PIGS: A never-ending story

Transcription

1 19. NOVEMBER 21 ECONOMIC SITUATION AND STRATEGY PIGS: A never-ending story Worries have mounted in recent days that the sovereign debt crisis could flare up again in the euro area and spread further. Ireland is groaning under the burdens of government support for banks, and Greece recently had to concede that new debt in 29 was not 13.8% of GDP, as previously reported, but rather 15.5%. The Greek deficit is likely to turn out higher than previously expected this year as well, because of weak economic development and associated lower tax revenues. Risk premiums on government bonds from Portugal, Ireland, Greece, and Spain (PIGS countries) have therefore risen sharply. The Southern European countries and Ireland are in a dilemma. On the one hand, investor confidence in their solvency is dwindling visibly, and on the other hand, the austerity measures needed for consolidation will not lead to success in the short term, but in the worst case (think Greece) rather directly back into recession. Against this background, we present in this report how the debt crisis has developed lately and what consequences emerge for the economy and companies in the PIGS countries Dec-7 1-year government bond yields in different European countries Mar-8 Jun-8 Sep-8 Dec-8 Jun-9 Sep-9 Dec-9 Jun-1 Germany Greece Spain Italy Ireland After Greece was rescued last May by the other euro states and the IMF, Ireland and Portugal might soon apply for assistance, as investors have become more nervous again, particularly in the last few weeks. Several factors have contributed to that. One reason is certainly the fact that distracting political influences have increased again recently. From the German side, there has been talk about how to get private creditors involved in future support actions after the rescue package expires in 213. Although that idea is completely justified from the standpoint of regulatory policy, the comments about it have not been very helpful for the capital markets. It makes it even more difficult for investors to calculate the risk of a possible default when distributing burdens in case of a default is already being openly considered; they will avoid or perhaps sell Irish and Portuguese bonds and thus additionally increase the pressure on bond prices. After hefty criticism of the countries in question, the German government has been backpedaling, emphasizing that involvement of private Sep-1 Dec-1 creditors in the case of bonds already on the market is not on the table. Government debt in selected countries (in % of GDP) Year Germany 66 73,2 78,8 81,6 Belgium 89,8 96,7 99 1,9 Greece 99,2 115,1 124,9 133,9 Spain 39,7 53,2 64,9 72,5 France 67,5 77,6 83,6 88,6 Ireland 43, ,3 87,3 Italy 16,1 115,8 118,2 118,9 Cyprus 48,4 56,2 62,3 67,6 Luxemburg 13,7 14, ,6 Malta 63,7 69,1 71,5 72,5 Netherlands 58,2 6,9 66,3 69,6 Austria 62,6 66,5 7,2 72,9 Portugal 66,3 76,8 85,8 91,1 Slovakia 27,7 35,7 4,8 44 Slovenia 22,6 35,9 41,6 45,4 Finland 34,2 44 5,5 54,9 Eurozone 69,4 78,7 84,7 88,5 Bulgaria 14,1 14,8 17,4 18,8 Denmark 34,2 41, ,5 Estonia 4,6 7,2 9,6 12,4 Latvia 19,5 36,1 48,5 57,3 Lithuania 15,6 29,3 38,6 45,4 Poland 47, ,9 59,3 Romania 13,3 23,7 3,5 35,8 Sweden 38,3 42,3 42,6 42,1 Czech Republic 3 35,4 39,8 43,5 Hungary 72,9 78,3 78,9 77,8 UK 52 68,1 79,1 86,9 EU 61,6 73,6 79,6 83,8 Japan ,2 193,5 194,9 United States 7,7 84,5 94,1 13 Source: German Ministry of Finance; as of May 21 We do not believe Ireland or Portugal will be able to consolidate their budgets successfully given the yields now demanded by the market. An assistance mechanism involving the other euro countries and the IMF is therefore needed for there to be even a chance that the national debts of the two countries can be reduced to a sustainable level. If Ireland and Portugal succeed in obtaining assistance under the existing euro rescue package, that could have positive effects on the stock markets in the short term, because it would ensure for the time being that the countries will be able to get refinancing at acceptable