The Pain In Spain Falls Mainly... Everywhere
Authored by Mint's Bill Blain,
European GDP and Spain – where it’s going?
Europe Q4 GDP declines 0.6%, and economy contracts 0.9%. No one should be surprised at the latest disappointing European GDP numbers, but they hide important trends – Germany’s Q4 0.6% GDP drop was worse than expected, although the expectations remain for growth later this year. France is going to miss the 3% GDP deficit target because of low growth. For the rest of Europe the numbers were generally worse than expected – and no one credible is talking about significant growth prospects. (Sure, the Euro Elites are telling us they see growth tomorrow.. but tomorrow is always tomorrow..)
The poor GDP numbers are likely to have significant knock-on effects in terms of confidence and the Euro – sure enough European Stocks are lower. France GDP was down 0.3%, Netherlands down 0.2%. And the critical peripheral worries: Italy down 0.9% in Q4. Spain Q4 contracted by 0.7% when its number was released in Jan.
Of course, slowing economies would normally be good news for bonds – rates should fall as the need for economic stimulus rises. True for Germany, but since the rest of Europe moves in step with Germany… until it doesn’t, and renewed doubts about the Euro economies take over!
Are we likely to see another round of Euro Peripheral weakness?
The difference now is NO-ONE really believes the Euro is going to break up. There are some doubts about Italy as the political tensions rise, and the Euro Elites face up to the implications of a Berlusconi resurgence. He’s back, and this time he’s serious... Get over it.
Let’s look at Spain. I’m assured there is nothing to worry about. The country is determined to stick with the programme and stay within the Euro. Sure, there have been some wobbles in terms of agreeing GDP/deficit targets, bailing out the banks, and refusing to be handcuffed to OMT shackles.
Let’s go back to 26th July 2012, the day Draghi promised to “do what is needed to preserve the Euro”... If you bought Spain that July day, you are sitting pretty. 5-year Spain CDS rallied from 642 to 244 in Jan. Spain’s worst of a bad bank bunch, Bankia, has seen its senior CDS tighten from 1575 in July to 709 currently! Spain stocks, IBEX, is up 38%.
What’s not to like..? Think hard about that one.
As we all know, the moment to exit a position is when you first think about it... not when you have to. So if you are bought into the Spain rally, let me ask... what’s the next move? Hold for now, hold to maturity, or sell?
What are the risks for Spain? We have few doubts it will stay in the Euro. If needed, it will get a bailout in whatever form the ECB can make acceptable - unlimited bond purchases and/or direct cash injections if markets close. Anything will be done to avoid an embarrassing default. The risks are more subtle – economic and the long-term consequences of economics.
I spent yesterday’s quieter moments reading through rafts of Spain stuff – particularly some excellent stuff from David Watts at CreditSights. I generally ignore most of the bank analysis – it’s ever so slightly biased and as turgid as over-ripe halibut. No bank is going to write negative Spain comment when there are potential Spain bond mandates to be won.
My current interest in Spain was pricked by Blackrock CEO Larry Fink’s comments to ABC following a visit to Madrid. He reckons “Spain will be a star economy if reforms continue” but it still faces 3-4 years of hard adjustment. Hmm.. so Blackrock has become establishment – agreeing with that the Spanish claims of an: “unprecedented fiscal consolidation effort”. However, there was nothing in the press release to back up any of Fink’s claims with real data or trends.
Data and graphs are the territory of my Macro-Man – Martin Malone - but he’s currently glad-handing in Japan, so let me present my own Spain snapshot:
- The government is extremely unpopular – that’s why the apparently faked attempts to frame them as slush fund recipients had limited effect. Rajoy et al are already marginally less welcome than Ebola fever.
- The government still has many unpopular spending decisions to take. Domestic tension remains high and with still rising unemployment, it could get worse. Which could spawn yet more anti-centralisation from the regions.
- Lowering Spain wages has made Spain more “competitive”, but only in European wage terms.
- Sadly, Spain’s only competitive advantage is lower wages: Spain isn’t a leader in the value-added factors of mature European economies; like cutting edge technology, unmatched engineering prowess, world class design, financial innovation or even sophisticated marketing. There are exceptions; Spain’s top company Zara is successfully selling middle market clothing on a pile ‘em high, sell ‘em cheap basis. Otherwise, Spanish manufacturing is basically making things cheaper than others.
- While European manufacturers may well be looking to move production to Spain because of low wages, it doesn’t help the strong Euro makes the whole country uncompetitive on the world stage, and that European consumers aint consuming very much.
- The improvements in Spain do mean it’s well placed in the short-term if… if… there is a recovery. Long-term prospects look worse with the university educated future generation now working as barista’s in London or anywhere outside Europe, and little being done to invest in a technology driven future.
- Emigration of the best and brightest adds to the demographic time bomb ticking in the Spain pension funds.
- Although the 25% plus Spain unemployment probably underestimates the black economy – it’s a simple fact the whole Spanish private sector is massively overleveraged, especially as family heads are losing their jobs. Falling wages and job losses increase the burden. Banks remain massively vulnerable to rising retail distress.
- All the above without even mentioning fact the economy is burdened by millions of unsellable homes with no one likely to buy. I really don’t understand how SAREB (the Spanish bad bank) is apparently selling property 30% above market.. If I don’t understand it.. my default position is its dodgy.
- Spanish banks may be funding again.. whoopee.. But that’s not a factor of better conditions or outlook – it’s entirely a factor of the scramble for yield rather than better Spain financial fundamentals.
When I ask the question.. what’s not to like about Spain..? Well actually quite a lot.. What are the positives. Well, turning to Mr Fink, the Euro Elites and the IMF, they all praise Spain for making great progress.. In what way? Last year the Spaniards told us they were targeting a 6.3% Deficit GDP. Everyone harrumphed and whined, but had little choice but to accept the number.
Guess what. Spain will miss that number by a significant margin. Now they say 7.4% is likely due to the cost of bank bailouts. But as CreditSights point out, they are probably underestimating the true impact of the 3.5% GDP cost of the bank bailouts. Even the Spain MOF predicts a 8.1% deficit number!
CreditSights suggests a significant Deficit miss will undermine Spain’s borrowing position. They say investors should lighten up on Spain because the likely deficit miss is one sided: if the number was hit, it won’t move market higher, but on a miss there will likely be a sell off – particularly at the long end.
Perhaps... but I’d add Spain’s borrowing position is only sustained by the Draghi promise of OMT support. What if that proves to be just talk and illusion? If Spain is so obviously failing to control its deficit, name a German politician who will be keen to allow them access to emergency OMT funding if there is a reversal? German election later this year.
One Key CreditSights soundbite: “Spain last ran a balanced budget in Q1 2008 when growth was 2%. Now the economy is shrinking 1.7% on an annualised basis.” That’s a massive amount of catch up to be achieved.
The real danger in Spain is long-term. Thus far the government has contained youth unemployment and social unrest. But long-term how will that fare as Spain comes to realise that the only future for it within the Euro is to remain the most competitive production country by dint of lower wages. That’s hardly an attractive option within the United States of Europe – being little more than low-paid arbiters for Corporate Germany.
We are looking at another 3-4 years of economic misery just to get the Spanish economy back into the EU’s 3% deficit/GDP groove. Then we’re looking at on-going relative poverty for Spanish workers within Europe. At some point... something has to give...