Another weekend, another problem with the eurozone.
In fact, there’s more than one. Greece’s financial woes keep piling up. The country’s bonds have just been downgraded again.
Fitch Ratings has cut its view on Greek debt from BB+ to B+. In credit score-speak, this lowers Greece’s rating from “non-investment grade speculative” to “highly speculative”. Put more simply, Fitch reckons that people buying Greek debt are taking a huge risk they won’t get their money back.
That’s bad enough. But meanwhile, an even bigger danger to the eurozone is developing 1,400 miles to the west – from Spain.
Greece’s problems are no surprise
Greece hitting the skids is no great shock. It may have already had a bail-out, but the value of its sovereign debt has still been steadily collapsing for several months (ie yields on Greek bonds have been soaring).
That’s because investors have been getting more and more jittery about the country eventually defaulting. As a result they’ve demanded larger and larger returns as compensation for holding Greek debt.
As Fitch points out, the “risks have risen, as further fiscal austerity measures are required to realise the 2011 budget deficit goal of 7.5% of GDP”.
In other words, Greece is running hard but still can’t manage even to stand still. Tax revenues have come in lower than first hoped, meaning the budget deficit will be higher. And the more the country cuts back, the less growth – and tax-take – there’ll be. So the downward spiral is set to continue. Default, or leaving the euro, looks more likely by the day. But while other smaller eurozone countries may end up going the same way, surely places like Spain ought to be safe?
What Spain has in common with Egypt
Maybe not. Here’s why.
At 9.3% of GDP, the Spanish 2010 budget deficit – what the country needs to borrow each year – wasn’t the worst in the eurozone. But it’s still far too high for comfort.
So Spain has also been forced to tighten its belt. Slashing state spending is the only way it can persuade the markets to lend the cash it needs.
In turn, the austerity programme is causing plenty of all-round angst. No wonder. The jobless rate stands at a staggering 21%, while youth unemployment is more than twice as high. Even those in work are being squeezed. The cost of living is climbing at 3.5% a year while average wages are shrinking.
Many Spaniards have become sufficiently angry to take to the streets. Heavy-duty protests have now carried on for over a week.
“From the outside looking in”, says Gregory White in Business Insider, “it resembles the situation in Egypt in many ways”. It’s hardly surprising that the government is pretty unpopular.
Not a good time to be running for re-election, you’d say.
Spain’s regional governments may be hiding an army of skeletons
Unfortunately, that’s just what’s been happening. The ruling Socialists have been desperately trying to cling onto power in the local and regional weekend’s elections. And they’ve taken a pounding at the polls – the opposition Popular Party has a near-10% lead, reports the BBC.
Although the prime minister has ruled out an early general election, this result could already mean more trouble for Spain. Government changes could signal “a potentially nasty surprise”, reckons Jonathan House in the Wall Street Journal. We could see “the revelation of piles of undisclosed debt in local governments that could undercut the country’s drive to avoid an international bailout”.
Why does he think that? Because it’s happened before. “Five months ago a government change in Spain’s Catalonia region revealed a budget deficit over twice as big as previously reported”, he says.
“A growing chorus of economists, local politicians and business leaders say new governments are likely to discover, as Catalonia did, piles of ‘hidden debt’ owed to health clinics and other suppliers.”
You’re getting the picture.
Sure, yields on Spain’s ten-year bonds – what the country has to pay to borrow – have jumped from 4% last October to 5.6% this morning (you can keep track of this every day on our bond yield page). But that’s been based on what the market already knows.
If bigger debt “skeletons come out of the closet in coming weeks”, says House, “Spain’s cost of funding could continue to rise”. This would “throw the country back into the limelight after it’s struggled to demonstrate it doesn’t need to be bailed out like Greece, Ireland and Portugal”.
An opportunity to profit from the crisis
Clearly, though, Spain is in a different league to these countries. If the markets lose all faith in it, and drive its debt costs up towards the point of no return, the cracks could really start to show in the eurozone.
Where should investors watch for the signs? Banks would be the first to bear the brunt. In March, the Bank for International Settlements totted up the numbers. It concluded that foreign banks had an eye-watering ÂŁ1.6 trillion of exposure to all four countries.
If these lenders are forced to make another major round of asset write-downs, several global bank balance sheets could start to look very threadbare indeed. That could cause widespread panic. At the very least, the risks for Europe’s stock markets overall, as well as the euro, are rising fast.
So is it all gloom? Not entirely. As we’ve been advising for many months, if you want to keep some money in the markets, it’s best to stay in defensive stocks. And we like natural gas as a fuel right now: The best bets on natural gas (If you’re not already a subscriber, subscribe to MoneyWeek magazine). So what better than a utility that distributes it in Spain and Latin America?
Gas Natural (SM: GAS) has dropped by two-thirds over the last four years and now stands on a current year p/e of 10.4. And the prospective yield is an inflation-busting 6.3%. That’s well worth having – at any time.
Category: Market updates