A quick note on Greece - as of Friday, the yield on 1-year Greek debt has soared to 212%, up from 144% a week ago, just after the grand "solution" to the crisis was announced. Over the past week, the price of 1-year Greek debt has plunged by 20%, to 38.4 (bid 35.81, ask 40.97 to be exact). Which begs the question - if everyone has agreed that Greek debt will only be written down by 50%, why is the 1-year note trading at just 38% of face value, with longer maturities trading below 30% of face? This sort of incongruence isn't inspiring.
Much of the reason Greece is seeking a voluntary exchange of debt from its bondholders is that an "involuntary" exchange would be a default event, which would trigger payments on credit default swaps. But across the global financial system, there are only about $3.7 billion in credit default swaps outstanding against Greek debt, and even in the event of an "involuntary" exchange, the actual amount of payouts would be less than that notional value.
One of the greatest advantages Greece has is that about 90% of its debt is governed by Greek law. The terms of any debt exchange, voluntary or involuntary, are more than simply technical details, as any restructuring should significantly reduce the discounted value of the new debt, and I suspect that the next stumbling block is that Greece will change its laws to impose "collective action clauses" on its debt, sufficient to restructure the debt more easily, given the consent of some supermajority of its bondholders. That would help to avoid any holdouts to "voluntary" restructuring, but it would also allow the possibility of a larger haircut. Little of this has been worked out, so even widely publicized "final" deals are not final until the details are settled. In any event, a 50% haircut still puts the Greek debt/GDP ratio above 100% by the end of the decade, so it's possible that Greece will pursue a further haircut, even if it triggers CDS payments. We'll see soon enough whether the widely accepted 50% figure actually holds up.
Reduce Risk
Here in the U.S., our broadest models (both ensembles and probit models) continue to imply a probability of oncoming recession near 100%. It's important to recognize, though, that there is such a uniformity of recession warnings here (in ECRI head Lakshman Achuthan's words, a "contagion") that even an unsophisticated, unweighted average of evidence indicates a very high likelihood of recession. The following chart presents an unweighted average of 20 binary (1/0) recession flags we follow (e.g. credit spreads widening versus 6 months earlier, S&P 500 lower than 6 months earlier, PMI below 54, ECRI weekly leading index below -5, consumer confidence more than 20 points below its 12-month average, etc, etc). The black brackets represent official recessions. The simple fact is that we've never seen a plurality (>50%) of these measures unfavorable except during or immediately prior to U.S. recessions. Maybe this time is different? We hope so, but we certainly wouldn't invest on that hope.
Meanwhile, nearly every traditional asset class is priced to achieve miserably low long-term returns. While Wall Street remains effusive about stocks being cheap on a "forward operating earnings" basis, that conclusion rests on the assumption that profit margins will sustain record highs more than 50% above their historical norms into the indefinite future. That assumption is terribly at odds with historical evidence (as it was in 2007 when Wall Street was gurgling exactly the same thing). Given that stocks are a claim on a very long-duration stream of deliverable cash flows, our money is clearly on more thoughtful and historically reliable valuation methods.
Read the complete commentary
Much of the reason Greece is seeking a voluntary exchange of debt from its bondholders is that an "involuntary" exchange would be a default event, which would trigger payments on credit default swaps. But across the global financial system, there are only about $3.7 billion in credit default swaps outstanding against Greek debt, and even in the event of an "involuntary" exchange, the actual amount of payouts would be less than that notional value.
One of the greatest advantages Greece has is that about 90% of its debt is governed by Greek law. The terms of any debt exchange, voluntary or involuntary, are more than simply technical details, as any restructuring should significantly reduce the discounted value of the new debt, and I suspect that the next stumbling block is that Greece will change its laws to impose "collective action clauses" on its debt, sufficient to restructure the debt more easily, given the consent of some supermajority of its bondholders. That would help to avoid any holdouts to "voluntary" restructuring, but it would also allow the possibility of a larger haircut. Little of this has been worked out, so even widely publicized "final" deals are not final until the details are settled. In any event, a 50% haircut still puts the Greek debt/GDP ratio above 100% by the end of the decade, so it's possible that Greece will pursue a further haircut, even if it triggers CDS payments. We'll see soon enough whether the widely accepted 50% figure actually holds up.
Reduce Risk
Here in the U.S., our broadest models (both ensembles and probit models) continue to imply a probability of oncoming recession near 100%. It's important to recognize, though, that there is such a uniformity of recession warnings here (in ECRI head Lakshman Achuthan's words, a "contagion") that even an unsophisticated, unweighted average of evidence indicates a very high likelihood of recession. The following chart presents an unweighted average of 20 binary (1/0) recession flags we follow (e.g. credit spreads widening versus 6 months earlier, S&P 500 lower than 6 months earlier, PMI below 54, ECRI weekly leading index below -5, consumer confidence more than 20 points below its 12-month average, etc, etc). The black brackets represent official recessions. The simple fact is that we've never seen a plurality (>50%) of these measures unfavorable except during or immediately prior to U.S. recessions. Maybe this time is different? We hope so, but we certainly wouldn't invest on that hope.
Meanwhile, nearly every traditional asset class is priced to achieve miserably low long-term returns. While Wall Street remains effusive about stocks being cheap on a "forward operating earnings" basis, that conclusion rests on the assumption that profit margins will sustain record highs more than 50% above their historical norms into the indefinite future. That assumption is terribly at odds with historical evidence (as it was in 2007 when Wall Street was gurgling exactly the same thing). Given that stocks are a claim on a very long-duration stream of deliverable cash flows, our money is clearly on more thoughtful and historically reliable valuation methods.
Read the complete commentary
