Scaring The World - Now Showing At A Sovereign Borrower Near You...

Newedge - Blain's Morning Porridge - September 27 2011

By Bill Blain, senior director, special situations, Newedge (as seen on TV)

T: +44 207 676 8615; Mobile: +44 777 088 1033; E: [email protected]

Scaring the World - now showing at a sovereign borrower near you..

Sorry for late porridge – putting folk off their breakfasts again.

What's this curiously unfamiliar euphoric feeling? Gosh...I think I'm suffering an outbreak of mildly short-term bullish sentiment. The leaks from Washington and Brussels suggest Europe's elites might finally be getting their act together, that a plan to ringfence Greek default from contaminating the other PIIS is being worked upon, and bank capital injections are being planned. Whoopee.

Fill my boots with cheap assets please. Tier 1 financials up 2-3 points already this morning – confirming stronger sentiment towards bank assets. (We have high-return/low risk view on the right strategy in the T1 sector – give me a call on how to execute it!)

That's the good news. Last week I wrote there were three possible outcomes for an orderly Greek default - broadly: the Good, The Bad and The Ugly. It does look like we could get option ii). It's not perfect, but it could be something under the merely bad but acceptable. It’s infinitely preferable to the very sharp pointy stick of not doing anything.

That said, it’s not a done deal yet - still lots of Indiana Jones moments to come:

i) Germany's leadership remains terrified: Despite the likely criticism, I'll go out on a limb and say Merkel is playing a pretty good game herding German politicians towards a solution that stands a chance of keeping the euro alive. She has to appear gradualist, skeptical and determinedly Germanic in order not to spook her nervous flock. While she understands and gets the scale of the euro-crisis, her colleagues aren't of the same calibre and are prone to electoral panic - hence her fears that leaking what will effectively be a third Greek plan before the Bundestag approves the second could panic her sheep.  

ii) A 50% Greek haircut is nowhere near enough - and everyone knows it. It will still leave the Greeks some €175bn to repay creditors - which is probably some €130bn more than their economy can cope with. Far better to simply bite the bullet and inflict a realistic haircut which will allow Greece to restructure its economy and structures from the base up. The market is fully discounting a 50% chop - let holders suffer more - nobody can claim to be surprised.

The Argentine President, no stranger to default, recently advised: defaulting big and early is better than a succession of smaller defaults. Get it over with.

iii) We'd like more details on the banking bailout plan - who pays? Probably better we don't provide the answer - Europe's taxpayers - until after the Finns, Austrians and Germans say...'well ok then...' and sign up to July’s rescue.

iv) We'd like to hear more on the leverage aspects of the new EFSF, and again who ultimately pays? Of course, the whole idea of making the EFSF look like a €2 trillion fund is that it will never get used (really??), and the markets will simply say: 'no point speculating against Spain and Italy as we can't beat the EFSF'.

Hm...reminds me more of one of these cute wee animals with the ability to puff up its cheeks, inflate its body, or blow out frills to make it look much larger and more aggressive. That plan unfortunately crashes as predators realise its all smoke and mirrors and gobble them up anyway. I shall characterise EFSF leverage as the 'puffer fish defence'. (Or a wee timorous beastie trying to look bigger than it actually is!)

And also good news is the ECB’s apparent willingness to talk about easing rates and provide emergency liquidity for banks. Talk of 12-month loans and re-opening its covered bond buying window to kick-start bank financing avenues is seen as highly positive.  

So, as I am officially bullish...what shall we go out and buy? Or...to put my bear hat on...what can sell into this rally?

Out of time, but smiling...