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Calm down dear! It’s only Grexit

As markets plummet, here are some trading tips from the sell-side.

With markets on the decline again, Nomura is offering some perhaps surprising advice: relax a little - the sell-off is an unjustified over-reaction, remember, so short the fear industry:

It’s not exactly that we’re surprised by the volatility in global equity markets since the May 6 French and Greek elections: Even before this episode, the MSCI World Index suffered no fewer than twelve separate pullbacks of 7.5% or more since January 2009 over similarly compressed time horizons. Rather, it’s the sheer rashness of the thing that strikes us as remarkable...and ultimately, probably tradable. From the way markets have behaved, you’d think not only that Greece has already fallen out of the euro, but that European institutions, despite plenty of available firepower and advanced warning, had entirely failed to stanch the contagion -- and that a material interruption in global growth was now unavoidably inflicting itself upon the planet.


What’s worse, the financial kangaroo court that seems already to have decided for you that tiny Greece is an uncontrollable global growth disaster literally just waiting to happen may not even be doing your portfolio any good: By asking you to embrace its verdict and seek the safety of US Treasuries, for example, the fear industry is asking you to be content with a yield of just 1.7% in a world still expected to produce 5.0% nominal GDP growth in 2012 (and 5.5% in 2013).

SocGen is going so far as to predict a bounce in Asia, arguing that the nature of the shorts we’re seeing at the moment generally presages a sharp rise in the Hang Seng. 

Shorts are crowded: Another way of measuring selling pressure on the markets right now is by looking at short positions. Chart 3 shows a ten day moving average of the short interest across the Hong Kong stock market, as a percentage of the day’s turnover. This measure is not quite as high as it was back in the trough of the bear market, in November 2010, but it is almost as high as it was during the 1998 Asian crisis.

And crowded shorts often lead to a market bounce: Now look at Chart 4, which shows the relationship between short positions and future performance of the stock market. The short positions (as in Chart 3) are shown in blue; the brown line shows the one month forward performance of the stock market. The correlation between the two lines since the start of this year has been almost 50%. Put another way, based on this trend, the current short interest of 10.3% of turnover implies a 5% rally in stocks in the coming month.


Goldman is a little less sanguine; accepting that while there are smart investments to be made in the medium-term – you just can’t trust European politicians to not ruin things for matter what course of action you take.

“In the near term, however, we believe that the risks on the downside are still relatively big. This is less because equity markets are not reflecting the likely path for growth from here, but more because markets not fully discounting the scale and magnitude of things that can go wrong. Of course the risks of political errors that push markets much lower, particularly in Europe, may be equally matched by the risk that there are further aggressive policy interventions that push markets higher. It is the uncertainty over the balance between these forces that reduces our conviction levels in the short-term path but, at the same time, makes us believe that buying protection for equity investors makes good sense.”

Right now, investors are expressing their bearish views by snapping up the dollar and US Treasuries but hedging Grexit - and the second-order impact of a eurozone implosion - is a game-changer. The consensus among sell-side analysts is to embark on relative value and flight-to-quality trades rather than directional bets. But, as we have reported, some brave souls are arguing the fundamental credit strength of emerging market sovereigns and corporates suggest external market technicals won't derail emerging market fundamentals. We have heard that one before.

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