Wednesday, July 25, 2012

Dangerous Dynamic Or Big Buying Opportunity?

Nathaniel Baker of Bloombeg reports, Bridgewater Sees ‘Dangerous Dynamic’ as Largest Economies Slow:

Bridgewater Associates LP, the hedge fund founded by Ray Dalio that manages about $120 billion in assets, said the global economy is facing the threat of a self- reinforcing decline after the world’s largest economies slowed in recent months.

Global growth has slowed to about 1.9 percent “in the past few months” from around 3.3 percent as Europe deleverages and China’s economic is cooling, the Westport, Connecticut-based firm estimated in its second-quarter report, a copy of which was obtained by Bloomberg News. Bridgewater also said the European debt crisis has been poorly managed, bringing Europe closer to a “debt implosion” or a currency collapse.

“The breadth of this slowdown creates a dangerous dynamic because, given the inter-connectedness of economies and capital flows, one country’s decline tends to reinforce another’s, making a self-reinforcing global decline more likely and a reversal more difficult to produce,” Bridgewater said in the report.

Bridgewater, which had three of the industry’s 12 best- performing funds last year, said Europe is in the “most critical” stage of a global deleveraging process, as deteriorating finances in France and differences with Germany make it less likely that the region’s strongest economies will pick up the tab to solve the region’s debt crisis.

The International Monetary Fund last week cut its 2013 global growth forecast to 3.9 percent from the 4.1 percent estimate in April, as Europe’s debt crisis prolongs Spain’s recession and slows expansions in emerging markets from China to India.

Moody’s Rating

Euro-area bonds fell today after Moody’s lowered the outlook to negative for the Aaa credit ratings of Germany, the Netherlands and Luxembourg. Moody’s cited “rising uncertainty” over Europe’s debt crisis. It left Finland as the only country in the 17-nation euro region with a stable outlook for its top ranking.

“We think that the popular assumption that the Germans and the ECB (which requires agreement of the key factions within it) will come through with money to make all of these debts good should not be taken for granted,” Bridgewater said. “We think there are good reasons to doubt that the European bank and sovereign deleveragings will be prevented from progressing to the next stage in a disorderly way.”

Financial markets have begun to discount weaker economic growth, as evidenced by the rise in credit spreads, fall in bond yields and lower future earnings expectations, Bridgewater said.

Earnings Miss

United Parcel Service Inc., the world’s largest package- delivery company, today cut its full-year forecast after a drop in international package sales dragged quarterly profit below analysts’ estimates. Yesterday, McDonald’s Corp. reported second-quarter profit that trailed analysts’ estimates amid slowing U.S. same-store sales and said the restaurant chain may miss its full-year operating income growth target.

The Standard & Poor’s 500 Index has declined 4.1 percent since the end of the first quarter, and global stocks are down 8.2 percent.

A “meaningful deleveraging for an extended period of time” is now priced into the market, Bridgewater said. With this pricing at a “midpoint of discounted expectations,” individual markets have an equal probability of outperforming or underperforming.

Bridgewater, which uses a macro strategy as it seeks to profit from economic trends, placed diversified bets in 2011 after predicting a flight to safer assets such as U.S. Treasuries and German bonds. Dalio’s Pure Alpha hedge fund made $13.8 billion for clients last year helping the manager beat rivals such as John Paulson, who posted a record loss of 51 percent in 2011 in one of his biggest funds. Bridgewater money for institutional investors such as pension funds, endowments and foreign governments, according to its website.

According to Bloomberg, John Paulson told clients he sees a 50 percent chance the euro will unravel:

An event causing a breakup may happen in three months to two years, Paulson said on a conference call today reviewing second-quarter performance, according to the investor, who asked not to be named because the call was private. Paulson, who runs Paulson & Co., said he expects sovereign yield spreads to widen.

Paulson, who posted a 16 percent loss from one of his largest funds in the first half of the year, told clients in February that Greece may default by the end of this March, and said the European currency is “structurally flawed and will likely eventually unravel.”

Armel Leslie, a spokesman for the $22 billion firm in New York, declined to comment.

Paulson is seeking to recoup losses after his Advantage Plus Fund fell a record 51 percent last year following failed bets on a U.S. economic recovery.

Paulson said on today’s call that his firm has reduced risk at some of its funds, according to the client. So-called net exposure in its Advantage funds, which seek to profit from corporate events such as takeovers and bankruptcies, is now 11 percent; at the Credit funds it’s minus 9 percent; and at the Recovery funds, which bet on assets Paulson believes will benefit from a long-term economic advance, it’s 31 percent, the investor said.

