Ibex Salad Blackballed

In an attempt to find something the writer may or may not have written at some point in the past, we entered a couple of words in the Google search widget on the sidebar of this blog. Clicking on the ensuing results gave us this dismal warning:

Notice - If you visit this website, your computer could be damaged.

Interpretations from the audience always welcome.

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What Goes Around, Comes Around

Rarely (not to say never) mentioned in the literature on the mechanics of asset price bubbles is the mass of participants, always entering late and therefore doomed, that can only be called hedgers. In the case of the dot-com affair, for example, this implies the entry of multitudes of innocents convinced that the risky option was missing out on the bonanza - in normal parlance, the opportunity cost was too excessive not to be hedged against. Compounding the situation, in the case of recent real estate hyperinflation in Spain, was the mass of legitimate buyers who forced themselves into the market in order to avoid the seemingly inevitable fate of never being able to afford a home. To accommodate this lot, as the pool of flush but sensible buyers dried up, the Spanish banking industry concocted the 50 year mortgage. As the reader can see from the table, the strategy of doubling repayment periods nets fewer and fewer more eligibles at every stage. The last, from 24 to 48 years moves down the income ladder by a mere 139€ a month. Clearly it was a sign of desperation on the part of an entire industry.

Having, in 2007, reached the depths of diminishing marginal returns to this game (notice that doubling from 48 to 96 years liberates only 39€ of monthly income towards the purchase of a 100,000€ home at 5% fixed), the country's financial sector now finds itself being similarly bailed out of an untenable situation by the Banco de España. According to an article in Cotizalia (hat tip to David Murphy), the BE is personally supervising the calculation of 2008 bank results, on an individual basis, to avoid (read - extend out the self-same diminishing return time line) the insolvency of any. Targetting specifically loans to, and direct investments in, constructors and promotors that are still functioning but have no chance of remaining solvent over any medium term, the governor of the state bank, Miguel Ángel Fernández Ordóñez, is forcing his subjects to slowly begin writing down these investments now - against what, in normal times, would be considered pure operating profits. The assumption, a longshot in itself, is that there will continue to be same over the amortization period.

The reader should note that what is being questioned here, in contrast to the situation in the United States, is not the value of property itself, but the ability to remain out of bankruptcy of companies in the real estate business. The difference may seem a touch finely tuned - and might turn out to be nonexistent, but this writer thinks it takes into account that the deeply ingrained cultural belief that land is worth more than money might make (were it possible to effect) a short-British-property/long-Spanish-likewise a wealth conserving trade.

As to Mr. Murphy's question, the banks and kin sure won't remain solvent be if this latter doesn't hold - and he can certainly expect intervention at the level of the cajas de ahorros, soon.

*This behaviour is most noticeable around race tracks when the punter, having taken it on the chin betting a series of well-considered, short-priced cans of dog food, starts tiptoeing further out on the tail 'just in case' the 20:1 shot that caught his eye in the post parade actually comes across.

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Horse Sense

The writer has recently become enamored of the concept best expressed as 'the beating of dead horses' - that is, diminishing marginal returns. Describing a situation in which money or energy expended in extracting more out of a given known set of circumstances fails to be rewarded at the same rate as it did in the past, some examples would be:

1). The reciprocity failure of photographic films - which is a measure of the degree to which, above or below certain limits of light intensity, silver emulsions fail to respond in the expected fashion to changes in aperture or shutter speed. Simply, in very dark situations, cranking open the f-stop and holding the shutter button down for half an hour at a time might not produce you a picture;

2). The technical analysis indicator known as the RSI. Admittedly reversing the order of the cart and the beaten nag, it is nonetheless true that a series of prices that take the indicator from 50 to 70 will not, if repeated, get it from 70 to 90. Worse, eventually the RSI will reach a maximum for that input that no number of repetitions can violate. Hence, the absolute certainty of receiving 'non-confirmation' signals (or, better said, non-confirmation noises - seeing as they are mostly generated by the formula itself);

3). Nortel Networks. Now bankrupt, this company (much as the yet breathing Alcatel-Lucent), never really recovered from the diminishing returns that came on the heels of the religiously-held, and funded, belief that the limitless possibilities of the information highway would require equally untethered amounts of bandwidth - forever;

4). Overcrowded trades resulting from the simultaneous moves of too many practitioners of similar trading methods.

