No end in sight for Eurozone’s troubles
One year after the first bail-out package, the eurozone remains in crisis and managers are changing how they analyse and trade sovereign debt.
In the year since eurozone finance ministers agreed the first sovereign bail-out for Greece, bond managers have correctly predicted that Ireland and Portugal would follow.
On Spain, portfolio managers disagree. But they note that Madrid will have to boost, at least three-fold, how much it has already committed to recapitalise banks.
Even after multiple cuts in official ratings, debt markets remain pessimistic about all four countries, and managers say the drama has forced a re-evaluation of how to analyse names and invest in sovereign markets.
Chris Bullock, manager of Henderson Global Investors’ Horizon European Corporate Bond fund, says rates imply Irish and Portuguese debt is like “single-B” rated paper, while Greece trades as CCC.
Tanguy Le Saout, Pioneer Investments’ head of investment grade fixed-income, says, as long as governments of beleaguered nations follow “tough policies demanded by the IMF, they will continue to receive support, one way or another. Volatility will be here for a while and should create good opportunities.”
He says the debt crisis led many managers to “revisit dogmas [and] going forward we need to be more flexible, not dogmatic”.
“We also believe that government bonds are a different asset class now. It is not so much about relative value anymore, but a deep credit analysis is needed for each single country. Some countries are falling sub-investment grade due to a structural change in the market, which means we have to change the way we trade accordingly.
“The market has begun splitting countries into categories. We don’t see too much opportunity in Greece as it looks like restructuring is almost inevitable. Ireland has a long and tough path to get out of the danger zone, however, some longer-dated bonds could be interesting.”
La Saout says trading Spanish debt brings with it execution risk due to the recapitalisation of the banking sector. “Italy still looks the best risk reward country within the peripherals as the high level of private sector saving is able to finance the government debt.”
Ultimately, says Bullock, popular unrest and unwillingness to live austerely could see countries abandon the euro – but not Germany, which has invested too much political capital to see the euro project fail.
Managers widely agree debt restructuring will occur in the periphery, and by mid-April Berlin was reportedly drafting plans to restructure Greece’s debt if Athens’ economic reforms failed to save the country – leading the spread between ten-year Greek and German debt to hit a record 1,000bps.
Joshua Feinman, global chief economist at DB Advisors, says restructuring is more likely from 2013 onwards. But he adds: “We doubt there will be a break-up of the monetary union because there has been so much political capital expended on creating it.”
Bullock warns Brussels has given the trio “a bail-out package, but not a rescue”, and painful haircuts for bondholders appear inevitable.
Henning Gebhardt, head of European equities at DWS Investments, says: “It is clear Spain, Greece and Ireland have to clean up part of their economies – that will be a difficult long-term structural issue.” He draws similarities with the span of rebuilding in Germany, which lasted over five years from the late 1990s.
A diverse story
“Europe’s economy is not uniform. Some parts are very healthy, others experience trouble. It is a totally diverse story in Europe country by country.”
Of more immediate concern, says Bullock, is whether European voters will use forthcoming elections to vent growing sentiment against the support packages and their authors.
Additionally, Portugal’s next government could face a hostile public if it inherits more punitive measures attached to its bail-out than those that the domestic political opposition has already rejected.