to do to avoid majority state ownership, Bank of Ireland less so.

Ireland may not be able to afford to pump more money into the banks. The budget deficit widened to 11.7 percent of gross domestic product last year, almost four times the European Union limit, and the government spent the past year trying to convince investors the state is in control of its finances.

“The bank losses, awful as they are, represent a one-off hit. It’s water under the bridge,” said Ciaran O’Hagan, a Paris-based fixed-income strategist at Societe Generale SA. “What’s of more concern for investors in government bonds is the budget deficit. Slashing the chronic overspending and raising taxation by the Irish state is vital.”

The bank plan is the latest building block in the stabilisation of the Ireland's economy, which has suffered the most severe contraction of any industrialised country: gross domestic product shrank by a cumulative 12 per cent in the three years to 2009. The announcement came as the government announced landmark deal with trade unions, under which future pay rises for the 350,000 public sector workers will be contingent on equivalent savings from the improved delivery of public services.

After a fiscal tightening equivalent to 6 per cent of GDP since 2008, the government is still targeting €2bn of cuts in both 2011 and 2012 and a further cut of €2.5bn in the following two years to bring the deficit back to below the European Union target of 3 per cent of GDP by 2014.