December 15, 2011 / 1:17 AM / 7 years ago

Insight: Trading EU summits: Hope to despair and back again

NEW YORK (Reuters) - Buy the rumor, sell the EU summit.

Eight times this year, European Union leaders have met to tackle their deepening sovereign debt crisis, raising hopes in financial markets that a solution could be close.

All eight times, the meetings have ended without a plan of action comprehensive enough to give more than a few days comfort to investors, often turning initial gains in stocks, the euro and European government bonds into declines within days.

“I guess that’s why they call them summits. You sort of go up on one side and come down the other,” said Gary Baker, European equity strategist at Bank of America-Merrill Lynch.

Investors’ lack of confidence in European leaders has become so ingrained that the time it takes for traders to begin dumping euro zone assets after each summit has grown shorter and shorter.

Strategists at Germany’s Commerzbank said it took 49 days from the first Greek bailout in 2010 for the cost of buying insurance against a Greek default to hit new highs.

When Ireland was bailed out later that year, it took 30 days, the bank said in a research note this week.

By the time Greece received a second bailout in April 2011, Greek credit default swap prices hit highs in just 14 days. Investors then moved quickly on to Italy. It took just 12 days for insurance against an Italian default to peak.

“Trading is like playing three-card monte these days — you’re always trying to guess what new trick policymakers will come up with and to what extent you can believe them,” said Michael Cheah, who manages a $1 billion fixed income fund at SunAmerica Asset Management in Jersey City.

Europe’s debt crisis has forced emergency bailouts for three countries and may, some fear, cause the euro itself to collapse and deal a blow to the global banking system.

Investors have had to re-learn the tools of the trade.

Tried and tested strategies such as picking stocks for value, a government bond based on interest-rate differentials or a currency because it is issued by a country with a strong economy seem almost quaint as political risk dominates.

As investors execute U-turns to avoid being trampled by the volatile markets, the new way that different assets increasingly move in lockstep has scared away buyers who traditionally trade on fundamentals like valuation.

That has tightened the relationships as the traders left in the market are those who buy and sell those assets — such as commodities, the euro and stocks — in tandem and often in a matter of a few hours.

Brown Brothers Harriman currency strategist Marc Chandler noted that the euro and the S&P 500 index of leading U.S. shares have rallied or sold off in lockstep for most of the year, an unusual linkage and a sign of how the twists and turns of Europe’s crisis are dominating trading beyond the continent.

In the 60 days to December 2, the direction and magnitude of their moves were correlated nearly the entire time.

And it’s not just markets that are correlated: Volatility levels are spilling over from one market to another, according to Credit Suisse.

“Without a doubt, this has been one of the most challenging years we have faced,” said John Taylor, chairman and chief investment officer at FX Concepts, one of the world’s biggest currency hedge funds with about $4.3 billion in assets.

FX Concepts’ Global Currency Program was down 17.8 percent through October and Taylor said the confusion surrounding the EU summits was at least partly to blame.

“When I figured out what was going on, I realized that the negativeness in my performance was the numbers of EU summits. Because every time there was a summit meeting I got crushed because they changed the rules every time they went through one of these meetings,” Taylor said.

“Now I am having an intervention more than every month from the Europeans and it looks like they will be meeting every month from now on.”

Traders said long-term investors such as mutual funds and pension funds long ago cut their risky positions and moved to the sidelines, both in equities and in sovereign credit markets.

The selloff of western European-focused debt funds has been relentless. So far in 2011, there has been a net outflow of $28.5 billion, Boston-based fund tracker EPFR Global says.

Flows are not the only change Europe has forced on Wall Street. Some U.S.-based traders have even had to change their sleep schedules.

“I advise everyone to check moves in European markets that take place around 2 a.m. or 3 a.m. our time,” said Don Bright, director and trader at Bright Trading in Chicago.


At the latest EU summit held last week, leaders agreed to impose stricter budget discipline. But Germany remained opposed to more action by the European Central Bank to support debt issued by Italy and Spain, a big hope of markets.

Nor is it clear the scale of planned new rescue funds, including loans to the IMF, will be enough.

Investors are left with few choices and since Europe’s problems are not going away, bets remain short-term.

“Since mid-year, we have ensured that our clients put their tactical cash to work, adding risk in anticipation of the various summits but making sure to encourage the nimble to take that risk off the table immediately before the summit occurs on the basis that, despite the fine words, nothing will be agreed,” said Jeremy Batstone-Carr, head of private client research at Charles Stanley in London.

“We regard the EU summits as a joke,” a U.S. fixed-income investor said on condition of anonymity. “We’re avoiding any long Europe trades. And all our long trades are in dollar-denominated assets, including in our emerging market debt portfolios.”

U.S. and European stocks have slumped this week and the euro has plunged below $1.30 for the first time in nearly a year. Italy’s cost of borrowing money for 10 years hit a euro-era high above 7 percent, levels that cannot be sustained given the slow growth in European economies.

“Increasingly people are realizing these are mature economies,” said Mark Dow, portfolio manager at Pharo Management LLC, a global macro hedge fund in New York. “This is not a Brazil or Turkey where ... there’s a natural growth rate that’s going to get you out of the problem.”


Hedge funds and traders with shorter-term strategies have been making money by following market momentum without committing to any long-term bets, largely because the underlying fundamentals have not changed. At best, investors see Europe escaping with a mild recession.

Joe Donohue, a money manager at Dimension Trading in Red Bank, New Jersey, said he gets “pretty active around the summits.” He has shorted the euro (FXE.P) and European stocks (EPV.P) through two exchange traded funds and is betting explicitly against financial stocks.

When asked how he was trading the currency markets amid all the euro zone summits, the first response of Pierre Lequeux, head of currency management at Aviva Investors, with $371 billion in assets, responded: “With difficulty.”

“Due to the high level of volatility that we are seeing in the markets, particularly around the EU summits, we have very little currency exposure,” said Lequeux. “On a scale of 1 to 10, I am closer to 2 in terms of the risk I can (take).”

Reporting by Ryan Vlastelica, Gertrude Chavez-Dreyfuss, Angela Moon, Daniel Bases and Steven C. Johnson in New York; Writing by Steven C. Johnson; Editing by David Gaffen and Phil Berlowitz

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