Is bull market talk all bull?

  • 23 January 2012
  • From the section Business
  • comments
An EU flag flies as tourists visit the ancient hill of Acropolis in Athens

In a financial sense, spring is in the air. But is a chill wind about to blow from Greece that could snuff out the buds of growing investor and banker optimism?

Perhaps the most important manifestation of a markets thaw is that some banks have been able to sell debt - to borrow - again. As Morgan Stanley pointed out last week, European banks, or at least the stronger northern European variety, have issued more senior unsecured bonds in the first few days of this year than in the whole of the second half of last year.

This matters, given that one of the great concerns has been over the 1.7 trillion euros that European banks need to borrow to repay maturing debts - which looked something of a challenge (ahem) after investors, especially US money market funds, boycotted them last autumn.

Also fund managers have been putting money back into shares. One accosted me over the weekend to whisper that he thought a bull market might be in the making, while a banker of the slightly more grizzled variety shared with me his bemusement at emails flying about his organisation claiming that we're off to the races (in an investment sense).

It is certainly true that we have seen stock markets perform almost as well as anyone can remember at the beginning of a calendar year. As for the FTSE100, it's back where it was at the beginning of last August, when the risks of a eurozone meltdown intensified.

So has something actually happened since 1 January, to transform the global economy from one fraught with risks to one bursting with opportunity?

Not really. There's a bit more evidence of the US economy decoupling from stagnating Europe - with signs of a bit of positive momentum in American output or GDP. And China's economy is slowing, but in a way seen by all but China's harshest critics as relatively benign (we'll postpone our chat about whether the Chinese property bubble is a big accident waiting to happen).

In fact the only really important event happened before Christmas - which was the first of the European Central Bank's auctions of three-year loans to eurozone banks, when banks took 489bn euros of money they don't have to repay till the end of 2014. Even our own Royal Bank of Scotland took 5bn euros from the ECB.

So with ECB support for eurozone banks in general heading to perhaps as much as 1.3bn euros, according to Morgan Stanley, it is now widely believed that for 2012 at least eurozone banks will be able to repay what they owe.

Spanish and Italian banks took 45% of the net new ECB money on offer - which shows both that they have the biggest funding problem and that (if you're are an optimist) they are facing up to it.

This perception, of receding dangers of banks collapsing in the eurozone, has been something of a slow burn. But as is always the way when an idea takes hold in the investment community, it is now taken as gospel truth by most that the ECB has saved the eurozone - which is probably overstating the case.

I have to say that when I talk to regulators, the guardians of the health of the banking system are not nearly so sanguine. They fear there is still a material risk that one of those banks that's only currently alive thanks to central-bank life support (in Ireland, Portugal, Greece, Spain or Italy) could by the middle of the year run out of collateral to swap for additional loans from the ECB or a relevant national central bank - and banks that can't borrow to pay their maturing debts are bust.

If the ECB were to cast all prudence to the winds, and chose to impose no "haircuts" or discounts on the collateral it takes in return for loans, then even the banks most addicted to what are in effect loans from the state could muddle through in this zombie-like state for months or even years. But that would be to expose taxpayers to a significant risk of loss on this support for banks - which central banks are not supposed to do.

So I don't think it is fair to say that the risk of a contagious bank failure is now zero. That's doubly true when there's considerable uncertainty about whether we are about to witness the first ever default by a developed economy in goodness knows how long, that of Greece.

The banks and hedge funds negotiating with the Greek government, through the medium of the IIF, have made their final offer of how much they are prepared to voluntarily reduce what Greece repays them. If their terms are rejected, then a formal default in March seems inevitable.

That would be messy, not least because it is extremely unclear where the direct losses would fall, since it would trigger de facto insurance claims on credit default swaps, and the underwriters of those credit derivatives have never been satisfactorily identified.

More worryingly, funding conditions for the governments and banks of all the more fiscally feeble eurozone states would at a stroke go from bad to worse - simply because the eurozone has not (as you well know) put in place bailout arrangements of sufficient size to serve as lender-of-last-resort to Spain, Italy, Portugal and any other out-of-favour government borrower.

So in sum I would say that bankers' and investors' optimism is probably to be welcomed and encouraged, but not relied upon. I'll be assessing the robustness of this new confidence in the coming few days, as I inhale the rarefied air of the World Economic Forum's annual confab between money and power in Davos.

That said, I would be staggered if I became persuaded that the eurozone is now basically fixed and that we can all sleep easy again.