terms. However, the assistance mechanism will not change anything in respect to the dizzyingly high deficits and mountains of debt. We therefore believe one cannot rule out the possibility that austerity efforts will have to be reinforced again under the pressure of the capital markets and other member states, which would entail further negative effects on economic activity in the countries involved. If Ireland or Portugal wants to apply for assistance, they will have to make use of the European Stabilization Mechanism (euro rescue package). The rescue package was conceived and adopted by the countries of the euro area after assistance to Greece did not lead to the desired calming effect on the capital markets. It has a volume of up to EUR 75 bn and consists of three pillars. The European Financial Stabilization Facility (EFSF) has the largest share. If it is used, bonds will be issued on the capital market by 1

2 way of a special-purpose vehicle that are guaranteed by the member states. The funds raised in this way will then be passed on to the member states in question. The rescue package also comprises the above-mentioned European Financial Stabilization Mechanism as a second pillar. The funds for this mechanism derive from the Community budget of the European Union. For a country to be able to use the EU rescue package, the EU Council must approve the application for assistance with a qualified majority. The third pillar of the rescue package consists of credit lines from the International Monetary Fund. The euro rescue package runs until the middle of 213, and a permanent crisis mechanism is now being negotiated. Since no member state has so far applied for and received assistance from the rescue package (the payments to Greece do not come from the euro rescue package), there is no empirical data yet as to whether the assistance actually is extended in an unproblematic and timely manner. We do not expect difficulties in that respect, but it does constitute a residual risk from an investor standpoint. Ireland need not seek refinancing on the capital market until mid-211, but pressure on the country to file an application for assistance is already growing now. That seems sensible primarily because confidence in the finances of other countries could also dwindle. If risk premiums on their bonds widen significantly as a consequence, refinancing will become more expensive and burden government budgets additionally. A vicious cycle may be set in motion. If Ireland makes use of the rescue package, so the calculation goes, the contagion effects could be at least partly contained. In our opinion, an early rescue of Ireland may contribute to restoring some calm to the capital market. But only a credible and sustainable budget policy and visible successes in reducing government debt will bring it about that risk premiums on government bonds of PIGS countries come down permanently. Although there will be no way of getting around a consolidation of government debt and that is true not only of the PIGS countries these measures promise a great deal of political trouble and not much economic relief at first. On the contrary, the path usually chosen, that of raising taxes and cutting expenditures, will lead first to a decline of private and public-sector demand. Despite higher tax rates and broader assessment bases, tax revenue will therefore hardly increase or might even fall, and the gap between government revenue and spending will continue to increase at first or can only be closed slowly. At the same time, economic growth will suffer under the austerity measures, so the ratio of debt to GDP will likewise only decline slowly. The economic difficulties to which government budget consolidation may lead are already evident in the Southern European countries and Ireland. That may be seen, for example, from an economic indicator that we have developed into which leading and financial market indicators as well as real economic data flow. It shows that Southern European countries initially recovered after the financial crisis