The IMF Suggests A Trade

Remember the sovereign debt issue from a few months ago?

It was supposed to be like cockroaches.  Greece was to be like Bear Stearns.  The dominoes would start falling.  The facile analogies came day after day.

There were plenty of pundits who predicted disaster.  The IMF was on the other side.  It has been several months since this issue surfaced, with many predictions of disaster.  It is time to review what has happened and what might lie ahead.

Predictions of a Crash

Rick Santelli (who seems unable to separate his politics from his market analysis) thought that the European debt restructuring plan would fail and the Euro would go to parity with the dollar.  Many agreed with him.  It was so scary that Art Cashin warned about how the market could crash if the dollar gained strength against the Euro, reducing earnings of US companies.

Here at “A Dash” we love Art Cashin.  He is an accurate reporter of what floor traders think.  In this case, many were expecting a collapse in the Euro and a crashing stock market.  That was his report.  Guess what?

They were wrong!  All of the floor pundits on TV.


 There is little accountability for these predictions.  Examples of draconian predictions can be found here and here and here.  Let us look at the chart to see how it played out.


FXE Stock Chart by YCharts

The IMF Viewpoint

The IMF has done some research on the topic.  In a strong article Colin Barr covers the story.  Here is a key quotation:

Considering data on sovereign bond spreads over the past decades, markets sounded false alarms in the vast majority of episodes,” writes a group of IMF researchers led by the group’s fiscal affairs director, Carlo Cottarelli. “In our view, the risk of debt restructuring is currently significantly overestimated.

His nicely balanced article observed the high level of debt to be restructured, while noting some key history:

…(T)here have been 40 instances over the past three decades, a third of them in advanced economies, in which a country has improved its structural primary budget balance by 7 percentage points or more.

“Judging from past experience, such a major adjustment will no doubt be difficult, but is possible,” the IMF said.

Investment Implications

This is a pretty simple choice.  You can cast your lot with the IMF, a multi-national version of “don’t fight the Fed” or you can bet your money on people whose politics cloud their  investment decisions.  (Here at “A Dash” we like to make money no matter who is in power.  You should too!)

US stocks have traded in line with the dollar for many months.  The Euro question is a special case.  There are two considerations, general and specific:

  • On the general front, markets have traded for many months in a strong correlation with the dollar.  If the Euro is not so weak, this is bullish for stocks in general.
  • On the specific front, stocks that do European business may have been unfairly punished in recent months.  That would be consistent with the IMF findings on excessive CDS premiums.  I continue to like US stocks with foreign exposure, including CAT and technology names like AAPL, MSFT, and ORCL.

You could also trade foreign CDS’s or currencies directly of course, but most investors do not have that access.

[Full Disclosure — Long stocks in long-term accounts, neutral in trading accounts, long CAT, AAPL, MSFT, and ORCL.]

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One comment

  • Proteus September 4, 2010  

    The idea that the unexpected happens all the time – such as Greece will default and drag the Eurozone down with it – has Taleb’s imprimatur all over it. He (and others with similar thinking) have done investors a considerable disservice by not reminding us more forcefully that while panics are fairly common, true collapses are rare.
    And of course, the IMF paper cited came in for a lot of criticism by those expecting a default.