PORTFOLIO POINTS: Rather than having a top down focus, investors should be taking a bottom up approach – and Spain is the main game at the moment.
After two years of denial and dithering, Europe’s politicians and bureaucrats finally appear to have been dragged into a position where they conceivably could just muddle through the seemingly endless crisis that has crippled financial markets and nobbled global economic growth.
But serious hurdles remain. For while global investors maintain their “top down” focus, poring over the latest developments with the European Stability Mechanism, dissecting the statements from Mario Draghi and the European Central Bank, the Bundesbank and the Bundestag, the ground beneath them has begun shifting, in some cases quite alarmingly.
Just as the social upheaval in Greece earlier this year created a political crisis and almost scuttled bail-out plans, unrest across Spain is quickly gathering momentum placing prime minister Mariano Rajoy under enormous pressure that has resulted in inertia and indecision over whether he should formally request a much needed bail-out.
A formal request for a bail-out would come with strings attached, presumably even harsher austerity calls which would not be tolerated by the public.
As a result, investors would be better served taking a “bottom up” approach in assessing the prospect of a European and global recovery, the impact on China, commodity prices, our major resource companies and Australian exports. Spain’s domestic politics are likely to be far more influential than proceedings in Brussels.
Incensed by the impact of austerity measures, independence movements – which for years have bubbled beneath the surface in Spain – have again risen to the fore, threatening to tear the country apart and re-opening decades old wounds harking back to the Franco era.
Catalonia, of which Barcelona is the capital, is spearheading the movement. For the past fortnight, strike action has become almost a daily event ever since thousands of protestors took to the streets on September 11, the region’s holiday, demanding independence.
The Catalan flag hangs from the balconies of the city’s apartment blocks in both wealthy and poorer suburbs and recent polls show a majority of voters in favour of independence, twice as high as in 2008 when the financial crisis first hit.
The past fortnight has borne witness to numerous violent clashes between protesters and police in Madrid and a resurgence of calls for autonomy in the Basque region on the Atlantic coast where for four decades separatist factions have employed terrorist tactics in their quest for independence.
In each case, protestors claim that they are bearing disproportionate costs of the crisis and not receiving adequate compensation from the central government. The claims are not entirely legitimate as even Catalonia has been on the receiving end of large central government handouts.
But with unemployment topping 20% and youth unemployment standing at more than 50% in some regions, reason doesn’t always prevail and after spending the past few weeks in the country, your columnist can report that tolerance across Spain is in short supply.
Unlike Greece, financially and geographically at the periphery of the Eurozone, the EU could not afford to let Spain, the Union’s fourth-biggest economy, falter. Nor could it tolerate the prospect of some of the country’s most prosperous regions seceding, a development that could spark similar movements across Europe and place the EU in jeopardy.
While not as immediate a threat, political discontent has spread to France where Francois Hollande, having swept to power just four months ago, now ranks among the most unpopular presidents in recent French history, with an approval rating of just 43%.
With mounting concerns over Spain’s solvency, following an admission last week that propping up its ailing banking system would further blow out budget deficit estimates and increase its debt loads, it is little wonder that markets this week brushed aside the formal commencement of the European Stability Mechanism.
Oil prices once again have slipped below US$90 a barrel, reinforcing Adam Carr’s prediction of a fortnight ago that energy prices had topped out while commodity prices this week again are under pressure.
This will impact our miners, particularly higher-cost iron ore operations such as Fortescue Metals. Having slipped below $3 a share last month, as metal prices crashed, FMG has recovered in recent weeks on the rebound in iron ore prices and following last week’s High Court victory that overturned an earlier adverse Appeal Court judgement that could have seen founder Andrew Forrest removed as a director.
Unlike BHP and Rio Tinto, both of which are diversified geographically and on an enterprise level, smaller Australian-based miners are likely to be captive to pincer movement of sluggish commodity prices and an Australian dollar that remains stubbornly high. That is likely to impact on earnings and stock prices in the near term.
As Alan Kohler pointed out last Saturday, AAA rated sovereign bonds are in short supply while demand is running hot. Australian government bonds, with a yield of around 3%, not surprisingly are extremely popular, one reason why the Aussie dollar refuses to drop below parity with the greenback even during periods of international upheaval and commodity price shocks.
The internal political situation in Spain is likely to come to a head within the next month after Catalan president Artur Mas last week failed to reach agreement with the Spanish prime minister on fiscal reform and then called for early elections in November.
Just as Greece’s elections earlier this year rattled global investor confidence, the rapid deterioration of public confidence in Spain could well test the resolve and capacity of EU leaders in Brussels to steer the region out of its debt problems and cause them to rethink the austerity programs.
Prepare for further volatility.