MarketView for January 10

 

 

Summary 

  

The major equity indexes hit a five-month high on Tuesday, after an upbeat forecast by Alcoa and strong gains in bank shares. Alcoa posted revenue that exceeded expectations late Monday and gave a bullish outlook for the aluminum industry. The stock gave up early gains to end at $9.44, up 1 cent. However, data showing strong Chinese imports of copper helped buoy the rest of the sector.

 

The markets continued their recent divergence from the woes of the euro zone. Recent economic reports and optimism over earnings season have pushed stocks higher in the start of the new year, with the benchmark S&P 500 rising in five of six sessions. That focus could change quickly. Key bond auctions later this week from Italy and Spain, two countries at the center of the euro zone crisis, could hurt sentiment if they go poorly.

 

Industrial and materials stocks, closely tied to economic performance, were the day's largest gainers. Caterpillar rose 3 percent to close at $99.96, leading the Dow Jones Industrial average higher. Bank stocks also continued their rebound. JPMorgan Chase ended the day up 2.1 percent to close at $36.05.

 

Easing some concerns about Europe, Fitch said it does not expect to cut France's AAA credit rating this year, but countries under review such as Italy or Spain could be downgraded by one or two notches.

 

The Dow and S&P 500 hit their highest intraday levels in five months. The S&P 500 close above 1,285.09 is the highest since the end of July and marked a breach of technical resistance, which could spur further gains.

 

Copper prices rose 3.1 percent, the best performance since late November, after China reported copper imports rose to a record high last month.

 

The CBOE Volatility Index, the VIX, Wall Street's so-called fear gauge, fell 2.9 percent to 20.46, again testing the psychologically key 20 level. The VIX is down 11.6 percent so far in 2012 and falling to levels last seen in late July as the S&P 500 has seen average daily price moves of fewer than 8 points so far this year.

 

Volume was solid, with about 7.02 billion shares changing hands on the three major exchanges, well above the daily average of 6.7 billion shares.

 

Wall Street Reassess Economic Growth Estimates

 

Wall Street banks lowered their outlook for domestic  economic growth due to concerns over the European debt crisis, oil prices, regulatory uncertainties and "continued disarray in Washington," according to a financial industry survey released on Tuesday.

 

The survey, which included bankers from Morgan Stanley, Wells Fargo Securities and Citigroup, forecast that the U.S. economy will grow at a rate of 2.2 percent this year, down from a previous forecast of 3.1 percent.

 

Several bankers said that U.S. financial markets and the economy were "greatly exposed to the risk of contagion from a systemic event arising from Europe."

 

The survey was released by the economic advisory roundtable of the Securities Industry and Financial Markets Association.

 

European debt problems, uncertainty over U.S. fiscal policy and lawmakers' general inability to look at long-term budget trends were most often cited as risks to the economic forecast.

 

Economic growth for 2011 is seen at 1.8 percent, down from a previous forecast of 2.5 percent, the roundtable said, noting that the outlook was considerably weaker than mid-year 2011. The Wall Street bankers also forecasted that the policy-setting Federal Open Market Committee would not change its current interest rate target of between 0 to 0.25 percent earlier than mid-2013.

 

Hedge Funds Could Topple Europe

 

Hedge funds are going up against the International Monetary Fund over its plan to radically cut Greece's towering debt burden as time runs out on talks that could sway the future of Europe's single currency.

 

The funds have built up such significant positions in Greek bonds that they could derail Europe's plan to have banks and other bondholders share the burden of reducing the country's debt on a voluntary basis. Translated, that means that bondholders will have to give up some 100 billion euros ($130 billion) of their investment in the planned bond swap, drawn up in October. However, many hedge funds plan not to play ball.

 

Their position is to either let Greece go under, which would trigger the credit insurance they have bought, or hope to get paid out in full if enough others sign up. That puts them in direct conflict with the IMF, which wants to force Greece's cost of financing down to an affordable level.

 

Without a deal, the IMF, the European Union and the European Central Bank -- the so-called troika of official lenders -- will not pay out a second bail-out package Greece needs to survive.

 

Without the bailout money, Greece is likely to default around March 20, when a 14.5 billion euro bond falls due. A deal needs to come well before that, because the paperwork alone takes at least six weeks. To that end, on Monday German Chancellor Angela Merkel and French President Nicolas Sarkozy, the euro zone's two leading powers, insisted private-sector bondholders must share in reducing Greece's debt burden.

 

But the hedge funds are resisting, unlike European banks holding Greek bonds, who have been pressured to agree by politicians.

 

There are also a few other problems Banks represented by the Institute of International Finance (IIF) agreed last year to write off the notional value of their Greek bond holdings by 50 percent, a deal designed to reduce Greece's debt ratio to 120 percent of its Gross Domestic Product by 2020. However, t they have been unable to agree on the fine print of the refinancing - the coupon, maturity and the credit guarantees. These will determine the bonds' Net Present Value (NPV), and thereby the actual hit the banks need to take.

 

There are 206 billion euros of Greek government bonds in private sector hands -- banks, institutional investors, and hedge funds -- and it is likely that hedge funds have been building up their positions in the past months. They have been snapping up chunks of Greece's next big maturing bond, the March 20, for around 40 cents on the euro. Yields on the bond began to rise sharply in September and it was priced at 41-45.5 cents in the euro on Tuesday.

 

The bet is that other creditors will sign up to a voluntary deal, and that Greece will pay out in full the hedge funds who do not to avoid a default and trigger pay-out of Credit Default Swaps, a form of credit protection. But it is a dangerous strategy.

 

Greece could change its laws, which for the largest part do not contain the so-called Collective Action Clauses (CAC) that force dissenting minorities into line when new conditions are imposed on outstanding bonds.

 

It is unclear how large hedge fund holdings of Greek debt are. About 20 to 25 percent of Greece's creditors were unidentified, and half of these could be hedge funds, one source close to the creditors told Reuters.

 

Regardless, the proportion of creditors seen likely to sign up for their haircut has slipped. The hopes are now 60 percent can be convinced by the end of the month, the same source said, far less than the 90 percent take-up the IIF was targeting in June. At that low a level, it is unclear whether the troika of international lenders will consider the uptake big enough to warrant a pay-out of the second bail-out package.

 

Finally, the IMF itself seemed to throw doubt on the debt swap in an internal memo cited by German magazine Der Spiegel on Saturday. According to the report, the IMF believes Greece will still be sinking under the burden of its debts even after a deal is struck, and that further measures may need to be taken if the country is to avoid default. Markets fear this could lead to reopening the October agreement.

 

In a leaked paper in October, the IMF already acknowledged that its the assumptions may need to be reassessed. That would mean lower interest rate payments by Greece, and a bitter hit for the banks.

 

The NPV loss for creditors could be near 65-70 percent and the coupon around 4.5 percent, bankers have indicated. Reuters reported in November Greece wanted a 75 percent NPV cut, a far higher number than the low 60s the banks had in mind.