to the same extent as the rest of the euro area. It only began to show divergences in economic development at the end of 29, and the Southern European countries started to fall behind the rest of the euro zone Mar-99 Economic performance in the Euro Area and Southern Europe Mar- Mar-1 Mar-2 Mar-3 Mar-4 Economic indicator Southern Europe Economic indicator Greece Mar-5 Mar-6 Mar-7 Mar-8 Economic indicator Eurozone The Greek economy especially is suffering from the austerity measures. Greece was the first euro area country that had to accept financial assistance and has so far made the greatest efforts to stabilize its out-of-control government budget. It is likely to be some time until the Greek economy has recovered from the side-effects of those massive austerity measures. According to IMF estimates, the Greek economy will contract by 4.% this year and again by 2.6% next year. The Greek austerity measures are also appreciably impacting the labor market, and the unemployment rate is likely to rise from 11.8% this year to about 14.6% next year. The influence of the austerity measures on companies likewise tends to be negative. Given such large deficits, it is inevitable that corporate taxes will be raised, and tax loopholes closed. And companies with a strong focus on the domestic market that applies particularly to small and medium-sized businesses will suffer from the decline of demand. Nevertheless, some companies should manage to increase earnings even in this environment, particularly if their sales markets are mostly abroad. To estimate the effects of the austerity measures on the situation of companies, we have investigated earnings expectations for the Stoxx 6 companies that are headquartered in Portugal, Ireland, Greece, or Spain. Altogether, they number 6 companies. As our benchmark for comparison, we take the companies that are headquartered outside the PIGS countries. And indeed, the increases in earnings per share expected for the PIGS countries through 211 are lower than those expected for the other Stoxx 6 companies. 2

3 PIGS countries: Earnings per share (median estimate; y/y) PIGS countries: Earnings estimates for 21 25% 25 2% 2 15% 15 1% 1 5% 5 % -5% -1% Jan-8 Mar-8 May-8 Jul-8 Sep-8 Nov-8 Jan-9 May-9 Jul-9 Sep-9 Nov-9 Jan-1 May-1 Jul-1 Sep-1 Nov-1 PIGS countries Non PIGS countries Portugal Ireland Greece Spain Analysts are skeptical particularly in the case of Greek companies. After the dramatic fall of earnings per share in 29, another decline by 4% is expected this year. The situation of Greek companies also appears so dismal in this evaluation because almost half of the companies from Greece listed on the Stoxx 6 are classified in the banking sector. Whether the positive expectations regarding earnings growth in 211 are justified therefore depends very much on whether consolidation of Greek state finances is successful and confidence returns to the banking sector. Among the PIGS countries, the situation of Irish companies appears to be the most favorable. However, they also include companies like internationally operating, low-fare airline Ryanair, so this statement is probably not representative for the Irish market overall. If the Irish government should be forced to institute additional austerity packages, that would then probably also negatively affect companies with fewer roots in the home market. PIGS countries: Earnings estimates for 211 5% 4% 3% 2% 1% % -1% -2% -3% -4% -5% PIGS countries: Earnings per share (median estimate; y/y) Portugal Ireland Greece Spain Non PIGS countries Generally speaking, the structural reforms in Greece and the other affected countries will lay the cornerstone for an increase of growth potential in the medium term, enabling companies to achieve above-average earnings again. However, we do not believe that this will already happen in the coming year. At first, the negative effects of the austerity measures and tax increases are likely to predominate. This view seems also to be taking hold among corporate analysts, who have successively lowered their earnings