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The Domino Effect of Spanish Housing

This note was originally published April 12, 2012 at 12:34 in Macro

Conclusion: Another leg down in Spanish home prices seems likely and this could potentially be the event that leads to an acceleration of stress in Spanish sovereign yields.


The focus of the sovereign debt crisis in Europe has been, rightfully so, on Greece and the potential derivative effects of a Greek default.  This despite the fact that Greece’s economy, based on the CIA’s 2011 Fact Book estimates, is only $312 billion, or less than 2% of the European Union in aggregate.  With an estimated 2011 GDP of $1.5 billion, Spain has the 12th largest economy in the world and an economy that is almost 5x the size of Greece’s GDP.

 

As the chart below of debt-as-percentage-of-GDP shows, Spain, so far, has been able to manage its balance sheet somewhat better than many of its neighbors with a debt-to-GDP of roughly 68.5% as of the end of 2011. (Incidentally, many believe that when incorporating regional debts, Spain is closer to 90%, currently.) Based on Spanish government estimates, this ratio will jump to 79.8% at the end of 2012.  While still below the Eurozone average of 90.4%, this is the highest acceleration in the Eurozone.  This last fact is at least partially reflected in the credit default swap market with Spain’s 5-year CDS accelerating in price in the year-to-date.

 

The Domino Effect of Spanish Housing - Sp.debt

 

Spain’s most significant headwind going forward is, simply put, growth.  Over the last two fiscal years of 2010 and 2011 combined, the lowest average growth rates in the European Union were the following countries in order:

  • Greece at an average annual growth rate of -5.2%;
  • Iceland at an average annual growth rate of -0.45%;
  • Portugal at an average annual growth rate of -0.1%;
  • Ireland at an average annual growth rate of +0.08%; and
  • Spain at an average annual growth rate of +0.15%.

Clearly, this is not an enviable group of countries and Spain is the only one amongst them that hasn’t had a complete sovereign debt meltdown.

 

As any sovereign credit analyst will tell you, the easiest way to resolve a sovereign debt issue is to grow out of it.  Spain’s economic growth outlook is constrained by two separate, though related, factors: employment and housing.  

 

In the chart below, we’ve highlighted Spanish unemployment going back to 2000.  The unemployment rate of Spain hit 23.6% in February for the 8th consecutive monthly increase, which is both the highest rate since 2000, but also literally the highest unemployment rate since World War II.  As if that weren’t enough, the government expects the unemployment rate, already the highest in the industrialized world, to increase to north of 24% this year.  The current number of unemployed in Spain is equivalent to 4.75 million, which is the highest number since the Spaniards began keeping the data in 1996.

 

The Domino Effect of Spanish Housing - SP.unempl

 

The counter view to this abnormally high unemployment rate in Spain is that there is a large and thriving underground economy, which means that government reported employment figures are understated.  Certainly, there is likely credence to this, but, even so, most estimates suggest accounting for the underground employment would only reduce the overall unemployment rate by 400 basis points.  In the shorter term, there is also the employment head wind of a recently implemented labor reform law in February that will make it easier for employers to unilaterally lay employees off and cut salaries.  Eventually, though, this is expected to make the Spanish employment market more fluid as it will likely make employers more willing to take on the risk of hiring.

 

The chart below highlights the structural employment issue in Spain versus the remainder of the Eurozone.  Specifically, it emphasizes the year-over-year change in unemployment by country.  In 2011, Greece was the only nation that saw unemployment increase at a quicker pace than Spain.

 

The Domino Effect of Spanish Housing - CH

 

A key reason that Spanish unemployment rates have ballooned versus the rest of the Eurozone is because Spain had a vastly more inflated housing and construction sector during the boom years.  In fact, according to Eurostat, Spain employed 2.9 million people in construction industries at, or near, the peak in 2007.  In total, this was about 1/5th of all construction workers in the EU-27 despite the fact that Spain has less than 10% of the total population.  Clearly, an improvement in Spanish employment will be predicated on a recovery in the construction sector.

 

Unfortunately, a recovery in Spanish housing and construction markets appears to be a long way in the coming.   Unlike most industrial nations that experienced extended housing price inflation in the late 1990s and mid-2000s, Spain actually had two bubble periods with the first beginning in 1985.  As the chart below highlights, from 1985 – 1991 home prices basically tripled, from 1992 – 1996 they basically remained flat, and from 1996 – 2008 prices more than doubled.   So far, from the peak, Spanish home prices are in aggregate only off about 20%.

 

There are two potential proxies for how much further home prices in Spain may have to fall.  The first is wage growth, which has historically tracked housing prices.  Intuitively, this makes sense.  The more consumers have in their pockets generally, the more they have to spend on housing (all else being equal).  As the chart below shows, wages and home prices tracked each other steadily until 2000, at which point home prices began to accelerate beyond wage growth.  Currently, home prices would need to decline just over 30% to revert back to wage growth. 

