Sovereign risk is back and Greece is still centre stage
The Greek Republic is once again the focus of investor concerns. Unlike the direct costs of “Grexit”, indirect costs are impossible to gauge. For the moment, the problem has turned political with three possible scenarios after Greece goes to the polls on June 17:
1. “Grexit”: Greece goes back to monetary independence, leaves the eurozone, brings back the drachma and defaults on government debt. The direct cost for other eurozone members in this scenario would vary between 1-2% of the eurozone’s GDP. But the impact of the indirect costs could be enormous.
2. Greece manages to form a viable government and meets the conditions needed to unlock aid by implementing the drastic measures laid out by the Troika. This scenario looks unlikely due to the circumstances and the probability that the new government would not have much legitimacy.
3. The Troika and Greece’s various political parties all know that the rescue plan is unworkable. So any successful resolution of the crisis might depend on the government rejecting the plan. This would plunge Greece into quasi bankruptcy. The country could issue another type of (Greek-law) debt like an IOU which might be restructured and/or devalued if it left the eurozone.
The picture in other peripheral countries seems less bleak but is still worrying. Spain’s property crisis is having a big impact on domestic banks’ balance sheets and the market is wondering just how deep the crisis really is.
Spanish property prices could well continue to fall, resulting in large-scale bank recapitalisations estimated at EUR 50-70bn.
That would make Spain’s debt/GDP ratio much worse but the situation would still be bearable.
This is why the ECB in the last few days has been trying to contain Spanish banking risk, just as news emerged that the country has seen net capital outflows of EUR 100bn so far in 2012.
Private issuers still boast good fundamentals
Edmond de Rothschild Investment Managers (EDRIM) had already recommended the corporate bond market at the beginning of 2012 and there are several reasons why this market segment remains an interesting investment. Companies still have good fundamentals, notably high levels of cash to meet future debt maturities, and cleaned-up balance sheets. Moreover, first quarter results were in line with expectations or even better.
In recent weeks, credit markets have proved somewhat resilient. The equity market sell-off has failed to spread to corporate debt because the search for yield is taking precedence over risk aversion. The market benefits from the support of major institutional investors like European pension funds which are attracted by regular yield and the fact that this market segment helps them to readjust their balance sheets.
In spite of volatility and the uncertain climate, recent investment grade issues have provided confirmation of investor interest in these markets. Recent issues from companies like Aéroport de Paris, Anglo American and BHP Billiton have been highly sought after.
In the high yield segment, valuations are still attractive. Today’s average actuarial yield excluding financials is 8.6%, up from 7% in March. The primary market is rather robust and the news on companies in the segment is generally upbeat. Despite the economic slowdown and declining sales, companies still have the cash to help them resist. A good example is French chemicals company SNE which has enough cash to service interest payments on its debt for the next five years.
Credit markets in 2012 should continue to offer better prospects than other markets.