Paulson is desperately trying to recoup losses, trying to bounce back. But as he shifts from using an event-driven approach to more of a global macro approach, it remains to be seen whether he'll be successful. I remain extremely skeptical and wrote all about the rise and fall of hedge fund titans.

Other hedge funds are optimistic that Europe will work through this mess. Nelson Schwartz of the New York Times reports, Hedge Fund Places Faith in Euro Zone:

Marc Lasry has never been afraid to go his own way.

While other Wall Streeters who supported President Obama in 2008 are rushing to distance themselves from the White House, Mr. Lasry remains one of the president’s most loyal backers.

He loaded up on Ford Motor bonds in late 2008 and early 2009 when it seemed that the company might join Chrysler and General Motors in bankruptcy, and made a bundle when it did not.

And after markets rallied in 2009 and 2010, instead of holding out for more gains, he took money off the table and returned $9 billion to investors in his hedge fund.

Now, even as Europe’s economic problems worsen and the markets punish giants like Spain and Italy, Mr. Lasry is betting on a long-term comeback for the Continent. This month, his hedge fund, Avenue Capital, finished raising nearly $3 billion for a fund that will invest in the debt of troubled European companies.

He has committed roughly $75 million of his own money to the new fund. That’s still a small part of his estimated $1.3 billion fortune, but Mr. Lasry is among a coterie of hedge fund and private equity managers who are gambling that the euro zone will stay intact and revive over the long run.

Besides Avenue, Blackstone and Kohlberg Kravis Roberts plan to buy assets in Europe and in some cases already have done so, as have other well-known money managers like Leon Black of Apollo Global Management.

Not that Mr. Lasry is expecting a quick turnaround for Europe. “It’s not a three-month bet or a six-month bet,” he said. “It’s a three- to five-year bet.”

Last week, renewed worries about Spain’s ability to keep borrowing sent stocks in Europe tumbling and sparked about a 1 percent decline Friday on Wall Street, though the major United States indexes were up slightly for the week. Mr. Lasry and Richard P. Furst, a senior portfolio manager at Avenue who directs the European strategy, say they expect worries about the Continent to keep rattling the markets, creating buying opportunities for the new fund.

So far, Mr. Lasry and Mr. Furst have put 25 percent to 30 percent of the fund to work, deploying an additional 5 percent or so each month.

“We could invest the whole fund today but you want to average in,” said Mr. Furst. “There will be relief rallies, but when the fear comes back in, we buy.”

The two money managers are using the broader fears about Europe to load up on troubled debt of companies in healthier countries in the region. The biggest chunk of the new fund’s assets have been invested in Britain, followed by France, with purchases in Sweden and other northern European nations, as well.

They are avoiding Greece, the country where the euro zone crisis began, and the home of one of their more notable mistakes, a losing bet in 2010 on the debt of a Greek casino operator in an earlier European fund. That position has steadily lost value as Greece’s outlook has deteriorated. Mr. Lasry and Mr. Furst are also steering clear of troubled giants like Spain and Italy.

Instead, they see opportunity as banks in Europe come under pressure from regulators to shrink their balance sheets and unload debt at deep discounts. Financial institutions also are focusing on home markets, prompting Italian and Spanish banks, for example, to sell off debt from other countries.

In Britain, Avenue’s bets include the debt of Punch Taverns as well as Travelodge, a hotel operator burdened by heavy borrowing from an unsuccessful 2006 $1.2 billion buyout by Dubai’s sovereign wealth fund.

“Travelodge is a good business but they’re having trouble in the current economic environment,” Mr. Lasry said. Another sizable investment is in Preem, the largest oil refiner in Sweden.

In Preem’s case, Avenue bought bonds from holders based in the United States, while Punch’s debt was purchased from British insurance companies. Travelodge’s debt was acquired from banks in Britain, Italy and Ireland.

In all three cases, Avenue’s traders benefited because investors were itching to get out of anything European, even though Sweden and Britain aren’t being directly buffeted by the problems in the euro zone and have their own currencies.

“Bad things happen in Spain and Greece, and people want to sell bonds in a refiner that’s doing well,” added Mr. Furst. “The perceived risk is greater than the actual risk.”

After founding Avenue in 1995, Mr. Lasry initially concentrated on distressed debt of American companies. He invested in Asia after the financial crisis there in the late 1990s, earning big profits when it roared back. He started an earlier European fund in 2004.

