Greece Exit Estimated Price Tag: €155bn for Germany and France, Possible Trillions for Contagion

Estimates have been made as to the cost of a Greece exit

Writes Ambrose Pritchard at the Telegraph, (Hat tip Bob Wenzel)

Eric Dor's team at the IESEG School of Management in Lille has put together a table on the direct costs to Germany and France if Greece is pushed out of the euro.

These assume that relations between Europe and Greece break down in acrimony, with a full-fledged "stuff-you" default on euro liabilities. It assumes a drachma devaluation of 50pc.

Potential losses for the states, including central banks

They conclude:

The total losses could reach €66.4bn for France and €89.8bn for Germany. These are upper bounds, but even in the case of a partial default, the losses would be huge.

Assuming that the new national currency would depreciate by 50 per cent against the euro, which is realistic, the losses for French banks would reach €19.8bn. They would reach €4.5bn for German banks.

Sounds about right.

I doubt that the US, China, and the world powers would sit back if the EU tried to "teach Greeks a lesson" by making life Hell for them.

There would be massive global pressure on Europe to handle the exit in a grown-up fashion, with backstops in place to stabilize Greece. The IMF would step in.

And here is the part to worry about.

More from Mr. Pritchard,

Needless to say, the real danger is contagion to Portugal, Ireland, Spain, Italy, Belgium, France, and the deadly linkages between €15 trillion in public and private debt in these countries and the €27 trillion European banking nexus.

The ECB will likely resort to printing of money in the scale like never before and will likely be backed by the US Federal Reserve.

If hell breaks lose and the Euro comes undone the more money printing will be unleashed by independent central banks to protect their banking system.

As a side note, this is about the preservation politically protected banking system which has functioned as an integral part of the current structure of political institutions—the welfare-warfare governments and central banks.

So we should expect markets to be highly volatile in either directions as events unfold.

Just a reminder, I bring this up NOT to scare the wits out of market participants (funny how from being a perceived Panglossian analyst, I am precipitately seen as the present day Jeremiah). Some people reduce stock market logic into a groupthink fallacy ("either you are with us or against us").

Paradoxically, the article I quoted above comes from the mainstream.

I am simply presenting the risks that faces the marketplace given the current conditions.

As an old saw goes, pray for the best, prepare for the worst.

As to whether Greece will exit the Eurozone or is beyond my knowledge. The Greek government emerging from the June elections will decide on that. I can only guess or toss a coin. But I can either act to ignore this or include this in my calculation for my positioning.

The fact is that in case the new Greek government decides to opt out of the EU, this would have a material impact on the marketplace—all over the world, the Phisix not withstanding.

Since the overall impact to the markets will likely be unknown, except for some numerical estimates to rely on (which may or may not be reliable) and where the psychological impact cannot be quantified or even qualified, such environment is called as uncertainty.

The current conditions suggests of greater than usual uncertainty. Add to that the China factor and the Fed’s monetary policies.

So, for me, it pays to keep a balanced understanding of how the local markets may become vulnerable to a contagion transmission from external events, than from blindly embracing or getting married to a single position.

I always try to keep in mind the legendary trader Jessie Livermore’s precious advice: There is only one side of the market and it is not the bull side or the bear side, but the right side

Since the markets are about managing opportunities, then opportunities will arise for profits, and opportunities will also arise for wealth preservation.

For now I see the right side of the trade as balancing my portfolio tilted towards the preservation of resources.

On the other hand, I must add that bloated egos will eventually be humbled by the marketplace.

Self-Discipline and Understanding Market Drivers as Key to Risk Management

Here is an investment tip for those who wish to protect themselves from market volatilities [dedicated to my friends at Stock Market Pilipinas]

As I have been writing, inflationary bullmarkets tend to inflate almost every issue on the stock exchange (rotational process).

This does not apply only to stocks but also to other assets.

In the US, small caps have been beating large caps… (US Global Investors)

…while junk bonds have been thrashing investment grade bonds as US companies with junk ratings pile into the bond markets at record pace to take advantage of ultra low interest rates (Wall Street Journal)

These are evidences of yield chasing phenomenon as an offshoot to central bank policies.

