What Do I Do with My Euros?

Not so long ago I opened an independent Italian newspaper and counted just how many times the euro crisis was mentioned in the articles. Then I counted how many times the names of Monti and Berlusconi were mentioned. You might wonder what the trick was. That’s correct, there’s no such thing as an independent Italian newspaper.

The euro crisis is anyhow an exciting topic to follow insofar as many of us keep some portion of our savings denominated in euros.  Well, I do. Recent months have brought a weakening of the euro against the dollar and little insight into the future of the exchange rates. So I am asking, what do I do with my euros in order to hedge against their price fluctuations in the short- and medium-term?

As we know, there’s no other market as competitive as the foreign exchange market. That means the curve expresses the common opinion of all players as to the price of the underlying good/asset (in our case the euro) to the best of their knowledge. One important question is whether that price is fair.

It’s hard to believe that for the price to be fair, it has to change so rapidly and decisively each second. The state of the world is volatile, but not as volatile as the curve displays. It seems more plausible to have a slow-moving equilibrium over the long run (the ‘fair’ price), while the medium-term movements hover around it in shape of steeper trends. Technical analysis can be called the art of predicting the ‘unfair’ price movements, and the fair price is more easily predictable using the common understanding of the worth of the currency.

Long-term financial planning is warranted relying on the fair price opinion, but unless you and I are D. Trump and G. Soros, we probably won’t make much money on it. The more exciting scenario for our savings is to monitor the current trends, hopping on and off whenever the trends change.

Dr. Skryhan, my co-national foreign exchange market analyst,  presented his technical analysis of the current situation on the ForEx (the graph follows).

The upper curve is the price of one euro in terms of dollars over the past two years. The lower graph features the long-term trend (the turquoise histogram) and the local trend (the red histogram). Until last year’s peak of 1.4938, the euro had been ascending in value against the dollar. Ever since, however, the long-term trend – and seemingly the fair price – has been descending.

Technically speaking, shorting the euros a year ago was a good long-term decision. Despite the recent upward price movements, the general trend is descending. The explanation lies in largely unsolved problems within the European monetary union and the resulting uncertainty about the underlying worth of its currency.

This is not to say we can’t be bullish on the euro. Long positions are plausible for short- and medium-term. The price has overcome the upper limit of the correction range stated at 1.2520 (the resistance line) and continues its ascent to its medium-term target of 1.3383. Before the price reaches that point, the general opinion is to long the euro. The local resistance point is 1.2646, but we can already see the outlined trend towards the medium-term target (see the graph below). That might seem counterintuitive, given the amount of discouraging news from Greece, Spain and several other countries of the Eurozone. But the nature of the ‘unfair’ price tendencies is simply – unfair.

So what will I do with my euros? Hop on the ‘unfair’ price for about a month but keep watching. Time deposits denominated in euros is a bad idea today in case we look to keep our money safe and growing. The long-term roll-back of the euro might cancel the effect of the low interest rates of foreign currency deposits. Dollar-denominated deposits sound better if we are interested in long-term (around one year) and a more stable growth (safety) of our wealth. Short-term currency deposits are risky to marry with. I will more likely short the dollar against the euro today, but will return to it in the near future, hoping the spreads remain tight as they seem to be today.

Baltinsky Financial keeps an eye on the exchange rates and the major shifts in the industries and will continue doing so in the future.

Investment Banking: Industry Outlook

Today I would like to discuss the investment banking industry from the financial and strategic points of view. Where is it heading and how is it changing? Let me comment on these questions. I tried to make this short, but miserably failed.

Intro

It can be argued that, historically, the investment banking industry has been cyclical in its development. With the conception of the industry, there was little or no regulation for banks all the way through the Great Depression. The Glass-Steagall Act separated investment banking into a distinct industry governed by laws different from those of commercial banks. It was the first time that the investment bankers were put into a legislative framework that limited their capabilities, which led to a framework-reassessment by banks. The latter further shaped the industry until it became too different from the past that new laws needed to be put to action. I present to you a simple overview model of this process below. I will refer to this as an industry change model (IC-model).

As 2007 kicked in, the industry stumbled. The past industry changes had been no longer sustainable, and that cranked up the 3-step carousel again. I couldn’t be more artistic here, I’m sure.

