Greece Is Bad but the Real Story Is Spain

by Ed Elfenbein | May 11, 2012 1:00 pm

Spain 150x150 Greece Is Bad but the Real Story Is SpainMake no mistake, Europe is in a bit of a crises. One day it’s France, the next Spain, mix in a little bit of Germany, and you get turmoil.

But first, let’s get to Greece. Here’s the 411: The bailout deals reached by Greece required them to get their fiscal house in order. The problem is that no one asked the voters. Now they’ve been asked and the voters don’t like it at all. Actually, I understated that—they’re royally PO’d.

Greece is massively in debt. They owe the equivalent of Switzerland’s entire GDP. Politically, everything has been upended. In Greece, there are two dominant political parties and both got creamed in the recent election. Seventy percent of Greeks voted for parties opposed to the bailouts. Mind you, the supposed beneficiaries of the bailout are the ones most opposed to them.

Since there was no clear-cut winner in the election, folks are scrambling to build a governing coalition. This won’t be easy. Whatever they do come up with probably won’t last long and they’ll need new elections. As investors, we fortunately don’t need to worry about the minutia of Greek politics. The important aspect for us is that the Greek public wants to ditch the austerity measures into the Aegean, but that means giving up all that euro cash that was promised them.

My take is that the bigwigs in Greece will do their best to stay in the euro but try to get the bailout terms renegotiated. That puts the ball in Europe’s court, and by Europe, I mean Germany. Too many people have invested too much to see the European project go down in flames. I think the Europeans will ultimately make some concessions in order to keep the euro going. If one country leaves the euro, it sets a precedent for others to leave — and that could start a flood.

As bad of a shape as Greece is in, they’re small potatoes (olives?). The real story is what’s happening in Spain. For the fourth time, the country is trying to convince investors that its screwed-up banks aren’t screwed-up. The problem is that Spanish banks are loaded down with toxic real estate debt.

The Spanish government is trying to prop up the banks, but it may delay the problem rather than solve it. It just took control of Bankia which itself was formed when the government forced some smaller banks together in an effort to save them. What’s most troubling about the problems in Spain is that the future is so cloudy. I really can’t say what will happen. Nouriel Roubini said that Spain will need an external bailout. If so, that may lead to a replay of what we’re seeing in Greece, except it would be much, much larger.

The immediate impact of the nervousness from Europe is that it spooked our markets. On May 1st, the Dow got to its highest point since 2007. The index then fell for six straight days which was its longest losing streak since August. But here’s the key: not all stocks are falling in the same manner.

Investors have been rushing away from cyclical sectors and towards defensive sectors. For example, the Utilities Sector ETF (NYSE:XLU[1]) closed slightly higher on Thursday than it did on May 1st.

Low-risk bonds are also doing well. Two months ago, the 30-year Treasury nearly broke above 3.5%. This past week, it dipped below 3%. On Thursday, Uncle Sam auctioned off $16 billion in 30-year bonds and it drew the heaviest bidding in months.

The trend towards defensive stocks is holding back some of our favorite cyclical stocks like Ford (NYSE:F[2]), Moog (NYSE:MOG.A[3]) and AFLAC (NYSE:AFL[4]). Let me assure investors that these stocks are very good buys right now and I expect them to rally once the skies clear up.

Endnotes:
  1. XLU: http://studio-5.financialcontent.com/investplace/quote?Symbol=XLU
  2. F: http://studio-5.financialcontent.com/investplace/quote?Symbol=F
  3. MOG.A: http://studio-5.financialcontent.com/investplace/quote?Symbol=MOG.A
  4. AFL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AFL

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