This week we saw what may qualify for the shortest-lived relief rally ever.
When Spain became the latest eurozone country to call for a bail-out, markets were initially ecstatic. But it didn’t take them long to find the catch in Spain’s call for €100bn in funding for its banks.
The biggest problem is the way the deal was structured, as John Stepek noted in Monday’s Money Morning.
“Europe’s bail-out funds will lend the Spanish government the money at low rates. This will then go into a specific fund created to recapitalise the banks (the Fund for Orderly Bank Restructuring, or FOBR).”
Quite aside from the problem of finding the money in the first place, “the loan from the eurozone almost certainly (in practice, if not in theory) will jump the creditor queue. In other words, if the Spanish government ever runs out of money, then the European loan will get paid ahead of any private sector bondholder,” as was the case with Greece.
So “by bailing out the banks this way… lending to Spain has just become even more risky. And by extension, so has every other European sovereign that might potentially need a bail-out – Italy, for example.
“So the question is, why would any private sector investor in their right mind lend money to a troubled eurozone sovereign now? I can’t think of a good answer. And that suggests that – without more action from Europe to prevent it – yields on European debt should rise even further.”
It didn’t take long for John’s forecast to come true. By the end of the week, both Spanish and Italian ten-year yields had at least poked their heads above the 7% level often seen as the ‘point of no return’.
So what happens next? Well, the next big step is the Greek election. We suspect that whatever happens, the outcome won’t be a clean one – there’ll be no immediate break up and no immediate solution.
However, as we’ve pointed out, some European stocks are getting to the point where they look cheap. We have a eurozone roundtable coming up shortly, where we’ll be asking various fund managers for their views – but John has already decided to start dripping some money into Italy, for example. You can find out why in his recent MoneyWeek magazine cover story: Why it’s time to pile into Italian stocks. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
How does this story end for the euro?
What about the longer run? What’s the endgame for the eurozone?
On Thursday, Tim Price, author of The Price Report newsletter, looked to history for clues about how the euro crisis may end. And it’s not pretty.
Reports that eurozone officials are considering imposing capital controls if Greece leaves the single currency reminded him of one episode in particular. Says Tim: “It was a race to reach the border. On one side were the Austrian police and army – their job was to seal every road and rail track in and out of the country.
“Against them were the ordinary citizens and savers. They needed to get their cash – their life savings and their life’s work – out of Austria-Hungary before the security forces executed their blockade.
“When the Austro-Hungarian currency went down, it took the savers with it. All their contingency plans and bail-outs and money printing came apart on one fateful day – the day Yugoslavia decided to quit the currency union.
“Then all hell broke loose.
“Savers raced across fields in the dead of night with wheelbarrows full of cash. One by one the other nations fell out of the currency union. Savers rushed their savings from one country to the next across the old empire, in the hope of recovering some of their paper’s value.
“The collapse of the forint tells me something very important about currency crises – they develop slowly at first… then very suddenly.
“If Greece is finally forced out of the euro, I believe the crisis will burn quicker and brighter than ever before. Like Austrian and Yugoslavian savers in 1918, there’ll be a race to evacuate wealth from the periphery before it’s too late.”
Tim’s mission? To help his readers get across the metaphorical border before it’s too late. He’s got a number of investments, across a range of asset classes, that he thinks will help him do just that.
Japan is looking cheap too
While most people have been focusing on Europe, Japanese shares have also had a tough time, says David in Tuesday’s Money Morning.
“Our favoured measure here is the Topix index (TPX), which tracks the performance of all the country’s leading domestic companies. Last week, the index hit a 28-year low.
“That’s a pretty grim-sounding statistic. But it could also provide a very promising entry point for investors in Japan.” Just look at how cheap it is, says David.
“The stocks in the Topix currently trade on an average price-to-book value (p/bv) ratio of 0.86, according to Bloomberg data. So investors are able to buy ¥100 of assets for just ¥86. Compare that with a p/bv ratio of 1.55 for the FTSE 100 and more than two for the S&P 500 index.”
