Three snapshots for Tuesday
Equities in the countries most exposed to the euro zone crisis seem to be being hit especially hard this year. The Datastream index of shares in Portugal, Italy, Ireland, Greece and Spain has a total return of -5.3% this year compared to +8.9% for a euro zone index excluding those countries.
U.S. consumers went back to using their credit cards in March to keep spending while student and new-car loans shot up as the value of outstanding consumer credit jumped at the fastest rate since late 2001, data from the Federal Reserve showed on Monday.
Total consumer credit grew by $21.36 billion – more than twice the $9.8 billion rise that Wall Street economists surveyed by Reuters had forecast.
Perhaps some of that credit card spending is finding its way to luxury goods companies – there certainly don’t seem to be too many worries about an economic slowdown coming through in their share price performance:
Yield-hungry tilt to equity from credit
For income-focused investors, the choice between stocks and corporate bonds has been a no-brainer in recent years. In a volatile world, corporate debt tends to be less sensitive to market gyrations and also has offered better yields – last year non-financial European corporate bonds provided a yield pickup of 73 basis points above stocks, Morgan Stanley calculates.
But, long a fan of credit over equity, MS reckons the picture may now be changing and points out that European equities are offering better yields than credit for the first time in over a decade. (The graphic below compares dividend yields on non-financial euro STOXX index with the IBOXX European non-financial corporate bond index. The former narrowly wins.)
The extra yield available on equities, coupled with perceptions of a more stable macro backdrop, may encourage income-oriented investors back into stocks.
The bank has put together a 10-stock basket with an average 2012 yield of 5.1 pct (vs MSCI Europe’s 3.9 pct). That is around 250 bps higher than corresponding bonds. Check out Britain’s Vodafone – its shares offer a whopping 8.3 percent yield. That’s 600 bps above its 5-year implied credit yield.
That sounds tempting. But there are caveats. The best yield pickup is available in sectors where investors remain underweight — utilities and telecoms. And a positive yield gap is not always a bullish signal for stocks, Morgan Stanley warns. Japanese dividend yields have been above bond yields since 2008.
Becoming less negative on Europe
Markets are unimpressed today by Europe finally agreeing to bail out Greece for the second time, with European stocks down -0.6% on the day.
But here’s some encouraging news: Credit Suisse has become less negative on Continental European stocks for the first time in almost two years.
The bank has moved to benchmark weighting from 5% underweight for a currency hedged portfolio.
Why?
We think that the ECB is increasingly dovish (and we would not rule out another three-year LTRO after the one on 29 February), which should help weaken the euro; and we now only expect a 1% decline in European credit (down from our previous estimate of a 5% decline); relative to other regions, economic momentum and earnings momentum have troughed. But there is not enough for us to raise weightings to overweight.
In CS’s earnings momentum scorecard, Europe ex-UK has moved up one place, off the bottom of the list, with a total score of -0.1 — above Japan’s -1.2.
On previous occasions when relative Continental European earnings revisions have troughed, Europe ex UK equities have on average outperformed 75% of the time and when they did outperform, it was by 3–5% in the next three to six months (in local currency terms).
from MacroScope:
Dramatic ending to Greek tragedy
Greece is in the danger zone. Even as the country's finance minister sought to reassure his euro zone counterparts at a meeting in Poland, Greek credit default swaps were pricing in a more than 90 percent chance of default, according to Reuters calculations of Markit data. Economists in a Reuters poll see a 65 percent chance of that happening, probably within a year.
Such fears recently sent jitters across financial markets, prompting some words of comfort from German Chancellor Angela Merkel and French President Nicolas Sarkozy that they are determined to keep Greece in the euro zone. But speculation is growing that Greece will default, and that it will be a messy ordeal. Here are some of the potential dangers if it occurs:
* Greece may be seen as setting a precedent for Portugal and Ireland, analysts said. Yields on peripheral euro zone debt could surge rapidly, making funding costs increasingly unsustainable as yields on Italian and Spanish 10-year bonds surge back towards 7 percent. The ECB could have to intervene more aggressively in the secondary bond market to the detriment of its balance sheet.
* European banks may have to make more significant write-downs of their Greek holdings than they already have. This would hit French banks especially hard, since they are the most heavily exposed to Greek debt, with $56.9 billion in their portfolio -- more than double as much as Germany's equivalent holdings. French banks are also the most vulnerable to Italian debt, with a hefty $410.2 billion.
