JP Morgan AM: momentum is good to resolve Spanish issues
Tensions in Spain are creating inevitable volatility in financial markets, but momentum is still good for resolution of key issues, according to Dan Morris, global strategist at JP Morgan Asset Management.
“Interest rates for Spanish non-financial corporates have not risen, giving the economy some breathing space. Company earnings revisions have stabilised, but clarity on banking recapitalisation and sovereign bailout are prerequisites for a move to market overweight,” he said in a note.
The primary concern is on the implementation and cost of the recapitalisation plan for the banking system.
“The inevitable difficulties in setting up an EU bank oversight system risk delaying the rescue funds, and some countries question whether the funds will cover existing bad loans,” Morris warned.
The government is likely to be liable for the full cost of recapitalising the banks if the banks themselves do not repay the funds, or the “bad bank” that will be set up does not turn a profit.
“The key advantage to obtaining the funds through the ESM is that they will come with a lower interest rate, but compared to the total cost of bad property lending for the country, this is a weak salve,” JP Morgan added.
On the positive side, yields that corporations have to pay for funding have not risen. Yields on non-financial corporate bonds are below the average over the last several years and not that much above inflation.
“This means that for those companies with profitable investment opportunities, the cost of financing should not prevent them from pursuing the projects,” Morris said.
According to JP Morgan AM, expectations for earnings growth have now fallen so sharply that there may finally be some potential for sustainable appreciation in the equity markets, though a definitive resolution of the banking recapitalisation and a final decision by the government on whether or not to seek support from the ESM are prerequisites.
“Earnings forecasts have dropped by 35% over the last year for the financial sector, and by 15% for the remaining sectors in the index. Over the last few months, however, the outlook has stabilised and some sectors have seen rising forecasts,” Morris said.