Spain Risk: Protect Your Assets

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 |  Includes: EWP
by: CRG Research

Part of fundamental analysis is macro-economic analysis and micro-economic analysis. In other words, you analyze the economic data and company financial statements etc... As part of the continued analysis of Apple (NASDAQ:AAPL), Intel (NASDAQ:INTC), Microsoft (NASDAQ:MSFT), LG (NYSE:LPL), International Business Machines (NYSE:IBM), Oracle (NYSE:ORCL), Exxon (NYSE:XOM), Conocco Phillips (NYSE:COP), Johnson & Johnson (NYSE:JNJ), Merck (NYSE:MRK), Pfizer (NYSE:PFE), we'll take a look at the macro-economic conditions in Spain.

The European Commission threw Spain, the latest frontline in Europe's debt war, two potential lifelines Wednesday, offering more time to reduce its budget deficit and direct aid from a euro zone rescue fund to recapitalize distressed banks.

EU Economic and Monetary Affairs Commissioner Olli Rehn said Brussels was ready to give Spain an extra year until 2014 to bring its deficit down to the EU limit of 3 percent of gross domestic product if Madrid presents a solid two-year budget plan for 2013-14, something it has committed to do.

The concession was on the condition that Spain effectively reins in overspending by its autonomous regions, makes further financial sector reforms and recapitalizes its troubled banks.

EU paymaster Germany has so far firmly opposed any collective European banking resolution and guarantee system or any use of bailout funds without a country having to submit to a politically humiliating EU/IMF austerity program.

The European Union's executive arm said the vicious circle of weak banks and heavily indebted states lending to each other must be broken and called for a banking union in the euro zone.

Commission President Jose Manuel Barroso said tighter euro zone integration could include a joint bank deposit guarantee scheme to prevent a bank run and euro area financial supervision.

"In the same vein, to sever the link between banks and the sovereigns, direct recapitalization by the ESM (European Stability Mechanism) might be envisaged," the report said.

Permitting the ESM to lend directly to banks would require a change to a treaty in the midst of ratification by member states that might come too late for Spain's needs. Spanish premier Mariano Rajoy backs the idea but Rehn appeared cool to it.

"Direct disbursements to banks are not foreseen as such in the treaty, and therefore this is not an available option ... in terms of direct recapitalization," Rehn told reporters.

Rajoy has insisted his government has no intention of seeking an EU/IMF bailout either for its banks or for the state.

In its country report on Spain, the Commission said the latest banking reform presented this month did not go far enough and needed to be strengthened to include provisioning on mortgages and lending to small businesses.

Spain will be granted an extension on meeting budget deficit rules if it reins in spending in its autonomous regions, recapitalizes it banks, and makes further financial sector reforms.

Analysis

What officials are asking Spain to do is cut spending and/or increase taxes regionally and nationally. The impact of tax increases and spending cuts is slower economic growth and quite possibly recessionary conditions or the opposite of what Spain needs to rein in its budget deficit.

Additionally, they are asking Spain to recapitalize its banks. At the same time Spain should be reining in the deficit. Essentially, Spain needs to spend more while spending less. That could be a difficult task.

Moving on to using the ESM to recapitalize Spanish banks, the ESM's mandate doesn't allow the direct capitalization of banks and it could be months if not years to change the mandate and have the fund capitalize banks. Spain is running out of time as assets flee the banking system. In my opinion, someone needs to come up with a better idea.

Let's talk about Spain's Prime Minister, Rajoy keeps saying Spain doesn't need a bailout from the EU/IMF. I wish he would stop saying that and take the bailout. Clearly the market for Spanish debt is saying Spain needs a bailout and the longer Spain goes without taking the bailout, the worst the global economic fallout will be as counter-party risk fears intensify.

The risk is of a global financial meltdown and European officials aren't handling this crisis well. Investors should protect their assets with options (buying puts or selling calls) or futures markets hedges.

I still like the company fundamentals (strategic competitive position, balance sheet, brand, management) of Apple, Intel, Microsoft, LG, International Business Machines, Oracle, Exxon, Conocco Phillips, Pfizer, Merck, Johnson & Johnson. That being said, unless the reporters are getting it wrong, the handling of the debt crisis in Europe seems like the height of (fill in the blank).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bare risk and thus his opinions may not be suitable for all investors.