Looking at Irish -- and Canadian -- Financials

by: Chris Damas

Ireland is going to be a trigger for another stock market meltdown. Call this Euro Credit Panic, the sequel.

With everyone effusing about great Black Friday retail sales and the stock market seemingly complacent, I get more worried about what is ahead. 

It’s getting near the time to sell your cyclical stocks and go on year-end holidays.

Irish retail sales jumped 0.7% last month, led by an increase in vehicle sales. Excluding motor trade, sales dropped 0.1% in value, but still up 0.1% in volume.

Are the Irish buying cars in preparation of leaving the island on another mass emigration to North America as they did during the Great Potato Famine of the 1840s?

(Hint to the Irish – it’s not any better in the USA – go to China).

Or is this a “buy before we go bankrupt” move, knowing that a unilateral sovereign default by the formerly fearsome but now de-clawed Celtic Tiger would mean years of economic depression, absence of foreign credit and financial exile?

Irish financial shares are sliding, with Allied Irish Bank ADRs (AIB), down 5 cents on the NYSE to 96 cents, the Bank of Ireland ADR (NYSE:IRE) down 12 cents to $1.46, and the Irish Life and Permanent Group down 14% to 51 euro cents on the Irish Stock Exchange. 

Worse, Irish financials senior note holders are getting beaten up on the prospect they will be forced to take a haircut in any restructuring, with debt trading at 70-80 cents on par. 

Unlike in the Greek situation, where austerity measures were successfully implemented by a strong majority government over the objections of the unions and opposition parties, the ruling Irish government party (Fianna Fail) is holding only a slim majority and yesterday’s by-election in the county of Donegal SW, with votes still to be counted, could reduce this to just two members in the Dail (Irish Parliament).

Any EU/IMF/ECB aid package agreed to by Prime Minister Brian Cowen's coalition government, expected to be announced Monday, would be thrown out after a likely change in government following a general election to be held next year.

The Irish opposition parties are publicly calling for Ireland to default on its foreign sovereign debt.

Much of this debt is held by banks in the U.K. and in the EU, therefore, an Irish default would ripple through the markets, resulting in lower yields for survivors, higher yields for other weak credits.

The IRA-descended Sinn Fein party is radical and would have no problem telling the rest of the world to take the debt and stuff it – these people used to plant bombs in mailboxes. Both the Liberal and Green parties are making similar noises about letting foreign and senior bank note holders take a haircut.

They, and the official opposition party Fine Gail, are against the Cowen government's budget and austerity measures, which include a cut in the minimum wage and a higher VAT sales tax. Public unrest is mounting and violent demonstrations are expected, which happened (and continue) in Greece.

The government's coalition partner, the Green Party, has vowed to end support for Fianna Fail after an austerity budget is passed, if and when.

The major question for all government leaders and international investors is could an Irish default be “ring-fenced” or would it lead to a domino-like fall of other peripheral sovereign credits?

My view is Portugal sovereignty could be voted off the European island in this high stakes version of “Survivor” and the Iberian Peninsula country must accept a Greek-style austerity package and EU-IMF bailout, despite their protestations to the contrary.

I do not believe Spain is in danger of short-term liquidity issues, but will certainly be going into a recession as its sovereign bond yields continue to climb and substantial corporate and private debt is pressured by the higher rates that will flow through the system.

The question most pertinent to North American investors and traders should be ... have our stock and bond markets discounted an Irish default?

The stock markets have rallied in a relief rally since the crisis hit two weeks ago. Irish 10-year sovereign debt traded at 8.80% on Nov. 11, and two weeks later, has risen only marginally to 9.1%. But the worst is yet to come.

The Euro Credit Panic sequel is hitting our shores just as we see better economic data coming out of the U.S., with weekly jobless claims falling to 407,000.

Canadian consumer confidence jumped 3.9 points to 83.6, recently released by the Conference Board of Canada.

Should we be selling our stocks now, or wait until the Dec. 7 vote on the budget being brought forth by the flailing Cowen government? A vote which could go against the ruling party, leading to austerity measures stipulated by the EU-IMF-ECB.

In spite of the bad news story emanating from across the Atlantic, we have some developments in Canada that could be positive for investors.

We have Q4 Canadian bank earnings being released on Thursday for Toronto Dominion Bank (NYSE:TD) and Canadian Imperial Bank of Commerce (NYSE:CM) and on Friday for Royal Bank of Canada (NYSE:RY).

My best guess is it will be time to sell this market which could enjoy a last but false gasp of relief soon after the Irish budget vote. 

I am concerned the markets will begin to focus on the probability Ireland will default early next year when there is a change in government. Major U.S. companies could have their flow of tax-advantaged profits curtailed by a more radical government, directly impacting their profitability.

My trading strategy is to sell large-cap stocks before Dec. 10 and go away for the holidays to take a "wait see" posture until the New Year. 

We are mainly invested in stocks which benefit from low bond yields and therefore we would see an Irish default and a Portugese bailout lowering U.S. bond yields. However, in a crisis, we expect investors to "throw the baby out with the bathwater" and sell everything in sight.

Trading Notes:

BCE (NYSE:BCE) – Close to our target of $35 and our option position has tripled. I expect to see C$35.50 next week and exercise or sell my options and liquidate the stock before the ex-dividend date on Dec. 13. I imagine we will hold TELUS (NYSE:TU) which goes ex on Dec. 8 and then sell out.

Canadian Imperial Bank of Commerce (CM) and Bank of Montreal (NYSE:BMO) – Rallying on the expectations of dividend increases. Sell on the news of a CIBC increase a few days after the company reports on Thursday. My targets are C$80 and C$62 respectively. Nice C70 cent BMO dividend received today.

Tembec (OTCPK:TMBCF) – Tembec has been on fire since the company disclosed renegotiated contracts from its specialty cellulose business will add C45 cents per share of cash flow to the pulp division next year. My six month target is five times 2011e CFPS or C$5/share.

Cascades (OTCPK:CADNF) – Cascades has been weak which is understandable given it has operations in Europe. But the stock is undervalued at C$5.77 and its 23% interest in Boralex could be sold to improve its credit position.

Happy U.S. Thanksgiving.

Disclosure: Long stocks mentioned.

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