Weekly Fundamental: Greek bailout continues to dominate market

[Exto Capital]

The financials lead the markets lower this week as news that the US attorney’s office was investigating Goldman Sachs for potential criminal misconduct. This news on top of the downgrades earlier in the week by S&P, Moody’s and Fitch, put pressure on the broad equity indexes. The S&P 500 finished the week down 25 points or 2.25%.

Calling what is taking place a "Greek bailout" is a misnomer. The funds that the European governments and the IMF are going to make available to Greece are not going to stay in Greece. The money will used to service Greece’s debt, of which something close to 70% appears to be in foreign hands. With various spending cuts, wage cuts and job losses, it is hard to see how Greece itself is being bailout out. Instead of Athens that is being made whole, it is Greece’s creditors that are getting so-called bailed out and essentially another bank will transfer (European) government funds to European banks. Greece is merely an intermediary. While other bond markets in southern Europe are benefiting from strong ideas that Greece will be given funds in time to avoid problems with the May 19th maturity and coupon payment, it is far from clear that investors will be satisfied for long. News today that Spanish unemployment rose to 20.1% in Q1 from 18.8% in Q4 09 illustrates the kind of economic headwind the periphery of Europe faces. This was a larger rise than economists expected and is around 7 times the EU average. Consider that since joining the euro zone Portugal has average less than 0.5% growth a year or that S&P expects Spain to average around 0.7% annual growth through 2016. It is difficult to see how the European/IMF package is scalable or how it really gets ahead of the curve of expectations or shows any appreciation for the fact that underlying the debt/deficit issues is really a competitive issue

During the week, S&P downgraded Spain one notch to AA from AA+ and kept a negative outlook. Greece was cut a full step (three notches) to BB+ by S&P from BBB+ previously, moving it into junk status. Negative outlook was kept in place. This is a very, very aggressive move, but the rating agencies are clearly trying to play catch-up after missing the boat on this earlier. Right before the Greece downgrade, Portugal was cut two notches to A- by S&P, who kept the negative outlook. This too was a very aggressive move. Fitch cut Portugal in March to AA- from AA previously, but it is clear that both it and Moody’s remain well behind the curve, as Portugal is clearly not a double-A credit. Moody’s and Fitch still have Spain as a triple-A credit. This will probably not last, and there will probably be multiple downgrades ahead for Spain. When those other two move into double-A range, they will likely cause even bigger ripples than today’s S&P move. Indeed, Spain is the 800-pound gorilla in the room. Greece and Portugal are small countries, but Spain is about five times their size concerning GDP.

Analysis provided by Exto Capital