Crime and Punishment

Bear Stearns and Lehman Brothers showed everyone what happens if you deviate from the laws of finance and common sense. The example was too good, however, and together with other financial troublemakers put into trouble the rest of the world. It brought economies to stagnation and underlined the danger of excessive debt.

Even though no major bank failed these years in Europe, all banks incurred massive losses, and some smaller banks did go out of business. In any case, investment banking became a tough industry to play in, at least in its 2007-2008 framework. High default rates of toxic derivatives in investment banks bit off a great chunk of bank assets and equities. Deutsche bank lost close to 30% of its equity in 2008 and only wrote down around $7.7 billion of its assets. For comparison, UBS lost $37.7 billion in write-downs, while HSBC lost in total $20.4 billion. And these banks are governed by thousands of extraterrestrially smart and presumably well-informed people.

Another reason the industry was tough was that, due to economic slowdown, business activity slumped and the markets turned bearish and highly volatile. Financial players put in question investment security and became reluctant to deal with the market the desired way. Apart from ill-fated mortgage bets investment banks had made previously, the ongoing business activity slowed down, bringing investment banks’ revenues further down.

Eventually, Greece, among other PIIGS countries, made matters impossible for regulators to overlook. The urge several years ago sounded to the tune of ‘Do something about your debt!’

Regulation: Thou Shalt Not Spend

I picked out three major reasons that brought investment banking to the first step of the IC-model I presented above. Below you can see the process, in which general economy problems trigger a regulatory tsunami (rhetoric used by Accenture in one of its reports), and the latter complicates the matters for investment banks.

Bankers hate regulation. In many reports and news releases regulation is viewed as a source of irritation by banks. One of the recent developments is an OTC Derivatives Reform; it implies spread tightening in trades and banks eventually having to compete on something other than price. Laws that restrict risk taking and set up new capital requirements are equally harming to the industry profits, as evidenced by Joseph Ackermann, Deutsche Bank CEO.

Even though the regulators certainly aren’t bankers, they aren’t complete idiots either. Problems are still evident in the investment reasoning of banks, and these problems may from time to time entail unpleasant news like the following. Some banks are still struggling to reap profits out of mortgage bets, while the mortgage market it still unhealthy. According to the DealBook of NYTimes, despite HSBC’s 2011 3^rd quarter profit rose, its investment banking branch saw a 50% fall in its pretax earnings. As a result of the losses, HSBC is planning on sale of some businesses, while exiting others. On top of it, HSBC is planning to cut 30000 jobs in an effort to cut costs. Stuart Gulliver, HSBC CEO, admitted that the sector is highly influenced by headwinds, such as financial regulation, market turbulence, political and economic uncertainty. Therefore, the need for increased capital requirements may be justified.

In any case, it seems that banks don’t know exactly in which direction the wind is blowing. On the one hand, the laws are trying to prohibit unreasonable risk-taking. On the other hand, they do it inconsistently and void of any coherent structure. Limiting profit opportunities and imposing direct and opportunity costs, legislators are wondering how to revive business activity and raise money. This is like yelling at your dog and wondering why it’s not happy with it.

Step 2: Framework Reassessment

Regulatory high tide essentially disturbs the status quo of the industry. Spurred by the various factors I mentioned above, the industry is undergoing a framework reassessment. I pointed out 4 areas where major reassessment is taking place.

It seems to me the industry is generally right here today, right on the second step of the IC-model. As more and more analysts are short on the markets, and less credibility is given to the sovereign debt, investment bankers are becoming wary of the increased risk factor of the investment bets.

Legislation is bringing in change into competition models and pricing of services. Accenture emphasized the necessity to re-focus on client needs, as the industry is getting tighter and allows customers to switch easier than ever among service providers. Some banks may have not grasped this need yet (as evidenced in a great article of a former Goldman Sacks employee that stunned the web), but they must do it. Value to customers is probably going to become a significantly more important benchmark for investment banks.

