by Ivan Martchev | February 15, 2011 2:04 pm
On Jan. 19, I opined that my global investment strategy was to sell euro-denominated risk assets, such as PIIGS sovereign bonds or European financials that were caught up in the short-squeeze rally following the “successful” auction of Portuguese 10-year bonds below 7%. I had referred to Portugal being in the final stages of a bailout plan, and someone commented that there was no such bailout — I beg to differ.
The only reason why the Portuguese bond auction was “successful” was because of the European Central Bank (ECB), which was taking Portuguese bonds off the hands of banks that participated in this auction. That is not what I would call a “market-determined interest rate.” Above 7%, the Portuguese government will have trouble funding itself as interest on the bonds becomes cost-prohibitive. As I write this, those “successfully auctioned” bonds in January are now trading with a yield of 7.42%. Someone should speed up finalizing that bailout plan fast.
Why should investors in emerging markets care about what goes on in Europe? Because we have low overall inflation in the United States, a deflationary shock in PIIGS countries (Portugal, Italy, Ireland, Greece and Spain) driven by austerity measures and bank losses that curb lending would mean inflationary problems in most emerging markets. The aggressive monetary policies that are targeting the problems in Europe help create inflation in the emerging world.
This is why India was down so much in January — and Indian small caps as measured by the Market Vectors India Small-Cap ETF (NYSE: SCIF) were down even more — as market participants assumed the BRIC market had the least stamina to withstand the developed-world-induced inflationary tsunami. We live in a global economy; what happens in the West affects the East.
Right now, I would be a buyer of Indian equities that have been punished by this inflationary scare such as Tata Motors (NYSE: TTM), HDFC Bank (NYSE: HDB) and ICICI Bank (NYSE: IBN). Indian stocks may go a little lower, but I know the fundamental backdrop is sound.
I feel very different about the fundamental backdrop in Europe. I would be a seller of any euro-denominated PIIGS risk assets that saw a short-squeeze driven spike in January. One way to play the coming sell-off, which is likely to take out the lows seen in many European financials in early January, is to outright short them. I see much more downside for Santander (NYSE: STD), BBVA (NYSE: BBVA) and even Deutsche Bank (NYSE: DB).
Someone pointed out that to me that both STD and BBVA have the majority of their business outside of Spain. However, the point is that if you see funding stress for STD and BBVA of the kind we saw for smaller Spanish banks last year, it does not matter what proportion of their business is in Spain. Rather, what matters most is whether they can get inter-bank funding that is not cost-prohibitive.
As for DB, rumor has it that German banks are long a lot of PIIGS bonds that have not been properly marked down for the huge haircuts that are inevitably coming. As the largest German bank, DB will certainly see a downward re-rating in the market as the haircut risk factor is priced in.
For those that don’t like shorting, simply stay away from EU financials, as I believe the cheap book values are highly deceptive. No book value is low enough for a bank with funding problems. And while we haven’t seen this quite yet, the likelihood is increasing by the minute, given the action in credit-default swaps and the stocks themselves. I have seen selling into strength in STD, BBVA and DB over the past week.
Another way to play this is to go long the ProShares UltraShort Euro (NYSE: EUO), which is a leveraged ETF that delivers twice the inverse daily performance of the euro. I don’t see the euro going above $1.40, and I do see it potentially going below $1.20 this year as the rolling sovereign debt crises continue on schedule.
It gives me no pleasure, as an EU passport holder myself, to be bearish on the euro, but a single currency with separate treasury departments and wildly diverging monetary policy needs simply does not work. More evidence to support this view is coming to your quote screens shortly.
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