Tuesday, November 30, 2010

Nightmare before Christmas

You know that dream where you find yourself back at school about to go into your finals and you have done NO revision and what’s more for some reason you aren’t wearing your trousers? No? Well we bet some Eurocrats are wishing that was their reality compared to their current “Nightmare before Christmas”.

But say we were to wake up and find ourselves in their nightmare. What would We do?

TMM notes that our path from here is not exactly clear but there are options for which we have invented code names used by the leaker in Merkel’s office***:

  1. Increase the size of the EFSF (“Big Bertha”).
  2. Create a pan-European bank recapitalization fund and new stress-test round (“Groundhog Day”).
  3. Explicitly rule out the SDRM (“Horatio Nelson”). Burying head in sand optional.
  4. Instruct the ECB to go nuclear and buy bonds unsterilized (“Dr Strangelove”). Utter loss of credibility counseling to be provided by the Fed.
  5. Require Sov CDS to be 100% margined (“The Little Bighorn”). Watch Euro dive some more as all those “down with Europe” flows go into the one remaining market they can.
  6. Immediately stick Portugal and Spain into the EFSF (“2 tons of you-know-what in a 1 ton bag”). Have you ever had your shopping bags rip breaking all your eggs on the way home from the grocery store? We have.

We would view (2) as the most positive development. In terms of finance, we would imagine that the Euromandarins are looking at the pre-funded EUR60bn EFSM as a potential source of bank recapitalization funds, supplemented by another draw to take us to, say ~EUR100bn which we would say is enough for the system. If the Euro-banks are capitalized properly (and credibly) this time, then there will be nothing to stop them scooping up all this peripheral debt and thus the sovereign-bank feedback mechanism will work in reverse.

At least, that's what we would do it was our nightmare. However, the Eurocrats have shown themselves to be utterly clueless and comments such as:

show that they are obviously suffering from sleep paralysis. Which as anyone who has suffered it will know is very frightening indeed.

But back to reality.

Another day, another 1.x% down on the Spanish 10yr and the Euro, though TMM notes that equities are doing OK all things considered. Maybe it’s that the supranational sector equities are actually becoming a sanctuary away from sovereigns, FX and bonds. Even the Ibex index is rapidly turning into the “Telefonica and Banco Santander” index, both of which have big businesses outside of Europe.

Telefonica got $6.4bn of its $15bn of Q3 revenues and $5.4bn of its $7.3bn of operating profit from Latin America. At 8% dividend yield and 8.5x PE it appears that the largest index constituent has reached, as pointed out by our friend, Charles, in the comments yesterday, the point of "compelling un-leveraged cash yield" from whence few things can trade down without any of the complexities of having a heavily debt financed balance sheet like Banco Santander. Though that is looking pretty ridiculous too. Take earnings from Latin America at 12.5x (Banco Itau's level) and the rest of the bank comes at 4.6x PE. That does look pretty cheap and with those two comprising 41% of the Ibex TMM wonders whether mindlessly selling Ibex futures might have had its day.

We are thinking of donning the Kevlar knife catching gloves as we cannot believe there isn’t a "surprise" change around the corner as the Eurostriches wake up and pull their heads out of the sand.


Anonymous said...

markets will shortly get bored with the whole eurozone thingy ... next up ... asia's inflation problems!

Anonymous said...

Asia's inflation got as much face time as eurozone crisis. Tax cut and trade war threat will come back as Hu is going to the US in Jan 2011.

Anonymous said...

Trade was 'threat'? What do you think QE2 is partially about?

Anonymous said...

QE2 is too slow, I am not sure the US congress has time for it. How about good old tariff?

Nic said...

Well no bank recapitalisation fund (yet) but they are going to re-do the stress tests and make them harder.
The last ones were supposed to include a double dip and a sovereign risk shock that included bond haircuts which never even happened yet.
Of all the things they have done it is hard to imagine anything more discredited than the EU bank stress tests.
They have had more than two years and done precisely nothing to set up a mechanism for an orderly unwind of a bank. Eurostriches indeud.
We need a debt jubilee.

FX said...

The Dow up here is looking in a state of "fimilarity breeds contempt" with honors going to your recently methodically plucked friends and first cousins,don't see your options changing that view...

Anonymous said...

uh, '09 dividend EUR4.8b, mkt cap EUR74b, I get 6.5% yield. and with 47b net debt not sure about that P/E

Nemo Incognito said...

Anon at 2.7x debt to ebitda i think its manageable. As for divs, check interim and guidance for year end.

Bob said...

The BBVA math is even more compelling than the Santander math (and Bancomer is a far better bank than BSBR). Take Latam+Mexico in Q310--a quarter where BBVA was certainly not overearning-- annualize it and get €2.8B. Stick 12x on it (and remember that you're sticking a forward comp multiple on trailing earnings!), and not only are you getting Spain for free*, but also for that same low price you're getting 25% of Garanti, 5% of CITIC, etc.