Is the G20 throwing a “Hail Mary” pass to try and save Europe

Depression is the only word to explain what is happening in southern Europe right now – especially in Spain and Italy.  The current unemployment rate in Spain is 27.2% and the young have been most affected.  The overall Eurozone youth unemployment rate – those under 25 years of age – is 24.0%.  Greece is over 59%, Spain is at 56% and Italy is at 39%.  In comparison, the US youth unemployment rate is 17% and Germany is at 8%.  This high rate of youth unemployment is not good because it usually is a catalyst for revolution and change.  This makes sense if one thinks about being that age and having no hope for the future.  In Spain, the long-term unemployed are growing rapidly as well – see chart below.  In Italy, there is already a revolution going on as comedian Beppe Grillo’s anti-establishment Five Star Movement gained the most seats in the lower parliament in March.  This was a wake-up call to “establishment” politicians around the world.  So are the G20 countries stepping in to give relief to Spain and Italy?

Both Spain and Italy have terrible debt and deficit problems.  The EU is trying to mandate austerity programs for these countries – this is only making matters worse.  As proof, Spain recently revised down its growth target for 2013 from -0.5% to -1.3%.  With no growth, Spain’s deficit and debt will continue to grow.  We’ve seen this play before – “The Greek Tragedy.”

Given this scenario, one would expect interest rates to begin to rise in these countries.  When a country, company or individual is nearing bankruptcy, its cost to borrow increases because they are at a higher risk of defaulting on their debt.  But, something very strange happened to Spanish and Italian interest rates once the G20 finished their meeting on April 19th.  On that date, 10-year Spanish bonds yielded 4.66% while 10-year Italian bonds yielded 4.17%.  Today, those yields are down significantly – in Spain they are now 4.1% and Italy’s rates are at 3.88%.  That is a sharp and unexpected move in just a few days.  It appears that the G20 countries are stepping in to lower interest rates in Spain and Italy.  This appears to be a “Hail Mary” attempt to save these countries.

Fundamentals do matter.

The stock market continues to plow ahead as economic problems persist.  More than half the companies in the S&P 500 have reported first quarter results.  Most companies – 60% or so –  have missed on revenue forecasts and on average, revenue has fallen -0.6% from a year earlier when it was expected to grow by 0.9%.  Over the long run, companies need to see revenue growth to justify current stock prices.  The news today that China’s export orders fell in April does not bode well for robust revenue growth.  If sales don’t pick up, we believe that earnings growth estimates by analysts are way too high – 9% for the S&P 500.  The market is now priced for perfection much like it was in 1999.  There are pockets –such as small cap stocks in 1999 – that are still attractive.  However, in our opinion, blindly buying into the S&P 500 currently is not a strategy for success.

Sincerely,

Your THOR team