Thursday, June 17, 2010

Can we say Adios to Spain?

What I found interesting over the past few days has been the transition from nervousness about Greece (from what used to be panic) to Spain pandemonium. One may ask, why are we seeing this? I will move forward with this article in a few directions hoping to express my opinion about why Spain has a danger flag hanging from its flag post, but that it's simply a danger flag, nothing more. We will explore some economic data, spreads, and yields, using all 3 in an attempt to draw a conclusion about what is really going on in Spain and what it's future prospects hold. We will conclude with a few reasons why concerns about Spain are greater than Greece, but serve only as smokescreens to the gem of Spanish debt buried beneath.

Let's being with some indicators. The graph below depicts the unemployment rate in Spain, on a quarterly basis, which is currently at 20.05%. I need not stress the absolutely ridiculousness of that number. For sustained growth to take place in a country, a low unemployment rate is a must, an obvious fact. With these rates rising in Spain, it will be extremely tough for them to rise out of this past recession and move forward with economic growth.

If we compare manzanas to manzanas, (manzanas are apples in Spanish), we can see the unemployment in Spain is much higher than the rest of the Eurozone. What's even more worrisome is that fact that both rates don't seem to have reached a ceiling yet.

Now granted having a housing bubble and subsequent burst can wreak havoc on an economy. Case and point, the country we all know and love, the US of A. However, what would a WORSE housing bubble and burst do to an economy? Well, for starters, growth will be sluggish, thus leaving a country more vulnerable to slipping back into a recession, as confidence among its citizens plunges. The graph below tells that story. 3.0% growth for the US (from the 2nd estimate of GDP) has been somewhat reflective of rising home prices. Spain is a different story. Housing prices in Spain just haven't seen the type of rebound experienced in the US. Side-note: I realize the housing market isn’t all fine and dandy, however things APPEAR to be turning in the right direction.

In my humbled opinion, the 2 indicators mentioned above are very important for growth. Of course, they are not the only ones but can be considered to be at the top of the list. Speaking of growth below is a chart of GDP in Spain on a quarterly basis dating back to 1996. That huge dip we see, well doesn’t seem to be improving. Yes, it is rising, but not at any sort of substantial rate. I guess one could classify it as less bad? Anyway, there will be another release at the end of June, which will surely shed some light on things.

Now that we have concluded that Spain needs an improvement in both employment and housing to improve economic growth, we will move into some other areas of concern. First off, the spread between Spanish 10-year notes and German 10-year notes was at an all time high, 220 bps at the time of this writing (it dipped Thursday morning to about 213 bps). Granted, this is nowhere near the level between Greek and German bonds, but for sufficient reasons. A few strong reasons for those high yields on Greek debt included fears they would default, destroy the Eurozone and Euro, and freeze up credit markets. This drove yields through the roof. However, over the past couple of weeks, this fear has waned and it appears that the market may have over exaggerated.

Looking at some of Greece's leading indicators, they are nowhere near as nerve-racking as Spain's. Spain is also one of the largest economies in the world. It is one of the largest havens for investments, meaning both companies that are based out of here, and investing done by this country. If Spain were to default and/or require some kind of assistance to help their debt-ridden country, the Eurozone would be in serious trouble. Being the 4th largest contributor to GDP, Spain's presence is extremely important in the Eurozone.

Let it be known that I DO NOT think that anything substantial will happen in the Eurozone, in regards to any collapse, break-up, or default. This article's purpose was so serve as a warning that Spain may be in trouble and a watchful eye should be kept on it. Like some previous articles I have written, I strongly support investing in the sovereign debt of these countries for both the yield and price appreciation. There will be no defaults and no breakups due to the fragile state of the global recovery. All these depressing indicators are simply a smoke screen meant to keep out weary investors. (That may be an exaggeration of sorts).

To cool the fuego de Espana (Spanish fire), the Bank of Spain has announced it will release stress tests performed on it's banks. Now, the US Treasury did this last year and it showed that some banks might be in trouble. The tests had different criticisms, most of which I don’t care to go into, but nonetheless, the stock market rallied and the stocks pertaining to these banks rose. Back to Spain, and the release of the results. My thinking is that these should be taken with a grain of salt, per say. Spain is releasing these results ahead of any other European this a good sign? Are Spanish banks well equipped to face a liquidity strain or worsening economic conditions? I think the results will come back positive. However, it should also be expected that some banks are going to be liquidity strains and some banks may be perceived to be in trouble, especially the smaller banks. All in all, I feel this is a step in the right direction, another reason why Spanish debt is certainly a market play.

Another side note, Spain sold debt on Thursday. The auctions went well, finishing with decent bid covers. This helped ease concerns about whether Spain will be able to pay upcoming debt in July. Spreads decreased and yields dipped on this news. All this news and awareness by the Spanish government will positively impact spreads and yields, so my advice, get in while the getting is good.


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