While we are sure Mitt Romney would not care to comment, private equity firm KKR's Henry McVey is strongly suggesting investors should avoid European sovereigns in his 2012 Outlook. While his reasoning is not unique, it does lay out a fundamental fact for real money investors as he still does not feel that Core or Periphery offer value. Specifically noting that "fiscal austerity among European nations is likely to lead to lower-than-expected growth, which would ultimately increase the debt-to-GDP ratios of several countries in the coming quarters", the head of KKR's asset allocation group sees a slowdown in Europe as core macro risk worth hedging. Expecting further multi-notch downgrades across both the core (more like BBB than AAA) and periphery, McVey also concludes in line with us) that Greece may need to restructure again in 2012 and will disappoint the Troika.
Among the major issues facing the financial sector in Europe, we believe, is that banks have not delevered enough, and our research shows that Greece is again on course to disappoint the Troika in 2012 (Exhibit below shows KKR's much worse estimates than even a consistently downgraded IMF perspective).
Outside the U.S., we believe European sovereigns still do not represent great value, since fiscal austerity among European nations is likely to lead to lower-than-expected growth, which would ultimately increase the debt-to-GDP ratios of several countries in the coming quarters. Hence, we feel that the ratings—and thus future performance—of Europe’s sovereign debt are still at risk. As one can see in the Exhibits below, comparing European sovereign CDS spreads to corporate credit spreads shows that the CDS in many cases are now implying multiple-notch sovereign ratings downgrades.
The CDSs may be overly pessimistic in their interpretation of Europe’s Economic and Monetary Union (EMU) core outlook, but we believe the historical AAA credit rating does not seem to match the current finances of the core either.