Don’t bet on a European resolution

By David Llewellyn-Smith

Over the past few weeks, as equity markets around the world have awoken to the renewed dangers of Greece by falling 4% to 5%, there’s been a growing chorus among the usual bullish suspects to buy the dip. Over the weekend, this line of thinking received some heavy duty support in the form of Jonathon Wilmot at Credit Suisse. From Alphaville:

Jonathan Wilmot, chief global strategist at Credit Suisse, reckons that Europe is set to lead a rebound in global growth this year. He and his team are saying BUY Spanish and Italian bonds, and probably equities as well.

While a note dispatched to CS clients this week contains a few escape chutes, the core bullish argument is broadly as follows:

  1. The revival in risk since last autumn is so far very much in line with the recoveries from the “Deep Panics” of 1982, 2002 and 2008/9 – and those panics were followed by rallies of 50 per cent over more in global equities within 18 months.
  2. Despite what you read on sites like this, the eurozone is not going to fall apart; instead some sort of pro-growth compromise will be cobbled together. There’s already consensus on the fact that austerity alone cannot work.
  3. The confidence shock at the end of last year hit Europe the hardest. But while production slumped, aggregate demand didn’t. Hence any uptick in demand now will set up the need for significantly higher European production.

We all know that being a good investor requires that you do just what Mr Wilmot is suggesting: buy the panic. That is hardly news. But, one has to ask, are all panics the same? And is the notion that you should buy equities ipso facto during a period of weakness the right one for the new era in which we live? Is this an era in which the old simplistic assessments of economics still leads to the conclusion that the reversion to a bullish trend can be relied upon in any respectable time frame?

For me the answer is a very obvious “no”.

There are two reasons why I say this, one macro and the other technical. The macro reason is a simple. The advice of Wilmot and Co is not based upon economics at all. It is based upon what is a thin or non existent assessment of political risk. As I wrote last week, there is every chance that Greece will find some new coalition of pro-austerity political parties any minute and that it will remain happily burning in the Eurozone until a new set of policies can be found to reverse its economic collapse whilst applying the Teutonic discipline demanded of it by the European core.

But that potential resolution has nothing whatsoever to with economics or markets. It has everything to with politics and unless the person advising you to “buy the dip” dedicates ninety percent of his reasoning to why the Greek polity is about to have its rage quenched, that advisor is, quite simply, making an ignorant punt.

And that brings me to my major objection to the “buy the dip” framework in these circumstances. Professional investors and especially hedge funds spend a great deal of time seeking out “asymmetric” trades. These are deeply unfashionable trades that are very cheap to lay but contain very large potential upside. Often they involve buying deeply “out of the money” instruments that, in the event of a sudden turnaround in the trend, will trigger an avalanche of interest from the consensus, dramatically boosting the price.

Those suggesting you “buy the dip” on Greece are recommending you do precisely the opposite, making an asymmetric bet with limited upside and large downside potential. Consider, if Greece and Europe do manage some kind of happy rapprochement, then yes, you’ll get some upside. Perhaps 5 or 10% before the reality that global growth will still be subdued sets in. But if Greece exits the euro, you’ve got an almost limitless and unfathomable downside to look forward to as Lehman Brothers II freezes global credit, trashes global equities and potentially ends the era of free global capital markets as governments worldwide nationalise and guarantee every bank in site.

Unless you are going to “buy the dip” using some kind of asymmetric instrument – and good luck with that given the consensus is still firmly on the side of ongoing growth – then you should stay right away from betting on happy outcomes in Greek politics.

David Llewellyn-Smith
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  1. I’d love to know Johnathan Wilmot’s reasoning behind Europe leading the world in economic growth. An uptick in demand? The likelyhood of that scenario under the current climate is very remote. I’m thinking the US is far better positioned to experience any upside in economic growth and has better implemented strategies to ensure it occurs.

  2. Looking at EU fundamentals just how is his prediction going to happen? Most likely profits on derivative plays. If he has any understanding and looked at TARGET 2 and the capital flows, how are the LTRO’s for example going to be paid back … wait for LTRO 3 to the rescue I suppose.

    I don’t buy his view at all. With contraction in credit, and rising unemployment along with the political mess it’s going to take a miracle IMO to get growth in the short term. Or maybe he thinks the ECB is about to do massive QE … possible.

  3. Just thinking……

    For a while my take has been that everyone will do absolutely anything to avoid the looming disaster. So LTRO15, Money drops, ‘education allowances’, consumer support bonus payments…anything is now on the cards and WILL happen.

    What will be the outcome? Inflation will be dodged initially because we are actually trying to back-fill the unsustainable private credit boom of the previous decades. That economy was unsustainable as is this one.

    So we can just print more and more money, create more and more jobs in Govt, serving coffees, and retailing Chinese imports. Production and productivity continue to decline. REAL productive jobs become less and less important since they pay less than Govt and service sector jobs. Production declines even further. We can just import everything we need. Hmmmmmmmmm sounds fine by me!

    I have a niggling (!) worry that currencies will become worth nothing!

    Anyway let’s not worry about that we can all live pretty well meanwhile and avoid any adjustment to our lifestyles.

  4. P,S. Sorry! The REAL point was MAYBE we are headed for all those money drops. Real growth will be zilch but the inflationary effects will drive the markets.
    So maybe the thing to do is take our bits of paper and throw them into the stock market?
    It’s worked so far since the GFC

    Sorry I got sidetracked on my hobby horse and didn’t mean to divert the discussion on this thread which is about how to make (preserve) money in this scenario.

  5. bskerr2MEMBER

    New elections in Greece will most likely give even more support to these new parties and less for ND and Pasok as people becoming confident in leaving the Euro. Indignant in Spain is growing in size again, has not turned violent but its just about there. To me it feels like we have only just started the decline on markets. This is what should have happened back in 2008 but instead governments along with the rich meet and came up with this plan to print money and strangle growth. Now we have 2012. 4 Years later and with no options really left. PIIGS will all fall at some stage, Greece is just the trigger.

    • Aristophrenia

      The Krugman article is so full on – that is incredibly serious. The tone of the respondents, not including rabid right wingers blaming socialism and Clinton for the current failures, is one of shock but acceptance that Krugman has said this.

      A good point to note was the danger of putting it all on the line with such a short and absolute prediction time frame……

      EU failure imminent within months.

      Tend to agree.

    • SweeperMEMBER

      Last week the Bundesbank said they may accept higher inflation – so things must be bad.

      • Aristophrenia

        Ok. it looks like they are going to set the agenda for a Greek exit – 5 pm today.

        Krugman was right –

        The interesting thing about this is, that the prediction was always – Why did Ireland accept such destructive terms ?, And would they join Greece if they left the union ?

        The news coming out of Iceland of a new constitution, criminal charges, dismissing debt, and restructuring the entire economy with great success may well be looking very appealing to Ireland right now, Spain next week, Portugal and then Italy.

        The question which was always raised regarding the EU by the northern countries was why should we pay for the southern life style – we should have two currencies, it looks like this may well be the only viable option.

        A southern dollar, the peso, and the northen mark.

  6. Is this the same guy that triggered a massive short selling of Macquarie Bank during the GFC?