Thursday, January 5, 2012

Merrill Lynch Bullish on Europe. Huh?

Merrill Lynch's Chief Investment Strategists are trying very hard to sound bullish on European investment prospects for 2012, in their most recent report.  How do they come up with this thesis, which might kindly be called counter intuitive?

ML opines that the initial auction of the LTRO, or the $500 billion bazooka, being oversubscribed by a factor of two is a positive sign for investors.  Say again?  ML feels that this is a clever mechanism for moving bad sovereign debt from the balance sheet of individual banks to the ECB balance sheet. 

It's one thing for Citigroup, as a private entity, to wall off questionable assets in a "bad bank" called  Citi Holdings.  It is another thing entirely, and not desirable, for a group of nations to create a "bad central bank."  Furthermore, ML claim that it's a good trade for European banks to borrow at 1% to acquire sovereign debt at 3-4%.  Really?

This questionable LTRO mechanism has kicked the can down the road.  I don't believe that it addresses any of the fundamental economic issues within the EU, nor does it build confidence in the future role of the euro.

Look instead at some of the private capital market developments.  UniCredit's shares fell 14% after announcing their rights offering sporting a 43% discount  to the previous day's closing share price; the discount is significantly larger than that of Commerzbank or HSBC's offerings.  Clearly, the capital markets are not sanguine about the outlook.

Italy floated a ten year note on 12/29/11 with a yield just south of 7%,  the LTRO notwithstanding.  Another no confidence vote from the market. 

Austerity in the face of recession will not make it easy for European incumbents who campaigned on the the "We've got it under control" platform.  And as we said right from the start of the European crisis, the interests of France and Germany would diverge, and they clearly have, perhaps wounding the political prospects of both national leaders.

ML's investment recommendations are large, European multinational equities: those companies with global business portfolios, limited need for access to capital markets, and good dividend yields.  These are defensive plays, not bullish trades, and they are last year's plays too. 

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