Because the world has been flushed with money, this only implies of highly volatile markets which are characterized by huge swings or strong surges and equally sharp retracements.

Again inflationary markets will tend to push up almost every issue but in different degrees and at different times. This impacts the stock markets in a similar manner. Eventually we will see this happen in consumer prices.

The same phenomenon impacts the second or third tier issues in the local markets, as money spillovers into the broader market.

Second while there will always be unscrupulous people (or stock market manipulators or operators), pump and dump and short and distort are activities that are difficult to establish.

Take for example of the 6 major holding issues constituting the Holding firm index of the Philippine Stock Exchange, 4 have been drifting in near or at record levels.

DM Consunji [PSE: DMC, RED], JG Summit [PSE: JGS, black], and Aboitiz Equity Ventures [PSE: AEV, black] (I did not include Ayala Corp [PSE: AC] because AC has yet to beat, but is about to, the 2007 high)

Are the record levels of stock prices of heavy caps JGS, AEV and DMC (and partly AC) justifying their valuations? So does this make JGS, AEV and DMC a pump and dump?

Some would say no because they are heavyweights (highly liquid issues with real cash flows). But this is would be a non-sequitor or irrelevant to the issue.

The following are the income statement statistics and estimates from 4-traders.com

JGS Summit

Aboitiz Equity Ventures

DMCI

The crux of the matter is: does the earnings trend justify the current price volatility?

In my view no, earnings in the contemporary sense DO NOT justify such volatility as shown above. There seems hardly any correlation between corporate performance and stock prices

And again this brings to fore the largely mistaken orthodox belief about earnings.

Today it has hardly earnings that drive prices but high powered money from central banks. By such thesis, one would understand the nature of inflationary booms and deflationary busts (Was there any pump and dump during the bear market in 2007-2008?)

Nevertheless here are very important tips for stock market participants to keep in mind which I will convey through the wisdom of my favorite stock market savants

Warren Buffett: Risk comes from not knowing what you are doing.

Warren Buffett: The dumbest reason in the world to buy a stock is because it's going up

My comment: Both of the above quotes from Mr. Buffett are intertwined.

Apparently many participants, both neophytes and veterans, are drawn to the fervent desire to earn fast buck while at the same time disregarding the risks involved that makes them easily fall prey to market volatilities and to manipulators.

Jesse Livermore (my all time favorite): “the average man doesn't wish to be told that it is a bull or bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing. He does not wish to work. He doesn't even wish to have to think. It is too much bother to have to count the money that he picks up from the ground.”

My comment:

Many people don't really want to think.

Example: getting information from newspapers and extrapolating them into investment isn't thinking at all. 50k-100k people read business section of the newspapers everyday. This means by the time one reads the newspaper, others may have already read them and may have already acted on the new information provided.

Yet in reality, these newspaper based information are likely to affect markets over the short run and are splashed with logical errors and fallacies.

That’s why I call the allure of mainstream media’s information as largely toxic.

So instead of working to get ahead of the curve, one acts at the tailend. As a famous Wall Street axiom goes,

Bulls make money, bear make money but pigs get slaughtered.

The desire to improve one’s grasp of the markets requires further scrutiny and goes beyond the conventional analytical methodology.

Moreover, many want to use the stock market to talk themselves or bloat their egos.

Aside from the economic role, stock markets or financial markets have social aspects, which is evident by the bandwagon effects.

More quotes of wisdom

Jesse Livermore: I began to realize that the big money must necessarily be in the big swing. Whatever might seem to give a big swing its initial impulse, the fact is that its continuance is not the result of manipulation by pools or artifice by financiers, but depends on underlying conditions. And no matter who opposes it, the swing must inevitably run as far and as fast and as long as the impelling forces determine.”

Jesse Livermore: In actual practice a man has to guard against many things, and most of all against himself—that is, against human nature.

The basic lesson from the above is that in order to protect one self, one needs to practice self-discipline which means controlling emotions or egos (Emotional Intelligence), as well as, to understand the underlying conditions of the marketplace.

