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This note was originally published January 11, 2011 at 08:14am.  It's available to Hedgeye subscribers in real-time.

 

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“It is odd to reflect that the prime advocate of a classless society had this early succeeded in making two classes of workers and in marking the difference so clearly with substantial rewards to one class.”

-Slavomir Rawicz

For those of you haven’t read Salovmir Rawicz’s book, The Long Walk, it is well worth your time.  The book tells the story of the author and six fellow prisoners who escape a Soviet labor camp in Yakutsk in 1941. The escapees travel over 4,000 miles through the Gobi Desert, Tibet, and the Himalayas to finally reach British India, and their freedom, in the winter of 1942. 

Last week I surveyed our team for their top book recommendations for 2011 and this book was recommended to me by our newly hired Managing Director of New Business Development, Bob Brooke.  After a brief description of the book, Bob ended his note with the apt, “Hard work is easy.”  In the context of an escape from a Soviet labor camp in Siberia, Bob’s point is a fair one.  Our daily grind through the global markets is certainly easy in comparison to the struggles many on this planet face every day.

On that note, I would like to officially welcome Bob to the Hedgeye team.  After obtaining a degree in economics from Yale, Bob went on to an illustrious professional hockey career, which began playing with the U.S. Olympic Hockey Team in Sarajevo and then tours of duty with the New York Rangers, Minnesota North Stars, and New Jersey Devils.   Bob then went on to get his MBA from Harvard and has spent the last few decades working and building businesses at CSFB, RBC Capital Markets, and Sanford Bernstein.  At Hedgeye, he will be leading many of our new business initiatives and he can be reached at bbrooke@hedgeye.com.  

The reason I highlighted Rawicz’s quote above, versus the many noteworthy quotes in the book, is because it emphsaizes the power of free markets.  The Soviet authorities needed cross country skis and in order to find the prisoners who had ski making skills, they had to offer increased pay, which in the case of a Soviet labor camp was nothing more than a doubling of rations.  Incentives are at the very foundation of free market systems.  While the Soviets could easily have used coercive incentives, they opted to use higher remuneration for what they perceived as a more critical skill set (that of ski making). 

Interestingly, incentives on an individual basis are often quite successful, but where they often fail is at the nation state level.  As we survey the global macro landscape, the key issue currently is sovereign debt in Europe.  While European debt concerns took a respite at the end of last year, they are again front and center, and rightfully so.  In the Chart of the Day below, we’ve highlighted some key debt maturities in Europe in 2011. Broadly, there are massive refinancing needs in Europe this year, highlighted by Italy and Spain.  It will be interesting to see if certain nations within Europe can be incentivized to get their fiscal houses in order in the coming year.

The Long Walk of Sovereign Debt is, of course, not limited to Europe.  In fact, CMA recently released its Q4 Sovereign Debt Credit Risk Report and highlighted its view of the top 5 riskiest countries, which were:

  1. Greece - $330BN in 2009 GDP
  2. Venezuela - $337BN in 2009 GDP
  3. Ireland - $227BN in 2009 GDP
  4. Portugal - $227BN in 2009 GDP
  5. Argentina - $310BN in 2009 GDP

The collective GDP of these highest at risk countries is $1.4 trillion, which in aggregate would make them the 10th largest country by economic output in the world (just ahead of Canada).  So, while on an individual basis these countries may have little impact, in aggregate they matter big time.

Beyond these hot spots, the key economies to watch in coming months will be Italy, the seventh largest economy in the world with a GDP of $2.1 trillion, and Spain, the ninth largest economy in the world with a GDP of $1.5 trillion.  The CDS market for both these nations is flashing Default Danger as Spanish 5-year CDS is trading at 359 basis points and Italian 5-year CDS is trading at 256 basis points.  This is up 237% year-over-year for Spain and 180% year-over-year for Italy . . .

As it relates to the calendar, The Long Walk of Sovereign Debt begins this week with the following auctions:

 

1.       Today: The Netherlands is pitching about 3.5 billion euros of debt. 

 

2.       Tomorrow: Portugal plans to borrow as much as 1.25 billion euros, repayable in October 2014 and June 2020. Germany seeking 7 billion euros. 

 

3.       Thursday: Spain will auction as much as 3 billion euros of five-year bonds. Italy will market securities maturing in 2026 and 2015.

 

As always, the market will ultimately be the arbiter in the coming days, weeks, and months as to whether Europe can survive The Long Walk of Sovereign Debt.

Yours in risk management,

Daryl G. Jones

EARLY LOOK: Long Walks - EL Chart Debt