And, of course, the two points up there plus the re-assessed resources lead to re-formulating the strategy. Picking the right battles is up on the agenda of the Chief Whatever Officers today. Increased costs of risk taking influence the choice of business models and target markets. HSBC, UBS, Deutsche Bank, and several other banks in Europe alone are going to re-focus their activities on more stable and less risky business models.

Step 3: Industry Change

Senior bankers confirm that the industry will change as soon as the regulatory and the financial outlooks reach the equilibrium. Shifts in the business focus within some industry players will leave space for new entrants. On the other hand, existing players focusing on largely similar products will wound up offering new investment products and methods in order to compete effectively.

Joseph Ackermann confirmed in a recent speech the likelihood of a new M&A wave in the industry. Together with this, as profits become harder to reap, restructurings are going to happen, too.

Below I present to you my last graph reiterating my final conclusions on the industry’s near future and the 3^rd step of the IC-model.

Status as of Today

The status of the industry is such that it’s at its peak of uncertainty, maybe a bit over it. The bottom line is anyway the fact that a lot will be uncertain for investment banks in Europe and throughout the world in the short-run. Financial viability and strategic change will be a challenge banks will need to handle. All that is certain is that this is good news for consultancies who are going to service this change.

On Europe and Its Banking Industry

First of all, I’d like to use these first lines to thank everyone. Your recent words of support and encouraging evaluations have inspired me on continuing with the blog.

Special credit goes to the love of my life, who’s shown passionate interest and given me the strongest support in what I’m doing here. Additionally, I thank my family, friends, classmates, professors, and other ‘fellaz’ for their sincere words of encouragement. I also thank all the ‘silent’ readers, because I can still see all your names in my pageviews statistics... Just kidding, I only see your country and the browser you used. And your home address with a picture of you.

Without all of you, guys, the time I’m spending here would be, putting it mildly, a bit less worthwhile. So thank you!

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Plunging into the fascinating and incredibly exciting world of finance now. Yeah.

I recently had an honor to meet Josef Ackermann, CEO of Deutsche Bank. He was visiting Bocconi earlier this week with a speech on the state of Europe’s banking industry today. If someone is to listen up to, he is the one. Head of one of the 5 largest banks in the world, Ackermann is also a member of the supervisory board of Siemens, a member of the boards of Royal Dutch Shell and Zurich Financial Services, as well as an honorary professor of several European universities and a welcomed speaker at large international conferences like the World Economic Forum.

When this man isn’t happy, you know things aren’t right. Ackermann confirmed his worry that the banking environment in Europe has become more troublesome than ever. I developed and further researched some ideas he presented, and came up with the following conclusions on Europe’s economy and the banking sector.

The importance of Europe as a world’s financial center is eroding. Let’s look at some numbers. Back in 1999, 44% of the world’s top-25 banks were European. Europe was less exposed to the dotcom crisis and looked as a safe place for investment, as the leading economies were approaching the creation of a common currency, the euro. As of January 2012, only 16% of the world’s top-25 banks were from Europe, while the others were replaced by the banks from China and Brazil.

The number of European stock exchanges fell to 2 in the list of the world’s top-10 stock exchanges by market cap, while some of those previously on the list were replaced by China, India, and Brazil.

On top of that, European economies have been largely stagnant over the past couple of years. GDP growth in Germany was 3% in 2011, and is forecasted at the level below 1% for 2012. France, UK, Italy, and Spain only grew at 0.01-0.07% in 2011, while the growth contracted in Eastern European economies which are traditionally faster-growing ones.

Politics is sending conflicting signals to economy. It all started with the credit agencies (but hang in there – they’re not the ones to blame). They gave the legislators worrying signals that some economies, if not reformed, may have troubles meeting their obligations. In practice it means two things. One is that debt levels have to be reduced. The other is that yields on the existing sovereign debt will need to be increased, thereby increasing taxation and/or decreasing quality of public services.

What would you do as a European politician? That’s right, you’d go to banks and take their money. One completely… odd idea was the transactions tax proposed recently. Not only would it dramatically decrease banks’ earnings; it would also alienate many investors away from an already stagnant Europe.