The companies Avenue aims for in Europe tend to be midsize, with valuations of $250 million to $1 billion. The first European fund has five-year returns with percentages in the high teens annually, according to Avenue.

The strategy requires investor patience — and an iron stomach when volatile markets produce roller-coaster returns for Avenue. In 2008, Avenue’s total portfolio dropped about 25 percent as investors fled all kinds of assets amid the collapse of Lehman Brothers and the overall market downturn.

When markets recovered in 2009 and big holdings like the Ford bonds soared in value, Avenue’s returns jumped by 66 percent, followed by a 20 percent gain in 2010. Returns dropped 10 percent last year, while Avenue is up 10 percent this year, according to the fund. In all, Avenue has $13 billion under management.

Over all, Mr. Lasry’s family and colleagues at the firm have more than $800 million in Avenue funds.

“Marc is definitely adventurous,” said David Bonderman, a fellow billionaire who helped found the buyout firm TPG Capital. Mr. Bonderman was Mr. Lasry’s boss when they managed money in the late 1980s for Robert M. Bass, whose family originally made its money in oil before diversifying. “He’s willing to take contrarian risks and he’s willing to act promptly. Avenue doesn’t have a big bureaucracy.”

“It’s still somewhat early, but if you have a feeling that Europe and the euro aren’t going to collapse, it’s appealing,” Mr. Bonderman said.

“He looks at every dollar he has under management like it’s his own dollar, and that gives him a certain credibility in terms of raising money from investors and keeping them satisfied over the long term,” said Blair W. Effron, a co-founder of Centerview Partners, a boutique investment bank.

Mr. Effron, who is also Mr. Lasry’s brother-in-law, adds that he is a competitive athlete, especially in basketball and tennis.

Mr. Lasry, 52, was born in Morocco and came to the United States as a child. He trained as a lawyer before turning to distressed investing. About once a month, he travels to London, where Avenue has a staff of about 20 that focuses on opportunities in Europe. Over all, the firm employs 275.

From 2006 to 2008, one of those employees included Chelsea Clinton, and Mr. Lasry remains close to the Clinton family as well as President Obama. One of Mr. Lasry’s five children recently worked for the White House.

While other prominent Wall Streeters like Jamie Dimon, the chief executive of JPMorgan Chase, have backed away from the president, and others complain that the White House has used bankers as a piñata, Mr. Lasry is more like the last man standing.

Last month, he held a $40,000 a plate fund-raiser for President Obama at Mr. Lasry’s Fifth Avenue home, and later this month he plans to hold another fund-raiser for the president at Nomad, a Manhattan restaurant.

Unlike his fellow Masters of the Universe, you won’t find Mr. Lasry spending summers on Raiders Row or other luxurious Hamptons hangouts. He prefers lower-key Westport, Conn.

“I’m a value guy,” he joked. “I can’t afford the Hamptons.”

As for Europe, he seems happy to wait out the waves of fear, like last week’s anxiety about Spain.

“Europe isn’t going away, and the companies aren’t going away,” Mr. Lasry said. “You can never time a bottom. What you can do is a time a cycle and five years from now, people will say, ‘Why didn’t I buy?’ ”

Marc Lasry is right, Europe isn't going away but in our hyper-sensitive world dominated by social media, every tweet on Spain, Greece or China sends investors running for cover.

Speaking of China, the IMF said China's slowing economy faces significant downside risks and relies too much on investment, urging leaders to boost consumption and channel citizens' savings away from housing. Indeed, CNBC reports, Think Libor's Bad? Fake China GDP Is Worse:

A fake Libor rate, the scandal involving global benchmark interest rates that has raised the level of distrust in major banks and markets, is nothing compared to the damage that could be done if China's true economic growth figures were revealed, according to Larry McDonald's newsletter.

"Is Chinese GDP the new Libor?" asked McDonald, author of "A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers," in a much talked about note to clients last week. "More and more investors are starting to question the Chinese math on GDP."

Annual gross domestic product came in at 7.6 percent in the second quarter, according to China's government on July 13th. The report was better than investors expected, easing concern of a dramatic slowdown for the world's second-biggest economy and sparking a bid in risk assets like stocks that has lasted for two weeks.

But slowing imports and industrial production, as well as harder-to-fudge electricity usage data, points to much slower growth, according to McDonald and other investors. Barclays believes the number should have been more like 7.15 percent.

