Last week’s market movements reflected investor frustration with the current state of EU and U.S. political decision-making and uncertainty. Contagion in European sovereign debt markets has reached Italy, which until recently was unthinkable. With 1.6 trillion euros in outstanding debt, which dwarfs existing at-risk countries, escalating contagion to Italy dramatically changes availability and type of solutions to address this growing monster. Worse, if Italy is at risk, concerns about France cannot lag far behind. In the U.S., the extent of political haggling and polarization at a crucial point in the face of weakening economic indicators has left many bewildered and even more disillusioned with seemingly irresponsible elected officials.
As Friday’s (9/5) market movements showed, current activity is being rocked mostly by sentiment, and perhaps outright frustration, on the lagging political response. On both sides of the Atlantic, politicians continue to reveal either their inability or unwillingness to forge necessary compromise to undertake hard decisions and address key issues, despite facing slowing global growth. Given lagging indicators, rating agencies are attempting to reverse past mistakes, with S&P’s same day downgrade of the U.S. AAA rating (to AA+, negative outlook) offering more a political report card than meaningful insight on the U.S. debt situation and Treasury issuance.
Against this chaotic backdrop and with growing impatience, investors are left simply dumping equities, marking a typical entry point for profitable investments. In the financial sector, medium-term investment opportunities remain. However, traditional price metrics for identifying entry points have temporarily fallen by the wayside and predicting the timing of a meaningful political response has proven entirely elusive.
In the midst of this turmoil, the opportunity for re-visiting European financials, particularly banks, remains. Core European bank names throughout the crisis included HSBC (HBC) and Svenska Handelsbanken. The names to review include Credit Suisse (NYSE:CS), Deutsche Bank (NYSE:DB) and Intesa SanPaolo (OTCPK:ISNPY). European insurers, though holders of European sovereign debt, also warrant consideration including Allianz (OTCQX:AZSEY), Generali (OTC:GDEUF), Munich Re and Zurich Financial Services (OTC:ZFSVY).
Astonishingly, the risk of a Spanish default has proven to be insufficient warning for EU politicians. While the U.S. and Japan have shown the continued ability to tap the debt markets at favorable interest rates, the evidence is much less so for many European countries supported by Euro-era sovereign spread highs. With an Italian default clearly unmanageable under currently allocated and available resources, the risk of Germany being left the last person standing is the entirely counter-intuitive outcome given its negotiating stance to date. Rising German bund yields are not inconceivable. A wake-up call for EU politicians has not sounded louder or clearer.
Disclosure: I am long HBC.
Additional disclosure: Long ALVG IX, MUV2 GR, SSHA SS, ZURN VX.