How do you use data for investment decisions?

He (Robert Gates) wasn't an investment person, he admitted, but he asked whether the data I had just presented as a reason for my bullish outlook was data that I had selected because it supported my theory. Or was it data that I consistently tracked, hoping to detect signs of change?

from Reading Minds and Markets by Jack Ablin

I have to highlight this passage from Jack Ablin book from a few years ago. It is very important to think about whether we are using or marshaling data to support our view or whether we are drawing conclusions from data that we look at on a regular basis. The right answer is that the data tells the story, but human nature often works in reverse.

Monday - S&P sovereign ratings massacre threat

S&P issued a sovereign ratings massacre threat as the rating agency has placed all 17 euro nation under review for possible downgrades. There are six AAA-rated EU countries that have been placed on negative outlook. In a highly political move, S&P sends a signal that if something is not done with controlling debt, countries will lose their ratings. While those countries that have lost their AAA ratings have seen large changes in their funding costs, this will be a significant wake-up call of Germany and France to reach some type of debt arrangement and broader fiscal union.

" All Europe all the time" - quote on the investment news focus

The quote was from Vince Reinhart the new chief domestic economist for Morgan Stanley.With all eyes on the finance ministers, the ECB, and EU presidents, there is little effort being placed on what is going on around the globe. The usual information transmission has been from the US to the rest of the world. Lead relationships both from the central bank and economic announcements came from the US. The ECB took their lead from the Fed. Equity prices often would reaction to US numbers. This has changed significantly with gap risk between the close and open in the US being more important than in the past.  Work flow has to now include a greater European component.

Currency swap lines from central banks come to the rescue

A coordinated effort by six central banks worked to ease funding tensions with European banks through bilateral swap programs so funding could be provided if needed through February 2013. Interest rates on borrowing costs from central banks fell about 50 bps based on the news.  The impact on stocks was immediate as the idea that central banks will stand ready to flood the market with liquidity has reduced funding pressure. The dollar dropped hard in response to the the new liquidity. It eased the pressure by European banks to find dollars.

Under the arrangement, similar to programs initially set-up in 2007 and used periodically over the last four years, the Fed will swap dollars (lends) to other central banks which will then lend the money to banks in their countries.

The Fed has an incentive to do this because a decrease in lending within the US by European banks will have a credit crunch effect on the US economy. The swaps were done at flat currency pricing so there is no exchange risk to the Fed. The foreign central bank will only pay interest to the Fed for the length of the swap.

The funding pressure on EU banks has increased as their institutional dollar funding sources have dried up. Money market funds and other banks do not plan to fund EU banks given their higher risk assessment. These banks have significant dollar assets which have to either be sold or funded. There is a clear credit crunch going on with European banks as they tighten credit for anything except funding at home. It would be natural during a crisis that financing will be focused in the home country.

The ECB has already seen an increase in their 7-day financing operations to European banks. At 265 billion euros, it is at the highest levels in two years.

The good news is that liquidity is going to be provided. The bad news is that liquidity is needed and there may be a growing solvency problem with EU banks.