* Fears of more contagion and further write-downs could make banks even more reluctant to lend to each other. A key measure of financial stress -- the three-month spread between euro Libor and overnight index swap rates -- hovered near its highest in over two years. Said Gary Jenkins, head of fixed income research at Evolution Securities:
You would get the loss on the Greek debt of course but I think much more important is the funding situation. Who is going to be lending the banks money if you have got euro zone sovereigns defaulting and you are unsure about what is going to happen next?
* Banking sector problems could hurt equity markets at large: stock valuations could fall significantly, raising concerns over the ability of corporations to raise capital. That would hurt business and consumer sentiment and further diminish the likelihood of a meaningful global recovery, says Richard McGuire of Rabobank.
Credit rules, ok?
Equities may be the poster child for this year’s market recovery, but corporate bonds have been the runaway outperformer.
As the graphic below shows, corporate debt was less volatile and moer profitable over the past nearly three years of crisis and recovery — even “junk” bonds.
This year’s performance for corporate bonds has been stunning. In December last year, the spread between global large cap company debt and U.S. Treasuries was 155 basis points, according to Bank of America Merrill Lynch. It has now narrowed to around 52 basis points.
The performance of high-yield, or “junk” bonds, has been even better. From a spread of 2,193 basis points in December, the BoA-ML global high-yield index now registers 773.
And what now? Investors still like the asset class, but there is evidence that the degree of passion may be cooling.
(Graphic: Scott Barber)
from DealZone:
Cocos – credit market classics?
"Cocos" has become the user-friendly name for a new type of hybrid bond created to help UK bank Lloyds raise money from investors to break away from a government insurance scheme for bad loans.
This nickname seems to have caught on in financial circles as it is much snappier than the bonds' official title: Enhanced Capital Notes.
The name Cocos seems to have derived from "contingent convertible," which describes one characteristic of these bonds - they convert to equity in certain circumstances.
Coco was famously the first name of French fashion designer Chanel. She was not known for her understanding of the credit markets but she did know a thing or two about fashion and the value of tradition over new-fangledness.
One senior capital markets banker pointed out these comments she made:
"Innovation! One cannot be forever innovating. I want to create classics."
Some bankers hope Cocos can become credit market classics, but admit that the jury is still out.
Ask the audience
No sign at a Fitch Ratings briefing today that things will get much better this year for emerging market debt. The 100 or so mainly industry attendees were asked to give their thoughts using a machine not unlike the “Ask the Audience” gadget seen on “Who Wants to be a Millionaire”.
Only 10 percent said credit quality would improve over the next 12 months. By far the largest vote — 59 percent — was for credit quality to “deteriorate” somewhat.
As for a wholesale crisis on emerging markets, the attendees were fairly sceptical. Only 12 percent thought there was a more than 50 percent chance of such event. Half the respondents said the odds were between 20 and 49 percent. SOme 38 percent said it was less than that.
Fitch, meanwhile, said it agreed that emerging market credit quality was likely to deteriorate further. It was corporate rather than sovereign debt that was most most likely to defauls. And emerging Europe was the most at risk.
Bah Humbug
Value managers and contrarian analysts long derided as permanent bears have been poking their heads out of the woods to bring some early Christmas cheer to delegates assembled at the CFA Institute’s European Conference in Amstedam.
James Montier, global strategist at SocGen, who likes to swim with sharks in his spare time, opened the conference on Tuesday by saying that he was more optimistic about equities than he had been for a long time, with the UK and European markets approaching bargain basement prices.
But on day two, Matt King, managing director, credit products strategy at Citigroup, rained all over this parade. “I have a message for equity investors,” he said. “It’s worse than you think!”
He argued that next year will be just as miserable as 2008, if not more so, for the majority of investors, as European bank deleveraging is only a third of the way through. “For credit investors it’s not as bad as we are still earning carry, but equity investors continue to amaze me with their over-optimism,” he said.
Citigroup’s equity strategists are forecasting 40 to 50 percent falls in EPS, and King foresees a weak recovery, more like that of the 1930s, as defaults have such a long way to go.
“Things have only stabilised because everything is on central bank life support – there has been no improvement in the underlying fundamentals,” he said. Because European banks are still unable to lend – due to regulation requiring further deleveraging – companies won’t be able to refinance, and will have to do everything they can to pay down their debt, or face liquidation, like UK retailer Woolworth’s. This will lead to cuts in capex and headcount, creating a strongly deflationary environment, spelling bad news for an equity market recovery.
Merry Christmas everyone.
One should duly note the stock market bottomed in July 1932, which was months before the banking system went into its death spiral … and years before the Great Depression ended.