As I previously noted, relying on tips and rumors can be a disastrous proposition.

Manipulators are hardly responsible for losses incurred by market participants. In reality, it is the self who is mostly culpable. Worst, it is policies of political authorities that influences people’s incentives to become short term oriented and to undertake reckless activities and makes them vulnerable to bubbles and to manipulation.

Are High IQs Key to Successful Investing?

Yale Professor Robert Shiller thinks so.

Writing at the New York Times,

YOU don’t have to be a genius to pick good investments. But does having a high I.Q. score help?

The answer, according to a paper published in the December issue of The Journal of Finance, is a qualified yes.

The study is certainly provocative. Even after taking into account factors like income and education, the authors concluded that people with relatively high I.Q.’s typically diversify their investment portfolios more than those with lower scores and invest more heavily in the stock market. They also tend to favor small-capitalization stocks, which have historically beaten the broader market, as well as companies with high book values relative to their share prices.

The results are that people with high I.Q.’s build portfolios with better risk-return profiles than their lower-scoring peers.

Certainly, caution is needed here. I.Q. tests are controversial as to what they measure, and factors like income, quality of education, and family background may not be completely controlled for. But the study’s results are worth pondering for their possible implications.

So how valid is such claim?

Let’s get some clues from some of my favorite investors.

Here is the legendary Jesse Livermore (bold emphasis mine)

The market does not beat them. They beat themselves, because though they have brains they cannot sit tight. Old Turkey was dead right in doing and saying what he did. He had not only the courage of his convictions but also the intelligence and patience to sit tight.

When I am long of stocks it is because my reading of conditions has made me bullish. But you find many people, reputed to be intelligent, who are bullish because they have stocks. I do not allow my possessions – or my prepossessions either – to do any thinking for me. That is why I repeat that I never argue with the tape.

Mr. Livermore simply posits that intelligence can be overwhelmed by egos and cognitive biases (particularly in the second quote the endowment effect, Wikipedia.org—where people place a higher value on objects they own than objects that they do not.).

Here is the 10 investing principles by another investing titan the late Sir John Templeton

1. Invest for real returns 2. Keep an open mind 3. Never follow the crowd 4. Everything changes 5. Avoid the popular 6. Learn from your mistakes 7. Buy during times of pessimism 8. Search worldwide 9. Hunt for value and bargains 10. No-one knows everything

More from John Templeton

“Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

Here is value investor turned crony, Warren Buffett. I’d say that Mr. Buffett’s original wisdom has been a treasure. (bold emphasis mine)

‘I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.’

‘Read Ben Graham and Phil Fisher read annual reports, but don’t do equations with Greek letters in them.’

‘Never invest in a business you cannot understand.’

‘You’re neither right nor wrong because other people agree with you. You’re right because your facts are right and your reasoning is right – that’s the only thing that makes you right. And if your facts and reasoning are right, you don’t have to worry about anybody else.’

Does all the above sound like high IQ stuff? Evidently they represent more common sense and the school of hard knocks stuff.

Yet to the contrary, high IQs can translate to portfolio disasters.

The landmark bankruptcy by Long Term Capital Management in 1998 had been a company headed by 2 Nobel Prize winners. The company’s failure has substantially been due to flawed trading models.

In 2008, the 5 largest US investment banks vanished. These companies had an army of economists, statisticians and quant modelers, accountants, lawyers and all sort of experts who we assume, because of their stratospheric salaries and perquisites, had high IQs.

When Queen Elizabeth asked why ‘no one foresaw’ the crisis coming, the reply by the London School of Economics (LSE)

"In summary, Your Majesty," they conclude, "the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole."

Imagination had been scarce because the same army of experts heavily relied on mathematical models in dealing with investments. They did not follow the common sense advise by the real experts.

My favorite iconoclast author Nassim Taleb in Fooled by Randomness offers an explanation (emphasis added)

it is also scientific fact, and a shocking one, that both risk detection and risk avoidance are not mediated in the “thinking” part of the brain but largely in the emotional one (the “risk as feelings” theory). The consequences are not trivial: It means that rational thinking has little, very little, to do with risk avoidance. Much of what rational thinking seems to do is rationalize one’s actions by fitting some logic to them.

