Research Watch

PORTFOLIO POINT: This is a sampling of the week's best research notes. In a world of too much information, we hope our selection helps you spot the market's key signals.

Even with lipstick, a PIG is still much uglier than a debt default; that is the message from Mark Gilbert, who heads up this week’s Hellenic special arguing that Greece and similar struggling nations must be allowed to go bust if another bout of moral hazard is to be avoided. We also look at Goldman Sachs’ role in masking Mediterranean debt and present an age-old Greek history lesson for the troubled nation’s disgruntled public sector workers. But maybe a default wouldn’t be as catastrophic as you might think, says Paul Krugman, based on Greece’s GDP share. In stocks, The Curious Capitalist studies the unsung hero of wealth creation, and whacky market indicators come up roses all over the place. On video, though, we learn that it’s probably best not to look to the sports field for tips, as US footballers struggle with the basics of finance.

A call to send PIGs to the slaughter to teach the world a lesson '¦ “A rescue would scream to the world that Greece’s financial hole is too deep for it to get out unaided – just as the Federal Reserve’s decision to supply $US29 billion of guarantees so that Bear Stearns could survive by selling itself to JPMorgan Chase was a red flag about the cannibalism erupting in the credit-crunched banking industry. Let Greece go bust if it can’t pay its own way. Sure, it will be messy and scary. A lot of banks will realise they still don’t focus enough on the credit quality of the firms they do business with. The euro project will suffer a crisis of confidence. The lesson from the credit crisis, though, is that the alternative of helping Greece off a hook of its own making is far, far worse. All of the 'PIGS’ – Portugal, Ireland, Greece and Spain (and maybe Italy, if you’re feeling particularly uncharitable or sceptical) – have been living beyond their means, much like the investment banks did in the credit boom. A bailout of one will produce the same outcome as the rescue of Bear Stearns did; moral hazard will kick in, and instead of allowing economic Darwinism to cleanse the gene pool, the weaker nations will lose any incentive to cut spending and trim their swollen deficits '¦ Why would an Irish policewoman swallow a pay cut that helps her government curb its spending if an EU handout eases the strictures demanded of Greek public-sector workers? If economic failure goes unpunished, then behaviour doesn’t change – another lesson that the finance world should have learned from the credit crisis. Daubing a layer of financial lipstick on the 'PIGS’ makes them less, not more, attractive.” (Mark Gilbert in Bloomberg, February 11)

And a look at how Greece’s imaginative accounting could blow up (even harder) later '¦ “Goldman Sachs helped the Greek government to mask the true extent of its deficit with the help of a derivatives deal that legally circumvented the EU Maastricht deficit rules '¦Greece's debt managers agreed to a huge deal with the savvy bankers of US investment bank Goldman Sachs at the start of 2002 involving so-called cross-currency swaps in which government debt issued in dollars and yen was swapped for euro debt for a certain period – to be exchanged back into the original currencies at a later date. Such transactions are part of normal government refinancing '¦ But in the Greek case the US bankers devised a special kind of swap with fictional exchange rates. That enabled Greece to receive a far higher sum than the actual euro market value of 10 billion dollars or yen. In that way Goldman Sachs secretly arranged additional credit of up to $US1 billion for the Greeks. This credit disguised as a swap didn't show up in the Greek debt statistics. Eurostat's reporting rules don't comprehensively record transactions involving financial derivatives. 'The Maastricht rules can be circumvented quite legally through swaps,’ says a German derivatives dealer '¦ At some point Greece will have to pay up for its swap transactions, and that will impact its deficit. The bond maturities range between 10 and 15 years.” (Beat Balzli in Der Spiegel, February 8)

A default might not be that bad '¦ “Big problems in Europe, no doubt. But it’s easy to lose perspective on the size of the Greek problem. So here’s an IMF chart showing 2008 shares of eurozone GDP:

Distribution of Eurozone GDP

A couple of points: first, Greece, which is making most of the headlines, is a tiny economy. So are Portugal and Ireland. The only sizable player among the countries in the news right now is Spain.” (Paul Krugman in the New York Times, February 8)

But a note to Greek workers: take it from history – don’t test the finance gods '¦ “Public sector workers in Greece are preparing to strike this week. They oppose the plan to reduce their wages and pensions '¦ But there is a lesson from Greek history the unions have ignored. The famous Greek philosopher and poet Simonides of Ceos was engaged by Scopas, a nobleman from Thessaly, to chant a lyric poem in honour of his host. Simonides performed admirably but also included a passage praising the famous twin young Greek gods Castor and Pollux. After the performance, Scopas offered to pay Simonides only half the agreed sum and told Simonides that he needed to get the other half from the two gods he had praised. Later during the banquet, Simonides received a message to come outside and meet two young men. When he exited the nobleman’s banquet he found no one waiting for him. Suddenly the roof of the banquet hall collapsed and killed the guests, including Scopas. The story is famous because Simonides '¦ remembered where folks were seated at the banquet and could state who was whom and coined the phrase “here lies so and so” as he identified the victims’ remains '¦ Like Scopas, the Greek public-sector unions are flirting with two relatively young gods of modern finance. They are similar to Castor and Pollux in that they are twins of sorts. They were born out of the post-war European evolution. And the unions are making the modern-day, public-sector equivalent of Scopas’ demands. Those two young organisations are the European Union (EU) and the European Central Bank (ECB).” (Cumberland Advisors, February 8)

