Global Investing

The (CDS) cost of being in the euro

What’s the damage from being a member of the euro? German credit default swaps, used to insure risk, have spiralled to record highs over 130 basis points, three times the level of a year ago amid the escalating brouhaha over Spain’s banks and Greek elections. U.S. CDS meanwhile remain around 45 bps. That means it costs 45,000 to insure $10 million worth of U.S. investments for five years, compared to $135,000 for Germany. (click the graphics to enlarge)

A smaller but similarly interesting anomaly can be found in central Europe. Take close neighbours, the Czech and Slovak Republics who are so similar they were once the same country. Both have small open  economies, reliant on producing goods for export to Germany.

The difference is that Slovakia joined the euro in 2009.

Back then, with the world grappling with the fallout from the Lehman crisis, Slovakia appeared at a distinct advantage versus the Czech Republic. At the height of the crisis in February 2009, Czech 5-year CDS exploded to 300 bps, well above Slovakia’s levels. But slowly that premium has eroded. A year ago CDS for both countries were quoted at similar levels of around 70 bps.  Now the Czech CDS are quoted at 125 bps, having risen along with everything else, but Slovak CDS have jumped to 250 bps, data from Markit shows. (bonds have not reacted in the same manner — Slovak 1-year debt still yields around 0.8 percent versus 1.4 percent for the Czech Republic; similarly German yields have fallen to zero; for an explanation see here).

According to Benoit Anne, head of emerging markets research at Societe Generale:

These days being outside the euro zone is better than being in it and being outside the European Union is better than being inside it. The Slovak market has suffered a huge cost from a market perspective because of its membership of the euro.

Sell in May? Yes they did

Just how miserable a month May was for global equity markets is summed up by index provider S&P which notes that every one of the 46 markets included in its world index (BMI)  fell last month, and of these 35 posted double-digit declines. Overall, the index slumped more than 9 percent.

With Greece’s anti-austerity May 6 election result responsible for much of the red ink, it was perhaps fitting that Athens was May’s worst performer, losing almost 30 percent (it’s down 65 percent so far this year).  With euro zone growth steadily deteriorating, even German stocks fell almost 15 percent in May while Portugal, Spain and Italy were the worst performing developed markets  (along with Finland).

The best of the bunch (at least in the developed world) was the United States which fell only 6.5 percent in May and is clinging to 2012 gains of around 5 percent. S&P analyst Howard Silverblatt writes:

Three snapshots for Wednesday

On Friday 283 companies in the S&P 500 had a dividend yield higher than the 10-year Treasury yield, at yesterday’s close this had fallen to 266 but remains very high compared to the last 5-years.

Italian consumer morale plunged to its lowest level on record in May as Italians’ pessimism over the state of the economy plumbed new depths.

Germany set a zero coupon on its new Schatz, the first time it has done so on debt of such maturity. The bid to cover ratio for the new bond at the auction was 1.7, compared with 1.8 at a sale of two-year debt on April 18.

Three snapshots for Thursday

The Bundesbank is preparing to stomach higher German inflation than it likes, above the European Central Bank’s target level, because of the euro zone crisis, a source at the central bank said on Thursday.

Although the Bundesbank still wants stable prices across the euro zone, its latest comments show the bank recognises that upward pressure on German wage costs and property prices suggest its inflation is likely to rise above the bloc’s average.

As this chart shows, historically the Bundesbank was quick to react to any signs of inflation:

Big Fish, Small Pond?

It’s the scenario that Bank of England economist Andrew Haldane last year termed the Big Fish Small Pond problem — the prospect of rising global investor allocations swamping the relatively small emerging markets asset class.

But as of now, the picture is better described as a Small Fish in a Big Pond, Morgan Stanley says in a recent study, because emerging markets still receive a tiny share of asset allocations from the giant investment funds in the developed world.

These currently stand at under 10% of diversified portfolios from G4 countries even though emerging markets make up almost a fifth of the market capitalisation of world equity and debt capital markets.  In the case of Japan, just 4% of cross-border investments are in emerging markets, MS estimates.

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.

Three snapshots for Wednesday

Euro zone factories sank further into decline last month but manufacturers in Asia upped their tempo to meet growing demand from the United States and China, exposing a widening gulf between Europe and the rest of the world.

Unemployment in the euro zone rose to a 15-year high of 10.9 percent in March – as this chart shows the level of youth unemployment paints a worrying picture:

U.S. private employers hired a far fewer than expected 119,000 people in April, the smallest gain since September 2011, a report showed on Wednesday, adding to concerns that the economy has lost some of its momentum. This chart shows the relationship between the first release of ADP figures and non-farm payrolls which are released on Friday.

Three snapshots for Friday

The U.S. economy expanded at a 2.2 percent annual rate in the first quarter, slightly weaker than expected.  Consumer spending which accounts for about 70 percent of U.S. economic activity, increased at a 2.9 percent rate – contributing two percentage points to the overall growth rate.

Sell in May and go away? Here are the average numbers for the MSCI world equity index:

More awful economic numbers from the euro zone, Spanish unemployment hit 24.4% in Q1 2012 with youth unemployment rising to 52%.

The “least worst” option?

Western governments saddled with mountainous debts will “repress” creditors and savers via banking regulation, capital controls, central bank bond buying and currency depreciation that effectively puts sovereign borrowers at the top of the credit queue while simultaneously wiping out real returns for their bond holders. So says HSBC chief economist Stephen King in his latest report this week called “From Depression to repression”.

Building on the work of U.S. economist Carmen Reinhardt and others, King’s focus on the history of heavily indebted governments applying “financial repression” to creditors arrives at several interesting conclusions. First, even though western governments appeared successful in using these tactics to reduce massive World War Two debts alongside brisk economic growth during the 1950s and 1960s, King argues that the debt was cut mainly by the impressive economic growth and tax revenues during that “Golden Age” – and this was mostly down to the once-in-a-century period of relative peace that involved unprecedented integration and cooperation among western governments also engaged in a Cold War with the Soviet Union. Compared to this boost, the financial repression was a “sideshow”, he reckons.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           To show that, he applies the interest rate and inflation conditions of the 1950s and 1960s to the current US government debt trajectory and then compares the growth scenario back then with the one faced now. The graphic is revealing. So, for repression to work, it needs to generate higher growth first. And despite lower real rates today than in the days of Mad Men, that seems not to be the case.

Instead, King says governments will adopt this repression tactic anyway just to stave off draconian austerity now and prevent a destabilising surge in economy-wide borrowing rates. This will effectively reduce the amount of credit to the rest of the private sector, or at least elevating its cost, while reducing the pressure on governments to cut the debt levels quickly. The net result, then will likely be “persistently lower growth”, whatever your conclusion about the desirability of  state or the market allocation of resources.

Three snapshots for Tuesday

U.S. consumer confidence came in slightly weaker than expected but the ‘jobs-hard-to-get’ index – historically a good lead indicator of the unemployment rate - fell to 37.5 in April.

Spanish equities in price terms are near their 2009 lows but valuations are still some way above:

Australian consumer prices rose by less than expected last quarter while key measures of underlying inflation showed the smallest rise in more than a decade, paving the way for a cut next week and suggesting further cuts were possible.