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Thursday, March 28, 2024

Debunking The "Spain Is Safe" Myth

Courtesy of Tyler Durden

Recently there has been a lot of bullish opinions in the market attempting to debunk the reality that Spain is next on the contagion bandwagon, despite glaring signs to the opposite. Below is probably the best analysis, from JPMorgan, destroying all myths and mirages that Spain will survive the contagion intact. Also, no love loss for Chiswick here.

Full report:

Market update: we continue to be concerned about Europe.  This week we look at Spain, Europe’s next weakest link, and U.S. job growth, which has yet to re-ignite.   While profits, capital spending and manufacturing trends are positive, unresolved legacy issues from the prior boom-bust argue against riskier portfolio allocations, which has been our overriding investment theme all year long.



European banks, which are 3x-4x larger than U.S. banks relative to GDP, are under pressure.  CP issued by non-U.S. banks in US markets continues to fall, and is down 20% this year (branch deposits of non-US banks are also falling).   In Europe, bank borrowings from the ECB are rising, as are European bank deposits at the ECB.  The latter suggests that banks are hoarding cash due to fears of being unable to access more, or are unwilling to take exposure to other European banks.  Either way, a sign of distress.  The larger size of Europe’s banks argue against using simple GDP weights to assess potential risks to global markets.  Due to a buyer’s strike over the last month, European banks now have 3.5x as much debt to issue than U.S. banks over the remainder of the year.



Next stop on the European credit crisis: Spain



On May 13, we reviewed why we believe Italy is more insulated from the European credit crisis, a result of a smaller budget deficit, greater public and private sector reliance on domestic financing, and lower banking sector risks.  Unfortunately, the same cannot be said of Spain.  I won’t repeat the 4-dimensional chart again, but Spain’s fiscal adjustment in a low growth-limited devaluation environment is almost as difficult as Greece’s.  We’re concerned about austerity in a country that already has 20% unemployment; where home prices are down only 11% with half the newly constructed ones sitting unoccupied; and with $3.4 trillion of household and corporate debt (220% of GDP, one of the highest ratios in the world).   Progress is being made on the lending mechanism that offers countries like Spain a chance to fund bilaterally rather than in debt markets, as well as on Spanish fiscal reform.  But systemic risks remain, and we retain large underweights to European equities and the Euro.



Among the comments I see regarding how Spain will be OK, these 2 are prevalent: “the current account is healing rapidly (reducing reliance on foreign capital)”, and “Spain’s public debt is not as high as in other countries”.  On the first, the current account has improved, from 10% to 4% of GDP.  But how?  In prior cases of current account improvement, imports and exports both rose, with exports rising faster.  Over the last two years, Spain’s current account improved as imports and exports both declined.  This is not a positive sign for growth, employment, or private sector solvency.

Secondly, after adding possible costs from Cajas (regional savings banks) and Autonomias (municipalities), Spain’s public debt is higher than Portugal and Ireland.  Some analysts believe the Cajas have enough capital and operating income to make it through the next couple of years.  A comparison of Survival Ratios  does show that Spanish banks are comparable to US banks circa May 2009, when the Treasury SCAP Stress Test was conducted.  But this is due to the strength of Santander and BBVA.  The Cajas, which represent 40% of banking sector assets, are in much weaker condition and may face more than EUR 100 bn of losses.  The Bank of Spain seized CajaSur, a savings bank in Cordoba (note that Moody’s last rating on CajaSur was A1, one of the highest of all the Cajas).  The 7 arranged mergers of undercapitalized Cajas seem to be based more on regional proximity than on relative financial strength, and may not reduce the government’s need to recapitalize them.

Wonderland.  We have expressed unease about consequences of European austerity.  The other day, I read the following from a Chief European Economist: “I have found that with respect to this assessment of the socio-political situation in each country, the further you get away from the Euro-zone, the more skeptical (and often the more convinced) observers get.  Makes you wonder, doesn’t it?”  No, it doesn’t.  The closer that economists and strategists are to a region, the harder it has been for them to see a negative paradigm shift.  Examples include Citicorp in Mexico 1994 (the only U.S. firm that had a Mexican branch banking license); Asian economists in 1997; Renaissance Capital, Deutsche Bank and CSFB in Russia in 1998; U.S. technology analysts in 2001; Argentina’s “Chicago Boys” economists defending its currency board; etc.  These are my own experiences, and others’ may differ.  But there is a Stockholm syndrome at work sometimes; investors are wise to be wary of it.

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