This last item merits its own bit of blather.

In the case of a company that takes on too much debt to invest in a line of business that suddenly becomes subject to diminishing marginal returns, the wrong move is paid for in the stock price and the correct procedure is to take one's lumps by downsizing and paying off creditors. However, a hedge fund manager, when faced with the same prospect - as slippage, for example, makes a mess of returns - actively looks to get fatter by borrowing money in order to goose the cash profits from which he gets his reputation and his cut, and was usually rewarded with people sending in more loot.

But in the case of long/short equity funds (which got beaten up early during the margin call phase of the present malaise) which might have depended heavily on certain corporate debt ratios to separate the wheat from the chaff, this raises the interesting possibility that they themselves, were they publicly traded entities, would be found on the short side of their own spread bets. Funny, isn't it? That investors seldom thought to look on them as functioning businesses before mailing in their cheques and money orders.

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Life On Planet Euro

We should be writing about things like the 12% that Grupo Santander has shed in the last 2 days on the Bolsa de Madrid (dragged down, not because of any S&P country rating but in RBS's wake). Or the fact that 4 of the 6 index banks are now trading below their fairly resistant lows of mid-November. Or even that, according to Reuters, the spread between Spanish interest rates (10 year, we assume) and their German counterparts remained stable, following a jerk of the knee, and that the item that took the brunt for the rating news was the euro itself - currently quoted at 1.29 to the buck.

But no. Instead we will wonder aloud about the phenomenally high levels of what can only be called 'self-satisfaction' - focussing almost exclusively on the man's racial background - oozing from Spain's TV stations in the runup to President Obama's inauguration.

Put it back in your pants, kiddies, before you cream yourselves. There are no bragging rights to be had here. It ain't your country, you didn't vote for him and it'll be a thousand years before we see anybody named Ibrahim, or even a Gypsy named Sánchez, in the hot seat of this country, or any other in Europe.

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Disinterested Parties

Hitting the wires yesterday was the news that the Spanish anti-corruption prosecutor was investigating the relationship between Banco Santander, Fairfield Greenwich and Bernard Madoff that has left various of Santander's private banking clients hung out for a 2.3 billion euro drying. Notwithstanding that at least one news report (from a daily in Botín's home town of Santander), dated the same day, has the fiscal denying that this is the case, the possibility that a bank is operating outside the law immediately brings to mind the case of Rumasa, the business empire that was removed from the control of its owner by the state just shy of 25 years ago.

This writer will not argue with the generally held opinion that the nationalization of the conglomerate that was generating 2% of Spanish GDP at the time was politically motivated. After all, its president, José María Ruiz Mateo, was a more than very important supporter of various organizations that would have liked nothing better than to see the very young Spanish democracy of the time put to a quick death. On the other hand, he sure made it easy for them.

At the centre of the government's legal justification lay the claim that Rumasa, because of the incestuous relationship between his banks and the rest of his holdings, was unstable enough to threaten the entire Spanish economy. In more specific terms (and very simply put), Banco Atlantico was lending too much money to other company divisions on the basis of inflated, internally assessed, collateral values.

Not that we mean to imply that either Banco Santander or Emilio Botín are to be compared to Rumasa or its principal owner with respect to accounting practices (or anything else) - except to the very great extent that the entire amalgam of Spanish financial institutions, construction companies and property developers ended up functioning identically to that 1983 threat to the Spanish economy. As Université de Montréal economics professor, Ricardo Verges*, points out in various papers, the banks and cajas who had lent to property developers had an undeniable interest in overvaluing these assets prior to lending the money to their other customers, home buyers. Add to the mix the multiple cases in which institutions held actual equity stakes in large constructors and the interesting fact that Tinsa, the dominant Spanish property assessor, is owned by the cajas de ahorros.

