2008 Redux

Research for Online Investors

by John Dalt

9/13/11

The market rallied yesterday in the last hour when the Financial Times reported Italy was in negotiations with China to buy sovereign debt.  One of my seeming insurmountable problems as an investor is to get past being a contrarian.  How was this interesting piece of news to be believed when it was 9 p.m. in Rome and past midnight in Beijing?

Were the negotiators having a toast to the deal they had put together?  Somehow I doubt it.  It looks awfully suspicious when market changing news comes out just in time to reverse our market while others are asleep!

The reason Italy is so important is the size of their debt.  Italy must refinance 192 billion euro in debt this year.  Then they have another 168 maturing next year followed by 100 billion euro in 2013.  Italy continues to run a 3.9% budget deficit, so they have to borrow more than their refunding amounts to keep the bills paid.

The European Financial Stability Fund (EFSF) is presently capped at 440,000 euros but cannot loan this full amount to countries in crisis as they must maintain a cash cushion.  The EFSF has already been tapped by Greece, Ireland and Portugal.  The first 110 billion euro bailout to Greece is not counted against the EFSF as it was not established until a few months after the first Greek rescue in 2010.

As interest rates climb on Greek and Italian debt the banks that hold these country’s bonds are under a cloud of suspicion by investors.  These banks are set to take a haircut if there is a default.  The same economic rules apply today as did in 2008.  When a bank leverages their balance sheet with debt that goes bad, equity quickly disappears.  Bankers in Europe are looking at each other’s credit risk with Greece and Italy teetering.

The EURIBOR (Euro Interbank Offered Rate) has been climbing.

This is like the LIBOR (London Interbank Overnight Rate) that we are familiar with.  In 2008 the LIBOR climbed and eventually froze up the credit markets as banks were afraid to loan money to each other because of the risk of default.

There is no “FDIC” type insurance on loans between banks.  If you send a few million dollars or euros out to make a paltry return and the other bank closes tomorrow morning, your bank just took a hit to equity.

We told you yesterday that credit default swaps (CDS) on Greek debt were priced at a 92% probability of a default in the next five years.  European banks are choosing to do business with the U.S. Federal Reserve for safety reasons rather than with other eurozone member banks.

Deposits by foreign banks have spiked higher in the last few months than during the credit crisis of 2008!

We are in a Twilight Zone right now.  A virtual merry-go-round of financial headlines!  The memory of 2008 has traders, bankers and investors on edge.  If you substitute bank names like Lehman and Bear Stearns with country names like Greece and Italy, the near term mechanizations of the market make more sense.  We think you can buy value today on dips, but be prepared.  The market may go lower.

Our Long-Term subscribers bought one new position today just above a 15 month low.  Let 'em bounce, then buy on the way up!  It has been rough on every investor, if you would like to follow a proven plan for profits check out our Long-Term Portfolio.

The mailbag:
I am glad your daughter stayed safe in New York.  Your picture of a humble president certainly contrasts to an arrogant one.---Long Term and Buy, Sell, Hold subscriber G.C.

John’s reply:  She had a wonderful time.  I will let the picture speak for itself.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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