Diary of a Financier

The Italian Job

In Capital Markets on Thu 28 Jul 2011 at 20:39

I’m sitting 30% long equities, from which I expect remarkable relative strength to US peers. My confidence in our long positions was redoubled by their behavior during the July 19 rally, after the White House held a press conference to announce a real debt deal proposal was on the table. That long book includes a Norwegian single-name and a Canadian single-name–both exposures are now denominated in USD. Further, I’ve stuck with my winner, Japan (EWJ). Going into the eye of this storm–where the Euro crisis and US debt deal converge–I’m trying to position the whole portfolio not just for relative strength, but for absolute return.

Recall my musing from earlier this week:

I’m waiting for a trigger before opening a short EWI position…

I regard the American situation as avoidable, fixable, or, at very least, sweep-under-the-rug-able. Harry Reid is onto something, and by virtue of having the only palatable plan on the table, he might get the nod from fellow Democrats plus the ratings agencies plus Messrs. Boehner & Cantor. Europe has no chance. At this point, neither EFSF supra-national bond issuance nor a European Monetary Fund has the magnitude to reverse the demise forecast by fundamentals, history, and the long-term charts. When a sovereign is tapped by the Reaper, he cannot escape death without renouncing his sins. The Original Sin for the Euro fringe was marrying into the EMU for a large dowry. Fiscal Union can start to mend these travails if Germany & France are willing to access credit markets at interest rates that reflect a higher weighted average, accounting for PIIGS subprime credit worthiness as of today. That’s in stark contrast to PIIGS having accessed credit markets at interest rates that reflected the prime credit worthiness of Germany throughout the decade. I’m suggesting that Germany & France will have to [largely] foot the bill in recapitalizing the PIIGS. That’s a substantial bill. That’s not worth the synergies of a Eurozone.

I was ready to short a chunk of the Italy ETF (EWI) this morning. My last words of Wednesday’s trading session were, ‘If EWI catches a momentary bid tomorrow, I’ll consider it a gift from the market and I’ll pounce on the offer.’ I’ve built a strong case against Italy and the European fringe states. Thus, I was poised to short EWI today.

The American-traded EWI closed Wednesday down 5%+, having accelerated after Italian markets ended their session down only 2.4%. I hit the phones after the NYSE close to check some American traders’ wits about the European situation.

Later that night, Italian futures were trading in the black, and my eyes widened. I woke up this morning… Italian cash markets were positive, and they accelerated into the close: FTSEMIB +0.34% on Thursday’s session.

American markets opened Thursday as I saw a Financial Times headline:

Italy’s borrowing costs rose sharply to an 11-year high at a bond auction on Thursday as markets reacted nervously to the Greek rescue package and the debt impasse in Washington.

Italy sold €2.7bn ($3.9bn) of its benchmark 10-year security at a yield of 5.77 per cent, the highest since 2000. That compares with 4.94 per cent at the last 10-year bond sale on June 28.

Traders noted that yields on Italian debt were close to the highs reached before the eurozone summit agreed a framework rescue package for Greece a week ago. Although Italy has a large domestic investor base, the country has increasingly come under pressure from nervous financial markets this summer.

…and I checked my charts to see the spike in Italian yields. It didn’t make sense: Italian equities close in the black, but bond yields blow-out at a failed auction?! EWI had oversold in Wednesday, but it gave me the gift I wanted by levitating for a few hours after the open to let me short it.

But then, the Italian equity/bond anomaly made me pause. It made me question myself. I felt as if everyone else saw or knew something that I was missing. So, I called an economist Germany. I called a trader & an analyst in London. I was looking for someone to refute me. I wanted a reason to nix my trade.

I asked how they thought Italy would react to an American debt deal–agnostic (due to their own problems) or relieved?

I asked their outlook for the Euro crisis.

I asked how the EMU could survive.

They all answered the same; they all gave me the party line. These are professionals I’ve dealt with before. They call me occasionally for my perspective. A couple of them eat what they kill, so they have no incentive to follow the herd. Yet, I got nothing but consensus from their answers.

He: ‘The Euro will get through this, it will just take a while. The EFSF has any wobbles covered, and it’s only 1/3rd funded.’

Me: ‘The EFSF fully funded cannot cover Greece & Italy. Not only that, but all the PIIGS are guarantors funding the EFSF, so if Greece & Italy need bailout funds, Germany & France will have to cover the PIIGS contributions. So the question is at which point do the liabilities outweigh the synergies of the EMU–for everyone from Germany to Spain to Greece?’

‘The EMU was more politically motivated than economically.’

‘I get that. I understand the Maastricht Treaty, I’m aware of the scars from WWII, etc. But have you seen Greece? Have you seen Ireland or Spain? The people are pissed. The uprisings are real. The Greeks curse the Germans. If EFSF funding is contingent upon austerity, the PIIGS’s hatred will only fester.’

‘These countries & their people knew the risks of a currency union. They consciously entered EMU without fiscal union because of national pride and bureaucratic prohibitors. They believe in the bloc, and they understand the sanctity of contracts.’

‘Like the contract of ERM?’

So on and so on. Their optimism was backed by nothing I didn’t already know. My silver lining: by the transitive property I had deduced that defection back to a local currency (e.g. Spain leaving the Euro and repaying its debt in Pasetas) wouldn’t trigger a default, since entry into the Euro currency wasn’t a “credit event” in the first place. I was able to confirm this with a CDS desk.¹ There’s less stopping a country from defecting from the Euro than most people think.

I let my phone rest for a while. With renewed conviction, I found a borrow, then entered my offer to short EWI at $16.04. The ETF was printing 16.01 ask. It ticked up to 16.02 at one point, but I never executed. I modified the order twice, but I just chased EWI all the way down into its close, $15.80. I never executed.

I was following my 1-minute chart almost exclusively the whole time. The 30-minute chart showed no chance of EWI reaching 16.04, and I deferred to the 1-minute, which looked more deterministic. What amateur mistakes though. It’s like leaving a birdie putt short of the hole. I questioned myself, I sat above the ask, then I chased it down. I missed the trade. Not only do I feel naked going into battle tomorrow, but I missed out on a huge opportunity. I’m now reactive to a market decline instead of proactive, and I hate being behind. I’ll have to reassess EWI on Friday. Kicking myself now, but I’ll have to shake it off, because pining for lost pennies messes with an investor’s psyche.

EWI 1-minute


¹Some English Law bonds (non-local) may have covenant language that could prompt bondholder suits in UK courts, but most vintage, pre-2011 CDS contracts don’t specify whether or not denomination of repayment constitutes a “credit event.”

  1. Haha, look at this from Business Insider this morning (as expected):
    “It has been reported that the European Financial Stability Fund may not be ready to loan Greece its next bailout tranche, in part because weaker European contributors like Italy and Spain may not be able to afford their payments into it.”

  2. […] politics, economics, et al. This has become existential. Given the status quo, I ask (as I have many times before): what good has this Monetary Union yielded for politics, economics or the […]


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