At its peak the real estate business constituted 20% of Spanish GDP. Rumasa's 2% pales at the side of this inadvertantly created monster.

*Sr. Verges' publications on real estate economics are true gems. Written primarily in French and Spanish, with a few in English, they can be found here. Well worth the visit.

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Pidgin 101

One of the things to which innocent foreigners in Spain must learn to adapt, even if they have gone to the trouble of making themselves fluent in the language, is the often very tenuous relationship that words here have with the reality they are intended to depict. To haul out an example from the overmuch-parodied Iberian attitude towards time, the reader might consider the expression, ahora después. Literally, and unambiguously, translated in to English as 'now later', the speaker uses it to give the listener assurances concerning when a certain event (for example, the repair of a broken water pipe) will take place. Noting that the construct gives its user a tremendous amount of leeway before he could rightly be judged as an incompetent and devious prick, one could easily interpret this as being a self-serving lie but, because of the pervasiveness of these verbal inventions in Spanish usage, we doubt that this kind of cynicism is actually warranted. What imaginable advantage to its utterer is offered by telling someone, for example, to carry and place something to the sysiphean location, payá pacá (transliterated, no point in looking it up or commenting on our spelling) - 'over here, over there'?

On the other hand, one would be a fool not to ascribe evil intent to the fairly widespread Spanish belief that 'unemployed' and 'working' are not mutually annulling states.

In this regard, both aficionados and professionals of the now wildly popular blood sport, macro-economics, will have noted with some glee that the unemployment rate in Spain has recently managed to make it to the 13% level and, better still for those looking for divine justice on the Costa del Sol, nearly 19% in Andalucía. Quite obviously at levels that echo the Great Depression, this latter figure is up from the 2006 record low of 11% - we repeat, 2006 record low of 11% - occuring in a year in which (if we recall) it was estimated that 350,000 foreigners, being a number almost equal to the unemployment rate itself, were also labouring in the sunny south. The question concerning how 11% unemployment translates to full cannot help but pose itself.

The answer, oddly given the introduction to this piece, lies in the Andalusian trick of being rich and poor at the same time, and the effect this has on electoral politics and the region's relationship with the European Union. In the first case, Andalucía has found itself governed by the same political party and the identical president for almost the entirety of its democratic history - despite the fact that the PSOE is categorically not the people's choice in most of the provincial capitols. Power is won through the overpopulated rural towns and the best way to ensure that this continues is to not force country folk to look for work in the city. The political policy that accomplishes this feat is the non-enforcement of laws governing the receipt of unemployment benefits - particularly that peculiarly ill-conceived one that says that if one is working one is not eligible. Votes paid for and delivered thus, the Junta de Andalucía can now turn its attentions to Brussels, flashing its credentials as an officially disadvantaged region on the basis of this untreatable lack of jobs to bring home the subsidy bacon - later to be reconstituted to its original raw pork, thrown in a barrel, and distributed amongst the hungry faithful.

A more realistic look at the unemployment rate might have placed it at something along the line of 4% (an acceptable full employment figure, we think) in 2006. And currently? If it is any indication, the present olive harvest in this part of Andalucía is more than ever in the hands of immigrant labour, of which there is a huge surplus seeing as what is left of the under-the-table positions that they occupied in the boom are being taken by some not inconsiderable percentage of the recently dismissed Spanish workers.

One would be less than rigorous if he or she were to assume that this scenario is not replicated to one degree or another throughout the country. After all, even in the good times, the underground economy was thought to be 25% of the official.