For now though, quirky indicators are pointing to a good year for stocks '¦ “Sports Illustrated just revealed that this year's cover model for the annual swimsuit issue was US model Brooklyn Decker. Based on Bespoke's Swimsuit Issue Indicator '¦ if history is any guide, the weak start to 2010 may soon reverse '¦ Since 1978, an American has now appeared on the cover of the annual Sports Illustrated swimsuit issue in 17 different years. The average performance of the S&P 500 during the prior 16 years is a gain of 10.6% with 13 positive years (81.3%). Of the 16 years where no American appeared on the cover, the S&P 500 has averaged a gain of 8.2% with 12 positive years (75%). While the S&P 500 has historically done better in years when an American has appeared on the cover, the percentage spread has narrowed considerably in the past two years. The S&P 500 declined 38.5% in 2008 when American Marissa Miller was on the cover, while it rose 23.5% in 2009 when Israeli model Bar Refaeli graced the cover. Given these exceptions, it is important to remember that there are always exceptions to the rule '¦ But at least they give you an excuse to read Sports Illustrated.” (Bespoke Investment Group, February 9)

And just as strangely '¦ “The Saints’ Super Bowl win will have New Orleans singing long '¦ but it might also be a harbinger of bon temps for the stockmarket '¦ When a National Football Conference team [such as the Saints] prevails in the Big Show, as one has done now 23 out of 44 times, the Standard & Poor's 500 Index of blue-chip stocks finishes the year with an average return of 15%, more than twice the average return delivered by the index when an American Football Conference team wins '¦ An even better omen is that the Saints claimed its first-ever Lombardi Trophy. In years in which teams win the Super Bowl for the first time, the S&P 500 has produced an average return of 20% '¦ 'Something such as a Super Bowl Indicator is nonsense, but as a statistician, one can't completely discount it,’ said Patrick Burns whose London-based company, Burns Statistics, provides statistical research to financial traders.” (ABC News, February 8)

Dividends are even more important than you think '¦ “With the latest market declines reminding us anew of the inherent risks of stocks, it's a good time to re-examine how the stockmarket creates wealth. There are all sorts of wrinkles but it all really comes down to two big things: stocks either rise in price (capital appreciation) or companies pay out a portion of profits (dividends) '¦ The folks at Morningstar/Ibbotson have stockmarket data going back to 1926. Over that time (1926 through 2009) stocks have provided an annual average return of 9.81%. Of that return '¦ capital appreciation accounts for 5.47 percentage points, a bit more than half. Dividends, however, are not far behind, delivering 4.13 percentage points. Some of you will quickly notice that the two components do not precisely add up to 9.81%, which owes to statistical noise and rounding over many decades of data. But the big point remains: Dividends are the unsung hero of the stockmarket and in many ways the more reliable provider of wealth '¦ Brian Belski, the chief strategist at Oppenheimer & Co '¦ looked at stock performance from 1990 to the present and concludes that 'companies with consistent dividend growth significantly outperform those with little dividend growth.’ '¦ Here are the numbers: The top quintile of dividend growers returned 12.5% while the lowest quintile returned just 4.6%; the overall S&P 500 returned an annual average of 5.7% over this period.”

(The Curious Capitalist, February 8)

And in the latest case of bankers behaving badly, unauthorised bonuses at the Royal Bank of Scotland '¦ “For the past few years, bonuses at RBS have been what you call not so great '¦ RBSGC managing director James Glover (apparently known to colleagues though not to his face as 'G-Love’), was all too aware of the bonus situation, particularly the potential scheme to pay employees entirely in RBS debt '¦ So Jim did what any thinking man would do and came up with a plan – help himself to a bonus. He did so by having junior employees submit wires that would normally go to a counterparty to pay for trades, and then approving them to, instead, go to his personal account. Jimbo put the plan into action months ago, and hundreds of thousands of dollars later, it was working out great! And it would’ve continued to keep working out great were it not for the chippies running the place and their 'internal controls’ finding out about the thing and taking issue with it '¦ Unfortunately Big J failed to turn the situation around on them by offering that no one ever told him when he first started working there that this sort of thing is frowned upon '¦ So now he’s out of there and the matter has been 'referred to law enforcement’.” (Dealbreaker, February 8)

Video of the week: Super Bowl Super Quiz '¦ See how you fare against America’s football elite on finance toughies such as: 'How many stocks are there in the S&P500?’ and 'How much is $1000 worth of gold worth?’ It might throw the earlier stock indicator into doubt.

(CNBC, February 6)