A Global Flight to Safety
Spanish sovereign debt yields have surged in the past few trading days, as pressure continues to mount on the country to shore up its banking system and rein in its regional government spending. In just the past two trading days, the yield on Spain’s ten-year note has climbed to 6.43 from 6.14 percent. The cost of recapitalizing the banking system that has buckled under the weight of a real estate collapse that has not yet fully run its course continues to rise, while at the same time deficit surprises at the regional government level place additional budgetary pressure on an administration determined to avoid a bailout. But with bond yields now close to levels deemed unsustainable, Spain’s ability to fund itself is looking increasingly precarious.
According to the latest tracking polls from Reuters, there has been a little movement in the sentiment of Greek voters since the election on May 6, which resulted in the inability to form a coalition government and heightened the possibility that Greece could leave the Eurozone. Then, 17 percent of the vote went to the left-wing Syriza Party, which wants Greece to remain in the Eurozone but also to repudiate its debt and toss out the country’s bailout package. The more moderate New Democracy party—which also desires to remain in the Eurozone, but within the context of the bailout terms—received 19 percent. As of Saturday, Syriza has 26 percent of the vote three weeks ahead of the next scheduled election, while New Democracy has 26.5 percent. However, the moderate Pasok party has seen its polling share grow to 15.5 percent from 13. These results suggest a hardening of voter attitudes, as the four remaining parties have seen their collective share of the vote diminish from 32 percent at the election to 24 percent currently. The election on June 17, is increasingly shaping up as a vote to either stay in the Eurozone, continue to receive funding, and hope that the austerity terms of the bailout package are modified—or to reject the terms of the bailout and dare the Eurozone to force Greek to exit. These latest polls indicate a modest increase in sentiment to stay. But, until the vote is taken, global markets will be hostage to the outcome, especially Spain. And even then, how open the EU and IMF will be in revisiting the terms of the bailout remains an open question.
The flight to safety that has been underway for some weeks now continues to push the dollar higher. The DXY index has risen 4.5 percent during May, most of it at the expense of the euro. Reflecting that strength, and concerns about the pace of global economic activity, the Dow Jones UBS Commodity index is down 5.8 percent. German bond yields continue to press lower, with the thirty-year bond yield falling below 2.0 percent and the new two-year note coming to market with a zero coupon. Lower quality assets have also suffered during the past four weeks. The yield on the Merrill Lynch High Yield Master II index rose to 7.90 percent. At the start of the month the yield was 7.56 percent. During this period the spread over the ten-year treasury has widened from 605 to 662 basis points. Emerging market equities have also taken a pounding. For the month through last Friday, the MSCI Emerging Markets Index is down 12 percent. In contrast, the S&P 500 is down just less than half as much. Notably weak have been equity markets in Latin America, particularly Brazil, which is struggling under softening global commodity demand, along with rising wage pressures and a falling currency. In short, what we are witnessing is a global migration to higher ground, to the relative safety of deeper, more liquid, and presumably safer markets.
We are also witnessing the triumph of fear over valuation. In Brazil, the Bovespa index is trading at 9.4x expected 2012 earnings, according to Bloomberg. The S&P 500 is trading at 12.7x. In Europe, the Euro Stoxx 50 index is trading at a 8.9x P/E ratio. Each of these represents a meaningful discount to their long-term averages, but these are not average times. Three full years into the economic recovery, investors’ first reaction remains to flee, not to fight. And who can blame them?
On Friday, the U.S. employment report for May is expected to show improvement over the disappointing April report. The consensus is looking for the creation of 150,000 new non-farm jobs after the creation of just 115,000 in April. It is still unclear whether the U.S. economy has slowed this spring or is simply adjusting to strength pulled forward as a result of mild weather. Measures of consumer confidence are equally ambiguous. Last week the Reuters/University of Michigan consumer sentiment survey showed a rise to its highest level since October 2007 before the start of the recession. In contrast, the Conference Board’s May survey showed a drop after three straight months of increases. Helping, of course, is the falling price of gasoline, a welcome development with the arrival of the unofficial start to summer. According to AAA, the average price for a gallon of unleaded regular gasoline is currently $3.64. One month ago the average price was $3.82. Since the start of May, the price of crude oil has fallen from $105 a barrel to $91.
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The U.S. Dollar Index (DXY) measures the dollar's value against a trade-weighted basket of six major currencies.
The Dow Jones-UBS Commodity Index? is composed of commodities traded on U.S. exchanges, with the exception of aluminum, nickel and zinc, which trade on the London Metal Exchange (LME).
The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The Bovespa Index tracks around 50 stocks traded on the São Paulo Stock, Mercantile & Futures Exchange which account for 80% of the total market volume traded in the last 12 months and that were traded on at least 80% of trading days.
The EURO STOXX 50 is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The universe for selection is found within the 18 Dow Jones EURO STOXX Supersector indexes, from which members are ranked by size and placed on a selection list.
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