Friday, November 4, 2011

PIIGS update


Greece continues to be the focal point of the world, with the other PIIGS not too far behind—since they are the other dominoes that could presumably fall if Greece defaults. Greek Credit Default Swaps are now trading around 6500 bps, which is about where they have been for almost two months now. In contrast, and to help put things in perspective, I offer this chart of CDS for the other PIIGS, all of which carry default risk that is orders of magnitude smaller than Greece. Italy and Spain are still trading near the low end of the range of what is termed "high-yield"—companies that have some risk of default, but are still very much ongoing businesses that more often than not succeed. Irish CDS are priced only slightly above the average CDS rate of high-yield companies, and there are a number of viable companies whose CDS trade around Portugal's levels. Markets have had over 18 months to digest the risks of a Eurozone sovereign default, and this chart tells me that the individual risks of defaults outside of Greece are not earth-shattering. If they all were to default that would be potentially catastrophic, but the chances of that are small. Yet the market (e.g., PE ratios of equities and the 10-yr Treasury yield) is priced to something close to Armageddon. Given market pricing, I think that the odds still favor being optimistic.
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15 comments:

  1. Jay Norman DavisNovember 4, 2011 at 12:51 PM

    Is this the same Europe that Mrs. Clinton and Mr.Obama in their campaign for the presidency called for the US to be a better country and reclaim the respect of Europe who had lost respect for us, as they claim?

    Jay Davis

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  2. Jon S.November 4, 2011 at 12:59 PM

    Scott: just saw your niece's video so I thought I'd comment on this latest post. It's really wonderful, and she is very talented. My daughter loves it! I posted the link on my Facebook page (Jonathan Stein) so now all 34 of my friends will see it!

    Thanks for sharing it with us.

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  3. broderoNovember 4, 2011 at 11:59 PM

    5 years ago Italy issued 5 year paper at 3.85%...today that paper has to rolled over at 6%...

    5 years ago the U.S. issued 5 year paper at 4.55%...today that paper
    can be rolled over at .95%

    Somebody likes America...

    ReplyDelete
  4. PerformanceSpeaksForItselfNovember 5, 2011 at 10:03 AM

    Scott: this is why I like to read your blog; your perspective is very different from mine. To your point about what the CDS market is saying about the likelihood of defaults across Europe, what do you make of Italian 2 year and 10 year bonds blowing out on Friday, with no apparent ECB intervention? Should this continue, wouldn't the fact that they can't feasibly roll over their debt be more telling of the likelihood of default than CDS currently discounting?

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  5. qweNovember 5, 2011 at 10:28 AM

    Maybe ECB lack of action was just the strongest argument of many others, to push Italy elite on track of budget improvement.

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  6. qweNovember 5, 2011 at 10:32 AM

    BTW, Scott's favorite risk indicator, EU swaps are above september highs.

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  7. McKibbinUSANovember 5, 2011 at 10:51 AM

    A default by Greece, followed by Italy, Spain, and Portugal, is emphatically not priced into the markets at this point...

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  8. Benjamin ColeNovember 5, 2011 at 11:00 AM

    There is a lesson in this: No nation should ever agree to lose control of its currency. If the Greeks had issued debt n drachmas, they could inflate their way out of this mess (while cutting outlays and devising a working tax code).

    A central bank has to be controlled nationally, or look out. National defaults are horrible, and market-crushing. If you cannot trust sovereign debt, than what can you trust?

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  9. Benjamin ColeNovember 5, 2011 at 11:06 AM

    BTW, the Cato Institute joins a growing list of outfits (Goldman Sachs, Milken, Christ Romer, Scott Sumner) who endorse Market Monetarism. It seems bona fide right-wingers are adopting Market Monetarism. It is the GOP that does not like Market Monetarism (see Rick Perry).

    There is a growing schism between real right-wingers--who favor limited government and controlled monetary expansionisn--and the present-day GOP, with its emphasis on heavy federal spending and huge defense outlays, gigantic rural subsidies and ultra-tight money.

    I invite everyone to explore Market Monetarism.

    Tim Lee, a scholar at the libertarian Cato Institute has been endorsing basically Market Monetarist ideas, in his latest article at forbes.com.

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  10. Pragmatic InvestorNovember 5, 2011 at 6:39 PM

    The difference between Italy, Spain and a high yield company is that a small company can easily grow 10%-20% while a country of the size of Italy or Spain can't. Therefore, a debt cost of 7%-8% is no big deal for a small firm as long as it can grow fast enough. But for Italy & Spain, a 6% yield is dangerous, a 7%-8% yield is fatal, given their growth prospect.

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  11. JimNovember 6, 2011 at 10:15 AM

    This is all going to end badly. The US will be affected no matter what our numbers look like.

    I look at the number of financial advisers growing out there, but the problem is where are the people creating the wealth?

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  12. sgt.red.blue.redNovember 6, 2011 at 11:00 AM

    Stop wasting time on this PIIGs stuff.

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  13. JohnNovember 6, 2011 at 5:32 PM

    "Where are the people creating wealth?"

    Jim has a point. But develping new goods and services people want to buy is risky. Corporate America has become too risk-averse. They expect to always be make whole.

    The phrase to sum up our time is "fear of uncertainty."

    No champion was ever paralyzed by uncertainty. It's this, not debt, that most threatens our country.

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  14. UnknownNovember 6, 2011 at 6:32 PM

    Scott,

    Can you give us your opinion of Steve Hanke's description of a new measurement of money supply called DIVISIA M4

    http://www.cato.org/pub_display.php?pub_id=13791

    They call it a market based approach to the monetary base vs an accounting view. Raising of Banks Capital ratios is resulting in a decline in the money supply and a possible recession. This is also from Steve's article.

    ====
    *Note: For those who want to delve into the intricacies of Divisia indexes, the best place to start is Prof. Barnett's new book — Getting It Wrong: How Faulty Monetary Statistics Undermine the Fed, the Financial System, and the Economy. It will be released by MIT Press in December. Also, Prof. Barnett's new Divisia money supply measures will be on the Center for Financial Stability's website (http://www.centerforfinancialstability.org/) by early December 2011.

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  15. BillNovember 7, 2011 at 12:43 PM

    Over the past 200 years, when have things ever been "certain"? I think we're still expecting double digit returns on average based on our experience in the late '90s and when we don't get it we all collapse. Things have been much worse through history yet we've managed to average about 2% growth per year through it all.

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