Another reform, already enacted, is the requirement for banks to increase their Tier 1 capital ratios to 9%. The idea is to increase banks’ reserves and the quality of their portfolios. The outcome is, as evidenced by Ackermann, that banks need to resort to narrower business models and concentrate on core-activities. Additionally, as European sovereign debt is not anymore risk-free, banks are hurrying to de-leverage their portfolios and revise the risk profiles.

Apart from bad signals to economy, there are good ones as well. The problem, however, lies in the poor interaction of these pieces of legislation among themselves. EU politicians should agree on a strategic rather than an opportunistic approach to problem-solving within the Union.

Finally, the banking sector is getting less profitable. This is caused entirely by the above-said. As a result of de-leveraging and retraction from non-core activities, banks’ profit margins are shrinking. In the recent years, the industry has seen rapid shifts of individual market shares. Since many parts of legislation have yet to be enacted, we are probably going to see some more of these shifts in the industry very soon. For this reason, let me postpone discussion of this third point until sometime in the future, when the trends become evident.

Stick around until then. And I’m off for a cup of good Italian coffee.

The Law Humanity Defies

John had a great day and was paid a large bonus at work. He took the money, brought it to the bank, and deposited it on his account. The bankers cheered. They knew exactly each dollar deposited means to the bank 5-10 dollars in extended credit. The bank kept some small part of John’s deposit, and lent out the rest to another institution. That next institution deposited the money in yet another bank, and the latter did the lending again. At the end of the day, everyone was happy; John and the bankers all drank beer that night.

They all enjoyed the blissful ignorance until the news came that, all else being equal, the house prices all over the country fell simultaneously, and it became extremely beneficial for everyone to buy houses. John and all the non-financial institutions immediately rushed to the bank where they deposited their money. The bankers didn’t see that coming and apparently didn’t have enough reserves to cover the immediate demand. But since they’re bankers and they know life tends to treat them well, they didn’t worry much, and called another bank to borrow federal funds. However, the bankers soon recognized that all banks in the country were experiencing the same problem and didn’t have enough cash on hands. The banks called the Fed, the lender of last resort. Suddenly, an asteroid came out of nowhere and hit the Fed’s building so that the printing press was destroyed. That really gave the bankers heebie jeebies.

They called London to borrow money from there. But the British bankers said they were indeed gobsmacked, as their national bank’s printing press was attacked by evil clowns and went out of order. In fact, for some absolutely random reason, no printing press functioned in the world that day. Then people started trading their commodities in order to get the worth they were entitled to. In very economic terms, the aggregate world demanded access to what is called M3 money supply (in very human terms, it’s ALL the money one can think of). Too bad only M0 was available, that is, printed currency plus coins, and there were just not as many commodities as their assigned value.

(http://news.goldseek.com/GoldSeek/1231778551.php)

It wasn’t too long until our friend John realized that everyone was entitled to more than his or her assets were actually worth. The world’s aggregate net worth  just didn’t cost that much! John very soon discovered that paper greenbacks were worth just the paper they were printed on. One way to drive at everything’s fair value would be to go back to barter trade, that is, trading goods for other goods. Or one could trade for gold, since everyone throughout the world could have a relatively easy access to it. But even if all the gold in the world were to circulate as our currency today, there STILL wouldn’t be just enough gold to match our net worth, since the world’s net worth increased 30+ times from what all the gold cost when the US abolished the gold standard in 1971.

Humanity thereby went against the nature and the laws of physics. Any physicist will admit what the bankers do is nonsense, since, according to the law of conservation of energy, NO energy can appear out of nowhere. ‘Nowhere’ is exactly where our money and assets come from. Put it this way, nothing in the world can physically cost more than the world itself; otherwise, how can one pay back?

I told my fiancée about this, and she actually called me out on it. She asked, Why is it bad? This is a truly interesting issue to discuss, so I must thank her for the contribution. In fact, I’ll let you leave your opinion.

Is it good or bad that the value of things is inflated? Is it good or bad to have a never-ending business cycle and inflationary tendencies? It’s highly unlikely for this story to unfold in reality, and it’s more likely that John will get his money anyway. But how are we so comfortable to live in the world where the value is created out of thin air and continues to grow in volume at a rapid velocity? My view is that this system is unsustainable in the long run. The physicists will agree. Apparently, the bankers are driven by other laws we’re not aware of.