Spain's 10-year treasury rates rose above 7% today, after the Greek election, showing limited confidence in Europe. The 7% level has been dubbed as an impossible level to support and as a tipping point for the need for a bailout.
Ireland and Portugal had to ask for bailouts when their rates rose above 7%. Spain probably cannot sustain its borrowing programs at that rate either.
While the 100 billion euro loaned to Spanish banks recently was fiercely defended by Spanish officials as relating to the banks and not the government, experience over the past few years around the world has clearly demonstrated that the major banks and the government in countries are inextricably linked.
The Spanish rates are the highest since the U.S. stock market bottom in 2009.
The spread between Spanish and U.S. 10-year treasuries is the highest since 2009 (as is the spread between Spanish and German rates).
The ratio of the rates for Spain to U.S. rates are the highest by far since 1980, when rates globally were at a peak -- now 4.5 times the U.S. rates, compared to a former peak in the 1990s at two times.
Italy, a much more important borrower, is not far behind Spain in these rate measures and comparisons (currently at 6.07% for 10-year rates).
The Spanish rate reaction to the Greek elections may not be contagion, but it is certainly not confidence. Greece, the pro-bailout vote notwithstanding, is still an inevitable euro exit.
Greece is unlikely to be able to meet the action targets that are built into the current agreements. Those targets include laying off 150,000 government workers, cutting the budget by billions, and collecting taxes at an increased level in a country noted for tax evasion. So the next shoe will drop in Greece. The pro-bailout election makes the shoe drop slower, but it will drop nonetheless.
Without something like a bank deposit guarantee of the amount denominated in euro, the evacuation of Spanish and probably Italian bank deposits in favor of German or other northern eurozone country banks will continue and accelerate. Such a bank "run" (these days, a bank "click" with electronic transfers) can bring down a government and an economy.
The equity markets are looking bad all around in Europe as a result of the debt issues. Germany is seen as a safe harbor for debt, its equity market falling with the rest of Europe, just not as much.
Our view is that there must be evolving equity value opportunities in the eurozone, and in Germany in particular. Its mega-cap companies are not captive to Europe, as the U.S. mega-cap companies are not captive to the U.S. We'd steer clear of European debt, but think sorting through the rubble of European stocks is an increasingly attractive research activity.
German debt runs huge interest rate risk, and peripheral countries run huge default risk. Europe-based global giants, however, may be presenting better opportunities as their prices sink. Their intermediate-term future earnings may not be declining as fast as their prices, and their ability to rebound is generally good.
Creating a eurozone stock shopping list with target prices could prove quite beneficial at some point in the not too distant future.
Disclosure: QVM has positions in SPY as of the creation date of this article (June 18, 2012).
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