Thursday, November 17, 2011

France the problem ???

Interesting comments from Jack Albin CIO of Harris Bank ....

For the past months, investors have been fixated on Greece, Italy and Spain. All the while we've been pointing to the rising spread between AAA rated French Bonds and AAA rated German Bunds. We've contended that this is truly ground zero in the euro crisis because France is suppose to be one of the healthy eurozone members that can “fix” the problems of the aforementioned troubled southern periphery countries. As the second largest contributor to the bailout fund (EFSF), France's AAA rating is vital to the bailout fund's creditworthiness. While Standard & Poor's stated that it “mistakenly” issued a downgrade to France on November 10th, we think that release was likely an unintended precursor to a future action. Unknowingly, French President Nicolas Sarkozy revealed how vulnerable he felt the country's rating was in early October when he suggested using the EFSF to recapitalize France's banks rather than use direct government interjection.

We have long held that the euro is a flawed construct in need of structural fixes. The problem is we don't think Europe knows whether it wants to make the necessary changes. We firmly believe that the bond market vigilantes will continue to hammer away until Europe is forced to decide. Longer term, this appears to be binomial decision. Either it is 1) full fiscal integration or 2) let the currency union break up. In the short to intermediate term, we assume other avenues will be explored to extend this decision. Unfortunately for Europe, this action requires cash which they have yet to find. While the Germans remain opposed, it currently appears that the only "solution" that provides the necessary firepower to stem the rising rates would be for the European Central Bank (ECB) to buy these troubled bonds in an unsterilized manner. Yes, that means revving up the printing presses.

The market is voicing its opinion that a break-up is a rising probability. If these countries are going to go their separate fiscal ways, wouldn't it make sense for the market to judge their creditworthiness on their own valor, rather than as a combined Europe? Kicking the can down the road has become a derided term over the past few years. However, one of its benefits is that it allows an event that would have otherwise been a shock, to be lessened in severity as market participants adjust to the now known realities. While Europe could certainly still unwind and cause market turmoil, we believe valuations in markets ex Europe are compelling enough to begin nibbling. We'll keep some dry powder just in case S&P decides to issue another downgrade.


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