The corporate profit picture is healthy too. The real problem for Japan is the strong yen, says David.
“Since the financial crisis kicked off in 2007, the yen has become just about the top ‘safety-first’ currency choice. Against such a backdrop, Japan’s exporters have had to cut their profit margins to keep selling their products.”
Given the ongoing problems in Europe, this picture might not change soon, says David. The Bank of Japan’s attempts to weaken the currency by printing more money are being undermined by similar actions from its peers around the world.
“But there comes a point when all the negatives become factored into a price. And the Topix at a 28-year low is ‘discounting’ a great deal of bad news. This really does feel like a good time to buy Japan.
“The downside risk from here looks limited. And if the yen does weaken a bit, exporters should really cash in profit-wise, which should give a big boost to their share prices.”
David explores Japanese shares have also had a tough time in the rest of his piece.
Could Scotland revolutionise the British tax system?
On Monday Merryn Somerset Webb took to her blog to investigate the financial details of Scottish independence.
“In all the talk about how Scotland might or might not end the decade an independent country, all sorts of things are being just a little too fudged”, says Merryn.
The Scottish National Party (SNP) has indicated it would both use sterling (and so sacrifice control of monetary policy) and also leave financial regulation to the Bank of England.
So “a foreign central bank would set Scotland’s interest rates, monetary policy and financial regulation. At least now Scotland has a say over this stuff. It looks like under independence it wouldn’t have a say – so it’d have less control than it has now”.
But the one area where Scotland could really change things is tax, says Merryn. “Starting a new state will give it a one-off chance to be disruptive – not just to mildly improve on the current UK tax system, but to change it dramatically into a good system.” It would be nice if Scotland opts for a simple, clear flat tax system, for example.
The blog drew several animated responses. ‘Jimmy Floyd’ believes that Alex Salmond has a poor understanding of how independence would work. “The guy is in cloud-cuckoo land, and I suspect Scotland will realise this over the next two years. The problem for unionists is that, on matters solely Scottish, the SNP are not the fools they appear to be intent on appearing.”
Meanwhile ‘Cath’ feels that it’s not a question of independence or union. “Polls don’t show support for independence, but do for a lot more fiscal powers than we have now. I suspect that’s precisely because most Scots are pragmatic and gradualist about it.”
It’s a lively debate – if you haven’t read the piece yet, the financial details of Scottish independence.
Making money from the football frenzy
Before I go, I’d just like to give a quick nod to one of my favourite articles this week, my colleague Phil Oakley’s piece on how to profit from Premier League football.
You may have read recently that the Premier League clubs managed to sell the rights to screen their matches for three seasons for £3bn. That’s a 70% increase on the current deal.
The shares of the two companies who agreed to hand over the cash – BSkyB and BT, fell on the news. Investors clearly think they paid too much. But Phil isn’t so sure, especially with regards to BT.
“While the company has been winning lots of new broadband customers, it has realised that it needs a credible TV offer to keep customers happy. Increasingly, customers are looking to buy their phone, broadband and pay-TV packages from the same provider. So far, BT Vision has failed to make a big impact with only 700,000 subscribers.
“Also, it’s not been reported much in the press, but BT is quietly building a pay–TV business that will exploit the high bandwidths of its fibre-optic network. This network allows BT to broadcast live channels (known as linear TV) over the internet.
“This means that BT will save money as it will no longer have to rent space from Freeview as it does now. It has already signed deals with FX, UKTV and National Geographic to have their live channels. The addition of football and other channels could eventually create a powerful third player in the pay-TV market.”
Phil runs through the numbers in detail. In a few years time this football deal might be seen as the moment BT became a serious player in the TV market.
To hear about other bits and pieces on the internet that have amused us or made us think, sign up for our Twitter feeds – we’ve listed them below.
Have a great weekend!
• MoneyWeek
• Merryn Somerset Webb
• John Stepek
• Tim Bennett
• James McKeigue
• Matthew Partridge
• David Stevenson