What the consensus mistakenly thinks as rational is, in reality, the emotional. Thus, we need more Emotional Intelligence (EI) rather than high IQs

The most important observation or lesson is one of the repeated botched attempts by high IQ people to transform investing into ‘science’.

Well, because investing involves people’s valuations and preferences, all of which constitutes human action, in truth, investing is more than science…

As the great Ludwig von Mises explained. (bold highlights mine)

For the science of human action, the valuations and goals of the final order at which men aim constitute the ultimate given, which it is unable to explain any further. Science can record and classify values, but it can no more "explain" them than it can prescribe the values that are to be acknowledged as correct or condemned as perverted. The intuitive apprehension of values by means of understanding is still not an "explanation." All that it attempts to do is to see and determine what the values in a given case are, and nothing more. Where the historian tries to go beyond this, he becomes an apologist or a judge, an agitator or a politician. He leaves the sphere of reflective, inquiring, theoretical science and himself enters the arena of human action.

...but rather, investing is an art.

Again Professor Mises from the same article.(emphasis added)

The position of science toward the other values of acting men is no different from that which it adopts toward aesthetic values. Here too science can do no more with respect to the values themselves than to record them and, at most, classify them as well. All that it can accomplish with the aid of "conception" relates to the means that are to lead to the realization of values, in short, to the rational behavior of men aiming at ends.

Bottom line: The art of managing our emotions or emotional intelligence, via common sense and self-discipline, is more important than having high IQs.

Phisix Should Outperform as Global Markets Improve

And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I've known many men who were right at exactly the right time, and began buying and selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine - that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance. Jesse Livermore

Mechanical chartists will consider the present environment a sell.

That’s because the Phisix has joined her ASEAN neighbors (MYDOW- Malaysia, IDDOW- Indonesia and Thailand-SETI) into a transition towards the bearish “death cross”—where long term moving averages have gone above the short term moving averages.

As an aside, it’s a heresy for fanatic chart practitioners to know the fact that trading based on mechanical charting usually leads to needless churning, which benefits brokers, commissioners (like me) and governments (taxes) more than investors, due to the accumulated transaction costs that only hampers or diminishes on investor’s returns. Who cares about truth, anyway? For most people, belief is about social acceptance than of reality.

Never mind if trying to catch tops and bottoms of highly dynamic price actions of each securities driven by variable human choices under unique circumstances would seem like fictional heroine Alice—of the famed Charles Lutwidge Dodgson known under the pseudonym Lewis Carroll’s fable—who tries to ascertain if Wonderland was a reality.

To quote the legendary Jesse Livermore via Edwin Lefevre through the classic Reminiscences of a Stock Operator[1]

The reason is that a man may see straight and clearly and yet become impatient or doubtful when the market takes its time about doing as he figured it must do. That is why so many men in Wall Street, who are not at all in the sucker class, not even in the third grade, nevertheless lose money. The market does not beat them. They beat themselves, because though they have brains they cannot sit tight.

Feeding on emotional impulses and cognitive biases only deprives market participants of the needed regimen of self-discipline and importantly narrows a participant’s time preference in conducting risk reward analysis in the silly pursuit of short term “frequent” gains but at the risks of the magnitude of greater risk.

Again the legendary Jesse Livermore

Disregarding the big swing and trying to jump in and out was fatal to me. Nobody can catch all the fluctuations. In a bull market your game is to buy and hold until you believe that the bull market is near its end. To do this you must study general conditions and not tips or special factors affecting individual stocks.

It is important for market practitioners to realize that what counts is the magnitude of the effects of one’s action than of its frequency[2].

Frequency will mostly be about luck while magnitude will account for the impact of patience, discipline and mental rigor.

Going back to the big picture, given that the developed economies has once again embarked on undertaking policies to substantially ease financial conditions, which this time includes developed markets periphery and some emerging markets, e.g. Australia recently joined Turkey, Brazil and Indonesia to cut policy rates[3], we may be looking at the next leg of the boom phase of the present bubble cycle.