What worries McDonald, a former vice president at Lehman, is that lying by governments and banks - be it Libor rates or GDP statistics - raises the systemic risk to the markets, which is much worse than just economic risk.

"As difficult as economically driven market sell offs are, they do not compare to 2011, 2008, 1929 and 1907," wrote McDonald. "A look through history shows traditional economically driven sell offs range from 5-15%, or one standard deviation. Systemic risk sell offs, 2008 and 2011 are 25-50%, or two standard deviations."

Governments not being forthright is happening right now in Europe, with the Bank of Spain the latest to update its number of actual bad loans.

"One of the primary reasons for Japan's lost decade was their government's cover up of bank losses," said McDonald. "The faster pain is taken, the faster the return to healthy markets."

Have news for McDonald et al., all governments and all major banks continuously lie about the true state of the economy and the health of their balance sheets. Barring a social revolution, the banking mafia will never be broken.

Not everyone is buying the China crash story. Famous hedge fund manager Jim Rogers has dismissed fears of a hard landing in China, saying slowing growth is simply proof the authorities are managing the economy as they intended:

Rogers’ bullish views on China’s long-term economic prospects place him at odds with well-known China bears Hugh Hendry of Eclectica and SocGen’s Albert Edwards.

“Hugh has been dead wrong about China for three years now and China has not collapsed as he predicted, loudly, verbally and widely,” said Rogers.

“Albert has been bearish on everything for a long time. So if you are telling me he is bearish on China and bullish on everything else that would be different. But no, he is bearish on everything, including you, me and Mother Teresa.”

Hendry, who runs the CF Eclectica Absolute Macro fund, has refuted claims China will act as the main driver for global economic growth and is extremely bearish on Asia as a whole, while SocGen’s Edwards expects China to suffer an extreme hard landing which will prompt stocks to collapse.

China’s benchmark index hit its lowest level in three and a half years last week, and the region’s slowing growth continues to fuel investor concern. The Shanghai Composite index closed at 2,147 on Monday – its lowest level since March 2009 and 40% down on August 2009 highs of 3,471.

In March, Rogers told Investment Week he was banking on a sharp sell-off of Chinese shares as an opportunity to buy back in, and last week’s price falls have caught his attention.

“The lower they go, the more interested I become,” he said. A full blown share price collapse could be triggered by any kind of shock event, according to Rogers, from a bankruptcy in Spain, Italy or the UK, to rocketing inflation or a natural disaster.

“We have many problems facing the world and are set for some very serious problems in 2013 and 2014,” he said. China reported GDP growth of 7.6% in 2012, its slowest growth rate since 2009, and last week Premier Wen Jiabao issued a warning on the country’s stability and economic prospects.

But Rogers said these developments are just evidence the Chinese government is sticking to its long-term plan for the economy. “For three years China has announced publicly, loudly and clearly it is trying to slow its economy down. They wanted to pop their real estate bubble and do something about inflation so they have slowed things down. What is the surprise here? What is the news?”

China is bound to face challenges along its journey to success, just as the US did in the nineteenth century, added Rogers. “China will have problems as it rises. In the nineteenth century, the US had 15 depressions. It was a huge mess, but out of that came a successful country in the twentieth century. That is my view of China.”

Although he is pessimistic about the global outlook, Rogers expects China will be better placed to withstand any upcoming shocks due to its substantial foreign exchange reserves, he added.

I am in partial agreement with Rogers. I'm actually very bullish on America. In fact, as China costs rise, technology lures US factories home. Moreover, the global game changer will spark a US manufacturing renaissance. And for once I agree with Goldman, the US will experience a strong housing recovery as employment growth picks up pace and excess inventories are shed.

Strong housing is bullish for banks. In my opinion, US financials are cheap. And so are energy and basic material shares trading at ridiculous levels. Oil, nat gas, and coal shares in particular have all been decimated by Europe's ongoing debt crisis and exaggerated fears of a significant Chinese slowdown.

For all you pension funds with a 'long-term investment horizon', stop paying hedgies 2 & 20 for beta, and start scaling in and buying up financial, energy, basic material and technology shares at these levels. I don't see another repeat of last summer and think this selloff is yet another big buying opportunity.

Below, Ryan Detrick, Senior Technical Strategist at Schaeffer's Investment Research, who says the ''extreme worry" out there makes for the "ultimate contrarian play." Simply put, he says too many people are positioned for higher volatility as measured by record open interest in the VIX (^VIX). I agree, time to buy the fear!

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