The euro crisis revisited

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  • Housing fall coming? The graph shows the gap between wages and housing prices in Spain

    Housing fall coming? The graph shows the gap between wages and housing prices in Spain


The sugar-induced high from the European Central Bank’s injection of more than $1.3 trillion in three-year money into Europe’s flailing banks has begun to subside. The Euro sovereign debt crisis, unfortunately, is far from over.

Yields on Italian and Spanish debt have begun a renewed ascent. I had to chuckle when Reuters on March 13 ran the following headline: “German, French Finance Ministers say Worst of Euro Crisis is Over”. Maybe “the worst” is over for some countries but this horror show is far from being done.

The recent bank financing has removed the tail-risk of a sudden systemic collapse in the Euro banking system, which is evident in the collapsing interbank spreads. Unfortunately, this extra liquidity will not fix the sovereign problems. The fiscal austerity required to correct the indebtedness will only make many struggling countries weaker and without a currency debasement we are likely to see deflationary forces take hold in Europe.

The latest target is Spain. Yields on ten-year Spanish debt have recently risen above six percent. This is an unsustainable rate for the country that probably needs rates around four percent to remain solvent over time.

Let’s look at some of the rather shocking headwinds and data facing the nation:

- Spain’s mess is really the result of a bursting housing bubble. This was a significant bubble. According to Bank Credit Analyst Research, the Spanish and Irish housing booms eclipsed even the US surge. In ten years, US houses doubled, Spanish prices trebled and Irish prices quadrupled. The number of Spanish houses went up by 35 percent as well. However, Spain’s housing market has only corrected some 20 percent so far compared to the US correction of 25 percent, and the Irish plunge of 50 percent.

According to Carmel Asset Management (http://www.scribd.com/doc/88388379/Investment-Focus-The-Pain-in-Spain ): Spain built one house for every additional person added to the population over the past two decades. They suggest that if wages in Spain fall to be more in line with Germany, Spanish house prices would need to fall 50 percent to be back to this pre-bubble relationship. They go further to note that Spain has only 1.7 people to fill each home the lowest of major developed countries. It’s likely that Spanish home prices have much further to fall.

- Losses will likely mount on the banks in Spain due to the pending housing correction. A large and growing backlog of mortgage-related losses is likely building. This is compounded by the fact that, according to the IMF, 87 percent of household wealth in Spain is held in the form of real estate with a “significant degree of ownership of secondary houses”.

If housing stagnates and collapses a colossal level of household wealth is likely to evaporate. Let this be a lesson for those not truly diversified in their assets!

- According to Edward Hugh in the Economonitor, Spanish gross debt to GDP is probably close to 90 percent and not the official data number of 67.8 percent as at the end of 2011. If this is true, the deleveraging facing Spain could be much worse.

- Spanish unemployment is at disastrous levels. Official unemployment stands at around 24 percent while youth unemployment is an epic 50 percent. Spain will require far-reaching labour reforms to correct its rigid system that remains one of the worst in Europe and what has caused an uncompetitive rise in wage rates and lower productivity.

Although select European countries look like they will have years of restructuring ahead, the rest of the news is not so dire. Most of the world’s economies are still recovering and China looks to possibly be able to engineer a soft landing. Global stocks can sustain a rally even in the face of a Eurozone contraction and stress as long as sovereign issues remained localised.

There are also a few opportunities amidst the pain. It will be important to remain wary of potential “value traps” in countries were a debt-deflationary spirals develop ( i.e bank equities in troubled regions) but there are also opportunities. Here are a couple of areas an investor should focus on to take advantage of the distress in Europe:

1. Buy the vultures. European banks need to recapitalise. As distressed countries enter periods of deflation, the banks will be looking to shrink their balance sheets and raise capital adequacy ratios. As a result, they will likely be selling what they can at bargain prices. The IMF recently suggested that European banks will need to sell some $3.8 trillion through 2013. Many insurers, reinsurers, hedge funds and private equity firms will swoop in and pick at the carcasses buying assets at cheap prices that should be able to generate satisfying returns. Apollo Global Management just raised about $7 billion in funds to target European distressed assets, for example.

2. Buy non-European companies that are European. Confused? Don’t be. Many companies that trade in Europe are not really “European” companies. Take, for example, LVMH Moet Hennessy Louis Vuitton (“LVMH”). LVMH is the world’s largest maker of luxury goods. It’s a French company that sells its upper end products throughout the world. Sales in Asia recently climbed 17 percent, in the US 16 percent and in Japan 10 percent. Although it is a French company, only about 12 percent of the luxury maker’s revenue is in France and its success is based on the growing affluent class in emerging markets. Across the board sell-offs in European markets may present an opportunity for savvy investors to pick up great companies that have been dragged down unjustifiably.

Nathan Kowalski is the chief financial officer of Anchor Investment Management Ltd.

Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Anchor Investment Management Ltd. to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisors prior to any investment decision.

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Published Apr 23, 2012 at 8:00 am (Updated Apr 23, 2012 at 8:28 am)

The euro crisis revisited

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