Outside another round of exogenous based political spooks, market internals in the Phisix appear to be showing meaningful signs of improvements.

While volume still lacks the vigor of a strong recovery, possibly due to the sluggishness brought about by the extended holiday from an abbreviated trading week, signs like average number of trades (computed on a weekly basis) seem to be holding ground and showing incremental improvements.

To consider this week’s losses in the Phisix seem to reflect on the weakness of the global markets.

My interpretation of last week’s action was one of natural profit taking following a strong push from the previous weeks. The correction of which only used the Greece political circus as an excuse to take profits.

For instance, the US Dow Jones Industrials saw a winning streak of 5 consecutive weeks which accrued gains of 12.92%, but gave back 2.03% this week for a retracement of 15% from the previous gains.

The Phisix seem to reflect on the same motions, the local benchmark racked up 11% over the same 5 week period where US markets went up, but lost 1.43% this week equivalent to a 13% retracement.

Yet over the broad market, except for the financial sector which was largely unchanged, the mining sector led the losses which weighed mostly on the local composite bellwether.

And this week’s losses have hardly dinted on foreign sentiments, which as stated last week, the present recovery appears to be accelerating.

Again one of the major surprises has been that foreign investors has hardly been affected even by the September shakeout.

Finally, the Peso’s performance again appear to reflect on the actions of the Phisix.

The gap generated the other week seeems as being filled, using the current profit taking mode as pretext.

Nevertheless, since the outperformance and the momentum by ASEAN bourses seem to have been spoiled by the recent exogenous contagion, an easing financial environment will likely spur the next leg up, barring unforeseen circumstances.

My bet is that the Phisix’s ‘death cross’ along with the ASEAN counterparts are likely false signals that will become whipsaws soon, another failed chart pattern.

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[1] Gold-eagle.com Wisdom of Jesse Livermore 6

[2] See Dealing With Financial Market Information, February 27, 2011

[3] FT.com Growth fears prompt Australian rate cut, November 1, 2011

How To Go About The Different Phases of The Bullmarket Cycle

``I’m hopeful that the answer is obvious: the market reflects vastly more information than the individuals. Yet we persist in listening to individuals in order to explain the markets. Executives point to analyst reports or discussions in the media to try to understand what’s going on with their stock. The media find an esteemed strategist to explain yesterday’s market move. Don’t ask the ants, ask the colony. The market is the best source for understanding expectations.” Michael J. Mauboussin

I’d like to point out that NOT all bullmarkets are the alike.

Bullmarkets come in different phases which effectively translate to different approaches in the management of portfolios under such evolving circumstances.

Thus it would be a darned big mistake to treat bullmarkets like a one-size-fits-all or a “whack a mole”[1] game- where everytime a mole randomly pops out of the hole, one takes a whack at them with a mallet in the hope to score a point.

Unlike the whac-a-mole, the goal isn’t about scoring points. In the financial markets, the goal is about maximizing profits—unless there are more important sublime goals that supersedes the profit motive such as thrill-seeking or ego tripping (i.e. the desire to brag about the ability to “time the market”—which bluntly speaking is based MOSTLY on luck).

Nevertheless it always pays to first to identify the phases of the bullmarket before deciding on how to approach deal with it.

To borrow the bubble cycle as defined by market savant George Soros, we can note of the following phases[2]:

-the unrecognized trend,

-the beginning of the self-reinforcing process,

-the successful test

-the growing conviction, resulting in a widening divergence between reality and expectations,

-the flaw in the perceptions

-the climax

-the self reinforcing process in the opposite direction

Bubble cycles reveals of these recognizable patterns from the hindsight view (see figure 4).

Figure 4: Stages of The Boom Bust cycle

But unfolding bubbles can be identified real-time by the prevailing market actions, the psychology that undergirds market action, as well as economic data on credit dynamics. Remember, booms are always lubricated by credit—a sine qua non of all bubble cycles.

And this has been NO stranger to us.

For instance, the Philippine Phisix has had minor boom-bust cycles within the secular bullmarket cycle of 1986-1997 (right window).