And one more doubt... the graph at the top of the page shows the raw unemployment numbers for the agricultural sector from 2004 to the present. The red line at the top represents 2008. Was there a drought that we missed, did people stop eating - or did somebody inadvertantly open the hotcold spigot?

Chart courtesy INEM.

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Portfolio Stuff

To bring the portfolio in line with our suspicions concerning Christmas market strength, we have put on a short position in steel maker, Acerinox at 12.04€. Currently trading at 40+% above October panic lows and having twice retreated from clearly defined resistance at 12.50€ since mid-December, it looks fairly vulnerable to continued bad industrial production statistics.

Not that we acted on them, but our late-November doubts concerning the outstanding performance of Viscofán proved to be prescient. From star performer, today's 13.33€ close has reduced it to slightly better than a breakeven proposition. On the brighter side, the IBR/ITX pair put on at the time of the writing of that entry has finally begun to behave as envisioned. Going long Iberdrola Renovables was the correct decision but, clearly, we started kicking Inditex long before it was actually down. A dismal Christmas shopping season, however, now has the spread a few points to the good.

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Movable Feast

Among the interesting events to take place over the festive season was a mass conversion, it seems, of investors to the optimists' camp. Sensing that a slab of rock was being removed from the entrance to a tomb, the writer quickly consulted his calendar to assure himself that it was, in fact, Christmas, and not the Easter that seems to be the consensus opinion concerning the event being celebrated. Of course, Wall Street enlisted far more adepts and true believers from the ranks of particle physicists than it did from the semiotics departments of the Ivy League.

Aside from revealing the fact that the writer was, when tested 40 years ago, outstandingly mediocre at mathematics but way out on the right tail when it came to literary comprehension, the truth is that we are less than totally convinced that the S&P will break 1000 by month's end - as appear to be some 20% of respondents to Macro Man's poll - or even that it will find itself losing a maximum of 3 percent, as seem to believe some 60% of those that took the trouble to vote. Then again, there would be an acceptable symmetry if all those that went long on the basis of exaggeratedly unbalanced negative sentiment in the diminishing light of October were to get their revenge in January.

Among the items which continue to concern us are:

1). The recent considerable loosening of credit markets will certainly save many corporations from the fate of not being able to meet operating obligations. But will it cause them to suddenly start making money?;

2). The quintessential one-trick Spanish bubble economy, as Edward Hugh rightly has been pointing out for some time, seems to be hurtling headlong towards price deflation. The most recent report (still subject to revision) has year on year CPI at a skimpy 1.5% - a year ago, Spain headed euroland with regard to this statistic. The degree to which the reader might think this either a mere special case or a coalmine canary would determine what he or she thought were the probability of a recuperation of consumer spending over the near term;

3). We, for no concrete reason, have a hard time believing that all the bad news concerning the banking sector anywhere is out, although we are not sure that new lows will be made;

4). The birth of Christ, beyond being the sine qua non of the tale that was to follow, is essentially irrelevant to western story telling. Easter, on the other hand, is so fundamental that it makes appearances at any and all perceived conjunctures, regardless of season or reason.

Perhaps Trevor could be convinced to key up a Northrop Frye plug-in for our charting program.

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An Epiphany

Only now stepping wearily out of the very long stay in the Spanish Christmas decompression chamber, the writer decided to reintroduce himself to reality by doing the accounting for the olive harvest. Certain features stand out.

1). The crop was considerably smaller than it had led us to believe it would be. The culprits behind this sleight of hand? Small fruit and an absolute concentration of same on the visible outside of the tree;

2). The oil yield is off 3 points from normal years. Given that this figure is usually 25%, that translates into a 12% drop in the production of the stuff we actually sell. Behind this, we think, is the unusually cool weather right through June;

3). The olive oil extracted, which will be more or less equivalent to last year, is facing prices that date back to 2002 - 30% less than year-ago levels;

4). The end result of the effort, if prices remain stable at these levels, will be approximately a wash.

Quite obviously, a rethinking of the whole effort will be in order.

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