the Eurozone haggling process

fully discounting the EU crisis?

I’m beginning to think that we’re at, or close to, the worst point for global stock markets in their discounting of the Eurozone financial crisis.  This doesn’t mean that the crisis itself is over, or even close to that.  It doesn’t mean, either, that European stocks will be good performers in absolute terms or relative to their peers listed in other countries from now on.

what this means

Instead, it means two things:

–I think global markets have already assessed and discounted most of the bad consequences that the euro crisis will have for the wold outside the EU.  After all, the crisis has been going on for almost three years, a longer time–as I pointed out yesterday–than it took the world to do the same thing for Japan in the early 1990s.  This means we are at, or close to, the point where future uncertainties can be shrugged off by other markets.  It may even be that future deterioration of the situation in the EU will also have little effect on trading outside Europe.  Certainly, that’s what happened with the Japenese stock market, which in 1992 was still first or second in capitalization in the world.  It declined into its current irrelevance.

I’m not sure this dire fate awaits the EU.  In fact, although, again, I’m not willing to bet on this outcome, I think there’s a good chance the EU will ultimately become a much closer political union.  But I think the EU and the rest of the world will soon “decouple” in stock market terms.

–It also means I think there’s a chance to make money in carefully selected UK or continental European stocks.  (Given the reports that US-based “vulture” investors are moving en masse to the EU, the reality may be somewhat better than this.)

For example, London-based Intercontinental Hotels Group, whose IHG ADR I own (I’ve mentioned several times in previous PSI posts), is up 20% in dollars (25% in £) over the past year.  That compares with a 3.6% gain for the S&P 500 over the same span, and a £ loss of around 4% for the FTSE 100.  I don’t see why outperformance for IHG shouldn’t continue.

I’m not willing to bet the farm on this hypothesis, but I do think it deserves considering.

the current situation??    …haggling about terms

If I’m right about this, how should I interpret the apparent current impasse between Germany, which wants structural reform in Italy, Spain et al. before it will consider sharing the burden of those countries’ excessive debt, and the rest of the EU, which wants debt relief before structural reform?

I think it all comes down to a process of haggling about terms.  It’s sometimes being conducted in private, sometimes in the press.  It’s the Greek bailout process writ large.  Both sides have already decided it’s in their best interest to come to an agreement that will contain both a measure of debt relief and some relinquishment of national sovereignty.  But neither side can be seen as simply rolling over and accepting the terms the other is demanding.  Both must be viewed by their electorates as having fought hard for every inch of ground won or lost.

Two other points:

–I think the EU generally, and Germany in particular, learned a lot from negotiations with Greece.  It came to understand that for a wily haggler like Greece, each apparent agreement only creates a new framework for further negotiation.  The EU also saw that the Greek parliament enacted reform legislation on cost decreases and on taxes–but then never enforced the new laws.  Maybe it’s been ok for Greece to conduct itself like this.  I think, however ,that Germany is determined that nothing similar will happen on the wider Eurozone stage.  Supra-national safeguards must be in place.

Therefore, any definitive agreement may take time–a lot of time.  Germany doesn’t care, because the stakes are so high.  Having gone through its own massive decade-long economic restructuring after the merger of East Germany and West, Germany understands what needs to be done.

–The interests of the EU and the rest of the world may not coincide.


-The EU is currently China’s largest trading partner; privately, China may think that the EU won’t be nearly so important to it ten years from now.  So it’s urging an immediate solution, at least in part because that’s what’s best for China at the moment.

-The US economy is  slowing (to a degree I didn’t foresee), partly because of recession in the EU.  Historically, administrations are reelected when the country is either healthy already or making good progress getting there.  On the other hand, administrations tend to be replaced when the economy is sagging and unemployment is high. There’s no time, nor is there any apparent inclination on either political party’s part, to start the legislative process of helping the US economy evolve.  Therefore, Washington has a strong interest in having a quick solution to the EU crisis, on the idea that this will make the domestic situation look a bit better.

a second Greek bailout payment agreed: implications

an agreement

Greece and the IMF/EU have finally agreed on conditions for the latest tranche of bailout money, €170 billion, to be paid to the troubled Mediterranean country.  Greece will now have the funds to redeem €130 billion of its bonds that mature in the next few weeks.

little stock market reaction

Stock market reaction in Europe has been muted–a 2% gain yesterday, a give-back of about half that amount today as I’m writing this.

what went on in the talks?