estimates for Greece this year and next Jan-9 May-9 Jul-9 Sep-9 Nov-9 Jan-1 May-1 Jul-1 Portugal Ireland Greece Spain Although the situation is negatively influencing the earnings of companies in the PIGS countries, the countries and companies cannot all be lumped together as if they were the same. The sales and earnings of individual companies may nevertheless increase, especially if the sales markets are primarily located abroad. If budget consolidation in the PIGS countries is successful, there is a chance that earnings will advance above average in the medium term. In the short term, however, a strong rise of corporate profits is not to be expected. The danger rather exists that further austerity packages will have to be passed to calm investors and meet the conditions for the rescue package. The earnings prospects of companies would also suffer from that, which would pose the threat of renewed share price declines. Sep-1 Nov-1 3

4 Weekly outlook for the period of November 22-26, 21 July Aug. Sept. Oct. Nov. Dec. Release DE: PMI, manufacturing Nov. 23 DE: PMI, services Nov. 23 DE: Ifo business sentiment Nov. 24 DE: GfK consumer sentiment Nov. 25 DE: Import prices, m/m -.2%.2%.3% -.1% from Nov. 25 DE: Import prices, y/y 9.9% 8.6% 9.9% 9.3% from Nov. 25 DE: Consumer prices, m/m.3%.% -.1%.1%.% Nov. 26 DE: Consumer prices, y/y 1.2% 1.% 1.3% 1.3% 1.4% Nov. 26 EUR16: PMI, manufacturing Nov. 23 EUR16: PMI, services Nov. 23 EUR16: New orders, m/m -2.4% 5.3% -2.4% Nov. 24 EUR16: New orders, y/y 11.2% 24.4% 15.8% Nov. 24 EUR16: M3 money supply, y/y.2% 1.1% 1.% 1.3% Nov. 26 MMWB estimates in red. Chart of the week: OECD leading indicator on the verge of trend reversal? 15% World economy: OECD leading indicator and industrial production 7 1% 5 5% 3 % 1-5% -1% % -5-2% -7 Jan 8 Jan 82 Jan 84 Jan 86 Jan 88 Jan 9 Jan 92 Jan 94 Jan 96 Jan 98 Jan Jan 2 Jan 4 Jan 6 Jan 8 Jan 1 Jan 12 Industrial production (y/y) ZEW Global Economic Sentiment (r.h.s.) Trend dynamic OECD leading indicator Although analysts commonly dismiss the surveys conducted by the Center for European Economic Research (ZEW) as having limited informative value, the ZEW Global Economic Sentiment indicator calculated by us shows good parallelism to the OECD leading indicator, with the ZEW indicator running slightly ahead. We combine in the ZEW Global Economic Sentiment the ZEW surveys for the euro area, Japan, and the United States. In the recently released November survey, there was improvement of global sentiment for the first time in many months. That is consistent with our expectation that the OECD leading indicator should reach its lower turning point in the beginning of

5 As of Change versus Stock markets -1 week -1 month -3 months YTD Dow Jones ,1%,3% 7,4% 7,2% S&P ,2% 1,% 9,4% 7,3% Nasdaq ,2% 1,4% 13,5% 1,8% Wilshire ,1% 1,4% 1,5% 9,4% DAX ,4% 4,8% 1,4% 14,7% MDAX 9.397,5% 2,4% 11,5% 25,2% TecDAX 796 1,7% -1,4% 5,1% -2,6% EuroStoxx ,2%,2% 4,6% -3,7% Stoxx ,2% 1,% 3,3%,1% Nikkei ,% 5,4% 8,4% -5,1% Topix 869 2,6% 4,6% 4,% -4,3% Bond markets 3 months Euribor 1, months Treasury Bill, year US Treasuries 2, year Bunds 2, year JGB 1, US mortgage rate 4, IBOXX AAA, 3, IBOXX BBB, 4, ML US High Yield 7, JPM EMBI+, Index 563-1,% -1,6%,5% 14,1% Convertible Bonds, Exane ,6% -,8% 3,% 3,1% Commodities CRB Index 569,16,5% 2,9% 14,9% 17,5% MG Base Metal Index 377,31-8,4% -5,3% 6,4% 4,5% Crude oil Brent 84,16-5,4%,7% 9,5% 8,1% Gold 1354,63-1,7% -1,2% 1,6% 23,6% Freight rates Baltic Dry Index ,4% -21,5% -15,4% -28,% Currencies Financial markets at a glance EUR/ USD 1,3647 -,5% -1,8% 6,% -5,3% EUR/ GBP,856,3% -3,2% 3,2% -4,3% EUR/ JPY 113,72 1,%,6% 3,4% -14,6% EUR/ CHF 1,3475,9%,9%,4% -9,2% USD/JPY 83,51 1,2% 2,8% -2,3% -1,1% Carsten Klude Dr. Christian Jasperneite Matthias Thiel cklude@mmwarburg.com cjasperneite@mmwarburg.com mthiel@mmwarburg.com The reports, tables, and charts presented are based on reliable information from publicly accessible sources. We, however, make no guarantee of accuracy. The content is protected by copyright. M.M.WARBURG INVESTMENT RESEARCH 5