2nd January 2012: Investment Themes To Look Out For in 2012, Part 1: The Death of AAA

Euro Rating Scores (Source: Economic Times - Fitch/Moody's'S&P)

Quote of the Day:

It was an act of responsibility and political initiative to keep the Spanish economy from reaching a situation that would have been practically unsustainable…

It is possible that it will exceed 8 per cent. Not by much, I certainly hope.

Luis de Guindos – Spanish Finance Minister (revelation of how shocking the Spanish deficit situation really is)

Macro Overview

The Slow and Painful Death of AAA

• Perhaps we all will recognize AA as the new AAA and just carry on regardless. But there is a constant reminder that AAA does exist at least in places like Germany, Austria, Hong Kong, Australia, Canada, Singapore, Sweden, Norway, Denmark, Finland and even some organizations like, for instance, Hong Kong’s Metro (MTR) and Airport Authority are both AAA rated.
• But the so-called elite economies are dropping like flies from the AAA echelons…

• The US, already downgraded by S&P to double-A status, faces a greater wall of worry in 2012 as Fitch too mumbles of a downgrade, citing the sheer volume of debt which needs to be somehow dealt with – without hindering growth, in a global economy without any drivers. Folk that ridiculed the S&P downgrade of America’s long term credit rating do not understand the reflexivity of the World’s benchmark instrument as a Giffen good. Take a crude example: if the BBC announced that China was going to provoke a World War by invading America, by the same logic these commentators would rubbish the rumours on the grounds that they saw ex-pat Americans rushing back into the US, the very subject of the ensuing attack. But you and I know that in the event of a “downgrade of the global outlook” the place most would rather be is inside the US. So it is with treasuries, as they represent the benchmark for the entire global economy. I’ve written about the Giffen behaviour of Treasuries before (see below). Investors rushing to buy the World’s deepest and most liquid asset at negative real yield is hardly a glowing endorsement for the fiscal or financial outlook for the World or it’s largest economy.

• It is like PIMCO’s Kashkari said; if you feel a building is going to collapse in an earthquake you run down the stairs, towards the origin of the tremor. Lower and lower treasury yields over the past 5 years are not a sign that people are happier with the state of America’s finances. Do they honestly think, with anemic growth expectations, people are more optimistic now about the state of America’s fiscal position than they were in 2006?
• You see Treasury price-dynamic work on a similar psychology to “Giffen Behaviour” – the less attractive the price is for the product, the more demand there is for it. If you want a better indicator of sentiment in the treasury markets, look at the yield of the 10 year note in relation to the 2 year note, or in other words, the yield curve steepness (see Chart of the Day).

• Europe has downgrade written all over it. France is clinging on to its AAA-rating by the skin of its teeth and I don’t think it can hold on for much longer and I’ve written about this many times as well – if the US is not AAA then France certainly does not deserve its AAA rating either. In fact, the whole of the EU is in the S&P’s cross-hairs. Unless we see a fast resolution, clear and fast communication from the EU elite on how the crisis will be resolved (they can start with some real detail on the Treaty Change terms and how they will draw a line under Greece). That’s a big ask – remember these are European politicians we are asking to deliver.
• Britain is not far behind and faces just as much problems as France, due to its gargantuan debt pile in the financial sector Britain is second in the World of all the large economies in the dubious rank of largest total debt to GDP at a whopping 466% of GDP – see this neat little chart (which is a little dated but still relevant, I think).
• Other nations facing the curse of downgrade (click the country to see the related article):
  • Japan
  • Spain
  • Italy
  • Belgium
  • Egypt
  • Slovenia
  • Bermuda
  • Hungary
  • Nigeria
• To name a few – and we have not even thought about the potential downgrades coming to the corporations especially the financial sector (namely banks and insurers). But let’s focus on debt of the nations in the Eurozone spot-light and look at their refinancing timetable. In my “Brokeback Europe” article, if you remember, I showed a cool graph depicting the ticking time-bomb the EU faces … and it’s front-loaded. Take a look at Chart of the Day – you’ll see that Spain, Italy, Ireland and Greece all have some imminent dates with destiny and, for Spain in particular, it does not get much easier throughout the course of this year.
• Speaking of Spain, it’s normal for a newly elected government to take a bath on the economic figures and blame it on the previous administration, but even accounting for this, nobody predicted that the Spanish Finance Minister would quietly admit that his country could be running a deficit a cool 270% higher than the required convergence criteria of the EU Growth and Stability Pact. May be good political timing from a domestic point of view, but from the perspective of the “save the Euro” movement, this was not a great time to drop the 8% deficit clanger!

Market Overview

Warming Up For 2012

• Europe rallied on the Manufacturing outlook but there is not really much going on today in the markets with much of Asia on holiday (holiday tomorrow too in China and Japan) and also the UK and US on holiday. Really this week is going to be quiet as usual, but there will be some interesting numbers coming out (see below). Just the markets warming up, dusting off the cobwebs and working off a bit of Christmas turkey.
• In the FX markets see the Euro still languishes below the 1.30 level vs the dollar – the downgrade sentiment weighing on all markets there and the Spanish deficit clanger really spoiling the prospects for an early dead-cat-bounce in the Eurozone currency.

Chart of the Day

Euro Debt Refinancing Profile (Source: ZeroHedge/AA&MR, Datastream)

Events

Macro Events:

Update:

• Nothing Significant

Alerts:

• HK Retail Sales
• Singaporean GDP
• US ISM Manufacturing

 

Corporate Events:

Results:

• Nothing Significant

Dividends:

• Nothing Significant

Reading, Links:

Nothing Significant