I find it hard to interpret with any confidence what has been going on in negotiations between Greece and the EU/IMF.  It’s possible that the brinksmanship displayed in the talks on the question of whether Greece would remain in the Eurozone was all a show, performed for home country voters by politicians eager to minimize the negative consequences of any accord for their future electability.  But that’s not what I think.  My take is that Greece–which hadn’t come close to fulfilling the conditions of its initial bailout payment–figured until recently that the EU was negotiating from a position of extreme weakness.  Until the EU made it clear it was willing to let Greece leave the Eurozone, Greece felt it could extract almost any concession, provided it didn’t do so all at once but rather moved the bar a little bit at a time.  Once the EU began to plan for a Greek exit, Athens was forced to become serious about striking a deal.


It seems to me that at the very least both sides have bought themselves some time.  I’d expect that the core EZ countries will continue to strengthen the capital structure of their domestic banks.  It’s understandable that potential buyers of the public assets Greece supposedly has on sale would be reluctant to bid until they were sure that they weren’t purchasing just before a significant currency devaluation.  So we’ll now have a chance to see how serious Greece is about these divestitures–and how desirable they actually are.

We’ll also have a chance to see whether the EU will retain its hard line that starving yourself through austerity is the best prescription for a return to robust health, or whether the ECB monetary policy will be a bit looser than it has let on to date. My guess is that it will.

Implications for stock market investors?  I think they’re less about a change in strategy than about confidence that the strategy is correct.  I view the EU as a low-growth area for an extended period of time.  And, although fears of a “Lehman moment” are off the table (not that markets ever really factored this possibility into stock prices), Europe will be subject to periodic worries about weaker EZ countries like Greece.

So the appropriate stance remains, I think, to be underweight the area and to concentrate on companies which are listed in the EU but which have the bulk of their operations located in the Americas or in the Pacific.

what’s that about Japan?

Actually, a much newer and more interesting macroeconomic development has been going on half a world away.  It’s quantitative easing in Japan.  More on this tomorrow.


the Unicredit rights issue

the Unicredit issue

Unicredit, a major Italian commercial bank, is in the midst of an equity raising aimed at shoring up its finances to meet new capital adequacy standards being set by the Bank for International Settlements.

It’s doing so in the customary European way, through a rights issue (see my post on rights issues for more detail).  The prospectus is available–but not to people in the US–on the company website.

No E-Z bank is eager to raise new equity today.  Their stocks are trading at well below half of the balance sheet carrying value of their net assets (which is the problem in a nutshell–no one believes the carrying values have much basis in reality).  Nevertheless, many are resigned to doing so.  Therefore, the Unicredit issue is attracting a lot of market attention as it proceeds.

Several aspects of the issue are striking:

its large size

Prior to announcement of the issue, Unicredit was trading at around €6.30 a share.  The issue gives existing shareholders the right to buy 2 new shares at €1.93 each for every one they held at the ex rights dateThe new money coming in from the issue amounts to about 60% of the pre-rights market value of Unicredit.

implied change of control possibility

The shares created by the issue will represent two-thirds of the new total.  The issue has the potential to completely rewrite the share register if traditional large shareholders choose not to participate.  That’s certainly an inducement for them to come up with the money.

the low exercise price

Think of rights as being like short-term warrants.  Suppose the existing shareholder doesn’t want to, or can’t afford to, exercise his right to buy new shares.  What happens then?

Usually, and in this case as well, the issue is underwritten.  That is, the investment bank group arranging the issue agrees to buy, at the rights price, any shares that shareholders don’t.  The underwriters, in turn, sub-underwrite part or all of their obligation to other investors–typically portfolio management companies (this is a whole other, semi-sordid, story–but a topic for another day).  No matter what, Unicredit will get the money it wants.

Underwriters don’t want shareholders en masse to refuse to take up their rights.  It’s embarrassing for all parties, for one thing.  The underwriters, or angry customers who act as sub-underwriters, are stuck with the shares on their books, at a loss and tying up capital.

Their solution?  Coercion.

Underwriters always price the new shares at a discount to the prevailing stock price.  The bigger the discount, the bigger the gun to the head of existing shareholders to avoid having their percentage ownership of the company assets diluted by not taking up their rights.  Conversely, the smaller the discount, the more eager underwriters figure existing shareholders are to give company management fresh capital.

In the Unicredit case, the discount is gigantic.  The new shares will be issued a less than a third of the pre-rights share quote.  More like a cannon than a gun.

the issue appears to be succeeding

…at least in the sense that the current share price is comfortably above the €1.93 level.  The stock hasn’t traded below the rights exercise price since it went ex rights and has strengthened each day, as well.

Unicredit is worth watching closely

This is a bellwether rights issue.  If it goes well–and signs are positive so far–other, stronger banks should be able to raise substantial new equity, too.