matisse capital management

Spain's Economy Is Key to Eurozone Solvency

It might be too big to bailout.  The PIIGS have faced tough economic times of late and today Ireland announced a €85 billion rescue package.  This will be combined with an austerity plan and an increase in value added tax to 23%.  Like Ireland, Spain is facing rising unemployment and a property bubble, but the assets of the country's banking system are estimated at €3.5 trillion, one third larger than Ireland, Greece and Portugal combined.  As the Wall Street Journal argues Spain may be too big to bail out.  Consider Spain's GDP as a share of euro zone GDP:

 

 

 

 

 

 

 

 

 

Also, per the WSJ: "(consider) Spain’s relatively modest gross government debt, which the IMF figures will come in at 63% of GDP this year, against Portugal’s 83%, Ireland’s 94%, and Greece’s astonishing 130%. Economists reckon once the debt to GDP ratio breaches around 90%, financial crisis and default become exponentially more likely."  The article continues to note Spain's growing financial problems: 

The Partitioning of Anglo Irish Bank

Anglo Irish Bank Now  =  Deposit Savings Bank  + Asset Bank for Troubled Loans

The bank has been dividend into two, given the extent of its troubled loans, which apparently far exceeded the original estimates of the National Asset Management Agency (NAMA).   The deposit savings bank will operate as a retail bank while the “asset recovery bank” will take over €38 billion in loans that are not being transferred to Nama, Ireland's "bad bank."  The retail bank will have €54 billion in deposits while the asset bank will be wound down over 15 years (an estimate).  More details here.

Royal Bank of Canada Stumbles in the Third Quarter

Q3 profit was down 18%.  For along time Canada's banks seemed to be the only ones bucking the down-trend, but that may have changed.  Royal Bank (RY) missed analysts earnings expectations by 15%.  Bank of Montreal also missed analyst expectations when it reported earnings on Tuesday.  In the third quarter, RY's results were as follows (disclosure: I am long RY):

• Earnings per share of C$0.84 versus the C$1.02 consensus.
• RBC Capital Markets trading profit was down 64%, due to lower trading revenues.
• The international banking division (which includes US operations) lost C$76 million for the quarter.

Standard & Poor's Downgrades Ireland's Sovereign Debt

From AA to AA-.  This is Standard & Poor's fourth highest rating, but it was coupled with a negative outlook, i.e. the possibility of another downgrade.  AA is defined as "very strong capacity to meet financial commitments."  S&P's release said: "The downgrade reflects our opinion that the rising budgetary cost of supporting the Irish financial sector will further weaken the government's fiscal flexibility over the medium term...In light of the recent announcement of new capital injections into Anglo Irish Bank Corp. Ltd. (BBB/Watch Neg/A-2), our updated projections suggest that Ireland's net general government debt will rise toward 113% of GDP in 2012. This is more than 1.5x the median for the average of eurozone sovereigns, and well above the debt burdens we project for similarly rated eurozone sovereigns such as Belgium (98%; Kingdom of; AA+/Stable/A-1+) and Spain (65%; Kingdom of; AA/Negative/A-1+)." Translation: The heavy debt load from this financial crisis means Ireland's economy will be deleveraging for some time and growth will be slow to nil.

Philadelphia Fed Activity Index Is Down for August

The Philadelphia Fed publishes a "General Activity Index" on a monthly basis that measures the business outlook for its region.  The index is based on a survey of local business regarding inventories, prices, new orders, employee hours as well as several other items.  In August, the index turned significantly negative at -7.1, the first decline since July 2009.  The major factors that led the index downward were the average employee workweek (-17.1), price receives (-12.5), and inventories (-11.6).

 

Moody's: The Crisis Has "Fast Forwarded"

"Time is running out for the west," from a Moody's report, per the Telegraph.  AAA ratings are no longer secure, as large western economies may not be able to outgrow their high levels of debt.  From Moody's "Genuinely adverse debt dynamics were only expected to materialise in 15 to 20 years. The crisis has 'fast-forwarded' history, eroding all the time available to adjust..."  The Telegraph on Moody's report: "Moody's fears that the US will crash through its safety buffer by 2013 if growth falters (adverse scenario), with interest payments topping 14% of tax revenues. The debt-to-revenue ratio has already doubled in three years to 430%...The US, UK, Germany, France, and Spain are all at risk of an 'interest rate shock,' either because they must roll over a cluster of short-term debt (US, France, Spain) or because deficits are so large...Countries that 'fail to demonstrate the level of social cohesion required to stabilise debt' will lose their AAA rating."

You have to wonder, should some of these governments have alreay lost their top credit rating?  Is Moody's late to the game and merely stating the obvious?

The Chicago Fed National Activity Index

An index of national economic activity. The Chicago Fed National Activity Index (CFNAI) is a number that measures overall economic activity and inflationary pressure.  The index is released monthly and is calculated using a "a weighted average of 85 indicators of national economic activity."  The line CFNAI-MA3 is the three month moving average of the index.  A zero value on the chart means the economy is growing at a rate that is equal to the long-term historical average, while a negative number means below-average growth, and positive number is above-average growth.  Note that the figures for March, April and May were positive at 0.47, 0.16 and 0.31, respectively.  In June, the most recent number released, the index turned negative at -0.63.  The second down-leg of the recession?

What Lies Ahead: Deflation or Stagflation?

Or just plain old inflation?  Warren Buffett seems to be betting on the latter.  According to Bloomberg: "Warren Buffett shortened the duration of bonds held by his Berkshire Hathaway Inc. after warning that deficit spending could force inflation higher...21% of holdings including Treasuries, municipal debt, foreign-government securities and corporate bonds were due in one year or less as of June 30, Omaha, Nebraska-based Berkshire said in a filing Aug. 6. That compares with 18% on March 31, and 16% at the end of last year’s second quarter...'It may be a sign that Buffett expects interest rates to start rising, maybe sooner than the conventional wisdom,' (per) Meyer Shields, an analyst in Baltimore at Stifel Nicolaus & Co..."  Below a Federal reserve chart of the change in the CPI:

Ireland's Second Quarter Housing Data

Prices are still declining, but more slowly.  Ireland's version of the Case-Shiller Index is the tsb/ESRI House Price Index, produced by the Irish Life & Permanent Group.  According to the tsb/ESRI, home prices in the Republic of Ireland peaked in February 2007.  Second quarter 2010 data just released showed the following:

• Nationally, prices are down 35.2% from the peak
• In the City of Dublin, prices are down 43.3% from the peak

The year-over-year rate of decline in home prices slowed in the second quarter.  For Dublin, as of the second quarter, year-over-year was -24.6%; nationwide it was -17.0%.  The prior quarter year-over-year numbers were -24.5% and -18.9%, respectively. The home price decline in the second quarter 2010 for Dublin was 3.5%, while in the first quarter it was 10.3%.  In the fourth quarter 2009, Dublin was down 7.5%.  At the peak of the market, the average home price in Dublin was €431,006; today it is €242,000.  The Bank of Ireland estimates that one in five homeowners have negative equity.   Chart, click to enlarge.  These numbers sound very similar to the Case-Shiller housing data in the US, don't they?

 

The Rise of Sovereign Debt in the Great Recession

From the St. Louis Fed.   Rising interest rates could make debts unsustainable for some of these countries in the future, when a recovery begins.  Debt-to-GDP and deficit-to-GDP are plotted for 2007 and 2009 year-end data.  The parentheses indicate average GDP growth between 2003 and 2007, a period of expansion.