Credit Writedowns

In the links today, the biggest threads outside of the NSA scandal were on Greece and Europe. I believe the economy there is bottoming and I want to discuss some of the news flow. There was also a rate decision by the Japanese central bank that was met with disappointment. Let’s put this into context regarding the viability of Abenomics.

The data flow out of Europe today is pretty bad. German factories orders missed and unemployment rose to record levels in France and Greece. Meanwhile the IMF admitted that Greece’s delayed debt restructuring “provided a window for private creditors to reduce exposures and shift debt into official hands.” Does any of this change my bullish bias on Europe’s economy? No, I believe Europe will exit recession at some point in the second half of 2013.

I don’t think it’s a big secret that I believe Greece will eventually leave the eurozone. I have said this repeatedly. But I have also written that I do not believe that Greece would attempt to do so while Europe’s economic crisis is ongoing. Instead I believe that Greece will exit once things have stabilized but it becomes clear that it faces an interminable jobless recovery.

Europe’s GDP numbers have just been released today and they are miserable. They show the Netherlands and France in recession along with the rest of the periphery. And even outside the euro zone, we got some pretty dire numbers out of the Czech Republic as well. A: What’s going on? and B: why I am still bullish despite this?

I have been posting for a while now that I think Greece provides the greatest upside potential. Greece’s sovereign bonds outperforming was one of my ten surprises for 2013 three months ago. And with bond yields now falling below 10%, Morgan Stanley is getting onboard so I am not the only one recommending this trade. I would also posit here that Greek equities have been well beaten down and trade at low multiples based on low earnings, meaning that if recovery does take hold in Greece as I expect it to, then you will get a double benefit from earnings growth and multiple expansion.

I am not going to say a whole lot here in this post because I have been writing non-stop about Europe of late. I just want to share the European links with you. I think what the links show is that the European paradigm is in transition from front-loaded austerity to back-loaded austerity. This is something I have remarked on at length in the past. What I would like to know is what impact this move is going to have on bond and stock prices.

Osborne has said in the past that his austerity approach is the right one and has pointed to a 2010 paper on government debt and growth by Carmen Reinhart and Kenneth Rogoff as evidence his approach is the right one. Given the recent furore over errors in the data used in that influential Reinhart-Rogoff paper, the British data and Osborne’s conclusions based on that data take on more significance internationally.

The overarching theme here is that the economy of Europe is in tatters and this is causing a re-think of the policy course. In my view, the political space for the re-think is limited and will ultimately entail some tacked on growth policies and relaxed deficit target timetables. The prevailing economic paradigm will remain the same, fiscal consolidation to prevent sovereign default. As fiscal consolidation is a deflationary policy, I expect European growth to be weak. On the bank and sovereign debt front, some leeway is available but crisis is never far away. However, fiscal consolidation is negative for periphery corporate bonds in particular as I will detail below.

Last year, I started off the newsletter with a list of ten surprises for 2012 which I reviewed last month. I apologize for not having a similar list of ten surprises for 2013 yet. I think it is a good exercise to go through to hone one’s thinking about the economic and investing landscape. Here is a preliminary list of top ten candidates for the list and links to the posts in which I tell you why.

According to Greece’s finance ministry, Greece’s government was able to record its first primary surplus in years. This is a measure of a budget based on revenue minus expenditure excluding interest costs and is commonly thought of a measure of fiscal sustainability.

I had intended to write this post yesterday morning. However, after the bank scandal in Italy and the surprise drop in US GDP, I waited a day. The gist of what I intend to say here is that Italy is in the process of decoupling from Spain. The Monte Paschi scandal certainly complicates this thesis a bit. But I think there are valid reasons for the decoupling.

I never subscribed to the idea that Greece was going to be expelled from the euro zone in 2012. However, my view on Greece is more pessimistic than most. Most policy makers in Europe would have you believe the euro crisis is over. Here’s what I wrote to subscribers in November and what I still believe is true.