Can We Really Stop Worrying About the Credit Crisis?

 |  Includes: ERO, ESR, FCX, FXE, RNE, SPY, USO
by: David White

The EU-IMF put together a bailout package of 750B Euros last month. This was supposed to stem the rising tide of PIIGS bond yields and CDS spreads, but did it? The following two graphs tell the real story.

The PIIGS bond spreads (vs. the German 10yr bond) chart is below (Bloomberg):

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You can see that all the countries’ yields are still rising quickly. They have all gone up significantly from the low hit soon after the EU-IMF rescue package announcement. No one would consider the rises insignificant.

The PIIGS CDS spreads chart is below (Bloomberg):

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The CDS spreads tell the same tale as the rising bond yields.

What may surprise some is that these PIIGS may not even be the most worrisome economies in Europe. The following is a table (from CMA) of the sovereigns that widened the fastest on Thursday June 3:

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All of the above are European countries. Romania even received a 20B Euro bailout from the IMF recently. It also approved harsh austerity measures. That does not seem to have alleviated its Cumulative Probability of Default (CPD%). Some of these countries are even close to the top of the highest probability of default list below (from CMA):

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Greece, Portugal, Ukraine, and Latvia are on this list. Many other European countries are not far behind. The other countries listed are important to US markets too. Are we out of the woods on the credit crisis? I don’t think so. The US markets may have turned their attention to the oil spill and its resultant deep sea drilling moratorium, FinReg, China’s slow down, China's real estate problems, and China's toxic assets (bad loans in Chinese banks), the Australian mining Super Tax, Korea (a possible budding war), Israel, nuclear technology in the hands of Iran, Syria, and Burma, etc. However, this just shows how really troubled the world situation is at the moment.

The Euro has continued to move downward. FXE closed at $121.25. It is still clearly in a down trend. It may soon move down to $116. If it does, it will likely take tech stocks and commodities for another leg down. The China borrowing to invest in these will exacerbate the fall as insecure positions are closed.

Commodities fell dramatically in May. Many think slowing in China is the main reason for this. Let me propose another reason, or a little know explanation. The average corporate bond yield rate for 9 big China RE developers rose 2.26 percentage points from January - April. This indicates a high degree of instability. Many China RE developers have used some of their loan monies to invest in other assets such as commodities and stocks. Most of these loans are short term loans. The developers do not have time to wait for fundamentals to kick in. When they decide to sell (as some have already), the prices of commodities will likely drop far below their fundamental values. Many China RE loans will suddenly become toxic. They are already worsening due to a slow down in the commercial RE market (and even in the RRE market). Some pundits have estimated that China has $4T in write offs that it will have to take soon. A large proportion of the Chinese economy is construction.

Ben Bernanke said this week that US banks are not lending to small businesses. He couldn’t say whether the businesses were not applying for loans or whether the banks were reluctant to lend. What is sure is that there will be little job growth in the US without small business growth (small business hiring). This will not take place without money. Most of these small companies do not have good access to the capital markets. They have to borrow monies for expansion.

New mortgage applications have been down for the last 4 weeks. More and more stories tell of homeowners walking away from underwater mortgages. Still others tell of defaulters living in their homes for more than a year without paying a dime. This seems to be a double dip in real estate. The real estate bordering the Gulf is certainly now in a double dip. It is incurring environmental damage. This will further depress prices for the next two years at least. Plus the lost revenue due to the drilling moratorium will hurt all Gulf states for many years into the future. Many states pay for their education systems with this money. Will more teachers be laid off? Will the jobs situation in these states worsen?

Is the credit crisis over? It is hard to believe so. The trend in the SPY is still down. It may get a blip up due to short term economic data, especially if the jobs number is great. However, the overwhelming, worldwide data suggests that pundits such as Rosenberg, Roubini, and Whitney are likely correct in their assessments of US equities near term direction. Is the European credit crisis over? It doesn’t appear so. We are just being distracted by other events as bad or worse for the world economy. What does that say about the likely direction of the US equities markets in the near term.

Disclosure: I have a small SPY short position.