One would note of the Soros boom tests in the two marked red ellipses which closely resembled the typical boom bust paradigm (left window).

In 1994-1997, the climax or the “massive flaw of perception” had been highlighted by the prominent label of “Tiger Economies”[3] (new paradigm) on the ASEAN-4, which of course, turned out to be a massive flop.

As a side note, let me tell you that the Philippines won’t be anywhere near a Tiger Economy UNTIL we learn to adapt and embrace economic freedom as a way of life. Boom bust cycles will not substitute for real growth from free trade. Instead what these policy induced actions will bring about is a false sense of prosperity and security which eventually will be unravelled.

Yet, if we read or watch media, and assume that the people imbues what media says as gospel of truths, then the prospects of a “Tiger Economy” remains an ever elusive dream. As corollary to this, the belief in the salvation by the political leadership who is assumed to take the role as economic messiah is a sign of either ignorance or immaturity or dogmatic espousal of superstition as truth.

Going back on how to read market cycles, the point I wish to make is that one should be cognizant of the operational phases of the market cycle, and adapt on the actions that befit the underlying circumstances.

At present, I would say that the Phisix has been transitioning from the “successful test” towards the “growing conviction” phase.

Figure 5: PSE Sectoral Groups: Industry Sector Rotation and Tidal Flows

And this phase will be characterized by sporadic explosive moves on select issues. But these activities will be rotated among specific issues or among issues within sectors.

So issues or sectors that may seem to have been in dormancy or has materially lagged will likewise see rejuvenated price movements overtime, while current market leaders may stall or temporarily underperform. Remember the axiom—no trend moves in a straight line, this should always apply. Otherwise those that manages to move in temporary defiance of this, would eventually pay a steep price later (Remember the BW scandal?). Hence, every action has its corresponding consequence.

And as the major benchmark continues to rise; the price levels of almost ALL issues will likewise keep in pace but differ in terms of degree, the timing and the time-motion of each price actions. But eventually, the cumulative actions would produce a net effect of having the “rising tide lifts all boats” phenomenon.

This has long been our Machlup-Livermore model.

For instance, today’s top performing sectors used to be last year’s laggard and vice versa (see figure 5).

During the last quarter of last year, the mining industry (black candle) and the service sectors (light orange) led the Phisix (red circle), and all the rest (red-banking, blue-holding, green-commercial Industrial and maroon-property) performed dismally.

And up to this point, last year’s top performers have essentially traded places with last year’s laggards, where the latter have taken much of the today’s limelight. Remember the proclivity of the crowd is to read today’s action as linear, hence while crowd may be right in major trends they are always wrong during turning points. And this applies both to specific issues and general activities on the marketplace.

And one of the latest spectacular moves has been in the property sector (maroon) which has likewise been among laggards going into July (the property sector was the third worst performer then).

But last week appears to be payback time for key property issues, as the property benchmark spectacularly skyrocketed by over 8% to nearly take the top spot which it now shares with the leaders.

And I’d venture a guess that based on the relative impact of inflation on stock market prices, today’s laggards will be doing a redux of last year’s actions soon.

To be blunt, the rotational effects will buoy the service sector and the mining industry. And a glimpse at the chart seems to show that such phenomenon may have already commenced!

Let me add that as the growing conviction phase deepens (I would presume that a break above the 2007 high should underscore this), the frequency of rotational explosive moves will increase.

Thus, trying to “time the market” will only result to missed opportunities, the chasing of higher prices and an increasing risk exposure to one’s portfolio.

Bottom line: We shouldn’t essentially “time” the market per se as the mainstream would define it, instead we should identify, read, analyse and act according to the whereabouts of the bubble cycle.

In other words, any “timing” must focus on the possibility of the emergence or rising risks of a major inflection point, in accordance to the stages of a bubble cycle. Meanwhile, all the rest of the one’s subsequent actions should be focused on the virtues of “waiting” and some “rebalancing”.

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[1] Wikipedia.org, Whac-A-Mole

[2] Soros George, The Alchemy of Finance p.58

[3] Wikipedia.org Tiger Cub Economies