French Fries

As far back as December 2010 I've been calling attention to weakness in French Banks. It started when I came across a little nugget that blew me away. I wrote about it here: J.P.Morgan Weighs In On Europe.

Some interesting comments from J.P. Morgan's Michael Cembalest (Eye on the Market) . . .

GDP figures can be misleading indicators of risk. Greece, Ireland, Spain and Portugal (GISP) are small in GDP terms relative to Germany and France. But their banking systems grew to be very large (e.g., a 20% haircut on French bank exposure to GISP countries would wipe out French bank equity).


Now it seems that the snowball is gaining speed down the hill.

Zero Hedge posted this yesterday. Moody's Announces That France's Debt Metrics Have Deteriorated And Are Now The Weakest Of All Aaa-Rated Peers

This is not what Europe needed, 6 days ahead of the G20 ultimatum's expiration for Europe to somehow fix itself, and hours after Deutsche Bank said the rating agencies may go ahead and put France on downgrade review. Just out "Moody's notes that the government's financial strength has weakened, as it has for other euro area sovereigns, because the global financial and economic crisis has led to a deterioration in French government debt metrics -- which are now among the weakest of France's Aaa peers." As for the timing... "Over the next three months, Moody's will monitor and assess the stable outlook in terms of the government's progress in implementing these measures, while taking into account any potential adverse economic or financial market developments."

Moody's notes that the French government now has less room for manoeuvre in terms if stretching its balance sheet than it had in 2008.


In case you missed that Deutsche Bank also warned about a downgrade, here is the Zero Hedge post about that, too:

Deutsche Bank Warns France May Be Put On Downgrade Review By Year-End

First we have Credit Suisse saying 66 European banks will fail the 3rd stress test, and will need hundreds of billions in fresh capital, something the market ignored entirely last week but may want to reevaluate now that the idiocy appears to have subsided. And now, inexplicably, we have Deutsche Bank warning that France may well be put on downgrade review by year end. "We highlight in this note that the French corporate sector is already financially stretched, with poor profitability and large borrowing requirements. We consider that the deterioration in economic conditions is now creating a distinct risk that France could be put under “negative watch” by the rating agencies before the end of this year. We think that France has the wherewithal to react to such an outcome and could avoid an outright downgrade by taking corrective measures quickly, but this naturally would be a very sensitive political decision a few months before a major election." Why either Credit Suisse or Deutsche Bank would jeopardize their own existence by telling the truth, we have no idea. If either of these two banks believe they can survive a vigilante attack on French spreads, and the subsequent shift of contagion to none other than Germany, we wish them all the best. Yet that is precisely what will likely happen, especially now that the market can no longer pull the trick it did for the past two weeks, and stick its head deep in the sand of complete factual avoidance.

I do not think things are getting better in Europe. I think it's only a matter of time before reality dawns on investors and markets. This reality, which seems to become more and more obvious to more and more participants, is that French banks are fried.

Wasn't a 50% haircut just mentioned with regards to holders of Greek debt? Wouldn't that merely set precedent for Portugal, Ireland, and Spain? Wouldn't that be more than double the haircut that J.P. Morgan warned would wipe out French bank equity?

Interestingly, this feeling that "it's just a matter of time" is the same thing that the fiscal and monetary authorities in Europe are thinking: that it's only a matter of time. If they have enough time, they say, they can solve their problem. Only there is too much debt and not enough growth, and all the time in the world cannot fix the two. Only psychology can. And the paradox is that the results of extreme ebullience of positive mood can only be cured by an equal extreme of negative mood. Only then will investors step in and take risks again.

In the meantime, curiously, my bias is higher over the next several weeks. Yes, I think we retrace a bit lower. I may have to change my 1132 target. But I'm inclined to be a buyer of a washout on this decline. I think we can get under 1174 and over 1230. I'm starting to look for 1250-1275.

More will need to unfold over the next few days. But I'm reading the current decline as a "sloppy" one so far. These are exceedingly difficult to trade, but that is their purpose -- to wrong-foot as many people as possible and then reverse. Be ready. Ideally, have a method that allows you to participate on both sides in a risk adverse way.