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Markets are called lower this morning. This is what's moving the markets today:
Investors are worried about Spain and Portugal and the contagion effect they could have on Italy. Spanish Prime minister Mariano Rajoy said yesterday that the nation's future is at stake in its battle to tame surging bond yields. The problem is that when things start going wrong for a country and it needs its yield to go down even further so that its debt is sustainable, the opposite happens. Investors start to panic and the cost of debt increases. The higher the yield goes, the less sustainable its debt becomes. Italy has E266.4bln worth of debt maturing this year, Spain has E121.9bln and Portugal has E21.6b. Don't forget that although bond auctions went well in Q112, Italy has not issued debt maturing longer than 10 years in order for banks to be able to use the LTRO liquidity to buy sovereign debt. Italy will have to issue longer debt and it would be interesting to see what yield the country has to pay for it.
Let me start off with Italy. Since Monti took over the country, things have been moving in the right direction. We have seen yields come down and the Italians were ready to sacrifice in order for the country to get back on its feet. At the beginning of the year we saw the 10-year debt yielding 7.26%. As time passed, we saw the 10-year trade at a low of 4.582%. Italy was never really a problem. It has a problem of slow growth that's true but its budget deficit/GDP was 4% and is expected to come down to 2.2%. This means that the expenses of the country are manageable even at higher rates. The problem in Italy has not worsened. But as problems in other countries like Spain and Portugal start to emerge, they have a contagion effect on Italy and the cost of the country's debt increases. Hopefully we won't see the Italian 10-year move to the 7% yield again but if it does, with hindsight and looking at the financials of the country, it would be a good entry point into Italian debt.
Spain and Portugal are another problem. There debt is not sustainable because the financials of the country are in a much worse situation. Spain has an unemployment rate of over 25% and its budget deficit/GDP is above 7%. It is expected to go into recession in 2012 with a negative growth rate of -1.2%. With negative growth, it is very difficult to say to least to get the unemployment rate down in order to increase the workforce and gather more money through income tax rather than having to pay unemployment benefits to the unemployed.
Portugal is in an even worse situation than Spain though its economy is much smaller. The deficit/GDP ratio of Portugal is that of 10% and it's expected to report a negative growth rate of -3.3% for 2012. Nomura had come up with a report that Portugal won't go down the route of Greece through a Private Sector Involvement exercise. The country will be given a loan to pay its E13bln worth of debt coming due in 2013. But in the meantime the country has to get its financials in order because no further aid will come. We will know more about how Portugal's debt problem will be tackled in H212.
Regarding Spain, we still don't know how its problems will be solved. However at this point in time it's more likely than not that Spain will need outside help in order to get back on track. And this is what's pushing the markets down.
As if the European problems weren't enough, at the end of last week the Jobs Report in the US came in worse than expected. 120,000 jobs were created in March and the street was expecting 220,000 jobs. Bernanke had said that further QE3 is needed in order for growth to be sustained however the Federal Reserve voted against further quantitative easing at this stage in the cycle. The situation has to worsen before we see further easing. It was hard to justify the Fed carrying out further easing in election year. The Republics will not want the Fed to favor the Democrats whereas the Democrats would want to Fed to inject money into the economy to bring it back on its feet.
As if the world doesn't have enough problems going on, there is also the elections taking place in France in less than two weeks. Elections will be held in Greece on May 6.
Back to the markets and investors' perceptions, it is normal for investors to put risk back on the table in times like these and it is even more understandable after the strong rally we have seen in Q112. In Q112, the DAX, NASDAQ and NIKKEI were all up 20%! Expected profit taking in times when uncertainty is once again driving the markets. Spain has already implemented alot of austerity measures and even with all these measures, it won't be able to get its deficit/GDP ratio down to 4% in 2012, but more like 6%. And if yields keep on going up, the ratio will worsen till the end of the year. But is it also true than there isn't the anarchy in Spain and Portugal that there is in Greece and that the size of Spain alone (a GDP of cE272bln) will warrant further aid from the Eurozone. However when and how this is going to take place, we still don't know.
This is why my opinion on an investors strategy remains the same. Stay away from banks though don't stay out of the market because the rally will resume in H212. Take this weakness in the market as an opportunity to pick up bargains. Invest in cash rich companies which are growing their margins despite the current global slowdown in growth. There are companies which will continue to grow in H212 despite everything that's going on. Refer to our CC Equity Recommendation List to get an idea of the sector and names we are adding to our portfolio. However, I stress the importance of getting in contact with your adviser before making a purchase to make sure that the constituent you want to add to your portfolio is in line with your risk/reward ratio.
Stock to watch: New Britain Palm Oil (Price 882p, Price Target 1200p)
We expect the ongoing surge in demand for vegetable oils to continue for the long term. Demand from emerging markets should climb sharply thanks to rising urbanization and per-capita income, supplemented by demand growth from the biodiesel industry. Moreover, the stock usage ratio of all major vegetable oils is declining, implying an inability of supply to match demand. The overall increase in demand for vegetable oils should boost demand for palm oil, the largest segment of this market. And NBPO is well placed to benefit. Palm oil constitutes 87% of NBPO's revenue, so higher palm oil prices translate into increased earnings. The palm oil produced by NBPO is also certified by the key sustainability body; it is thus priced at a premium, which translates into superior margins. Despite its exposure to the above structural trends, NBPO is the least expensive company in its peer group on traditional multiple valuation. We thus see it as a highly compelling investment opportunity – Buy.
For further information on New Britain Palm Oil or other stocks we follow, contact our offices on 25688688.
Good day and happy trading!
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