 

The Domino Effect of Spanish Housing - SP.housing.wage

 

The second proxy for further correction in Spanish home prices is the path of U.S. home prices.  Based on the Case-Shiller 20-city seasonally adjusted series, U.S. home prices have already corrected 34% peak-to-trough.  Comparing Spain to the U.S. is not quite apples-to-apples as home prices were driven much higher due to ownership rates that eclipsed 80% at the peak in Spain.  So, depending on the data set we use, from the start of the second leg of the Spanish home price bubble in 2000 compared to the U.S., Spanish home prices have a potential downside of more than 35% from current levels.

 

The Domino Effect of Spanish Housing - SP.us.housing

 

The risk to the downside in Spanish home prices is being clearly reflected in real estate transactions in Spain.  The chart below highlights year-over-year real estate transactions by month.  In the most recent month of February 2012, transactions were down more than -30% from the prior year.  Without a sustainable pick up in the real estate market, it will be impossible for employment to improve meaningfully.  

 

The Domino Effect of Spanish Housing - Sp.transactions

 

The second derivatives of continued decline in real estate prices in Spain are both economic growth and the health of the banking system.  On the first point, the Bank of Spain estimates that a decline in home prices of one dollar will decrease consumption by $0.03.  Thus, a 15% decline in housing should reduce GDP by almost 2% over the next two years. (Hat tip to Carmel Asset Management for highlighting this analysis in the WSJ.)  This would obviously have a direct impact on Spanish banks.

 

Currently, the Spanish banking system is estimated to have a 1.8 trillion euro loan book.  It is estimated that roughly 20% of that is in real estate assets, of which almost half are considered troubled.  Obviously both declining real estate prices and slowing economic growth generally put increased pressure on the portion of the loan book which is currently not troubled, and equates to almost 150% of Spanish GDP.

 

Certainly Greece has been the rightful focus of the sovereign debt issues in Europe, but the likelihood of another serious leg down in Spanish home price could put Spain front and center in 2012.

 

 

 

Daryl G. Jones

 

Director of Research

 

 

 

 

 

 

 


MORGAN STANLEY: The next Lehman?

Morgan Stanley can not catch a break, especially from Hedgeye Financials Sector Head Josh Steiner. Triple trouble for Morgan Stanley CEO James Gorman and Co. this week as whispers indicate that Moody’s will pull the trigger on its wave of bank downgrades. Combine that with the CDS problems that are reminiscent of Lehman Brothers, the problems with the European Union and the $9 billion+ collateral call courtesy of Moody’s and things are not looking good. 

 

We have three key takeaways on what’s really going on inside MS:
 

• It is the most exposed US bank to EU contagion. Greece’s election represents a potential catalyst for things to go from bad to worse.

 

• It is incredibly vulnerable to counterparty confidence flight. Default swaps are already reflecting great uncertainty about MS’ future. Coming downgrades must be watched closely for any impact on business flows. Counterparty concern can go from gradual to sudden virtually overnight.

 

• Even though the company’s liquidity and capital are much improved vs. 2008, the market is trading it as though there is no implicit US backstop. A further slowdown in the economy or in its core business could raise concerns about a downgrade to junk status, which would throw their institutional business into chaos.

 

Once again, when the time is right, we will short MS and will enjoy doing so.

 

 

MORGAN STANLEY:  The next Lehman? - chart ms june11

 


MAY KNAPP TRACK (CORRECTED)

The Knapp Track release for casual dining trends in May suggests that casual dining trends sequentially slowed from April to May.  Comparing the Blackbox data to Knapp Track, it seems that a slowdown in Darden’s comps could be on the cards.

 

* Earlier today, we published a note titled "MAY KNAPP TRACK"  that, in part discussed a slowdown that could be inferred from the spread between the Knapp Track and Blackbox casual dining comparable sales data sets. Our wording of that conclusion could have been better; discrepancies between the two data sets mean that such a conclusion cannot be definitively drawn. Given the size of Darden's system, however, we believe that the opinion is likely (but not certainly) correct. The text below has been revised from an earlier version to reflect this.

 

Malcolm Knapp released his Knapp Track casual dining sales numbers for May this weekend.  The May 2012 comparable restaurant sales change was -1.3% and the comparable restaurant guest count change was -3.9%.  The sequential change from April to May, in terms of the two-year average trend in Knapp Track casual dining comparable restaurant sales, was -80 bps.  For Knapp Track casual dining guest counts in May, the sequential change from April was -85 bps. 

 

The comparable store sales growth decline in May was the second in three months and implies that casual dining is still a group that investors should handle with care.  We have been advocating a cautious stance toward the casual dining group since mid-April.

 

Takeaways

 

Darden is emerging as a stock that could be emerging as a short or, at least, a stock that should not be bought. The Knapp-Blackbox spread has declined over the course of the last three months, indicating that Darden could be seeing increased softness over the past few weeks (not included in Blackbox data but included in Knapp Track).  There are several differences between the Knapp Track and Blackbox data sets so the spread is not a sure-fire indicator of a slowdown in Darden comps but, given the size of the Darden system, we believe that the spread between Knapp Track and Blackbox is likely relevant for Darden’s top line trends.  The spread has gone from +0.8% in February to -0.5%, -0.6%, and -0.9% in March, April, and May, respectively. 

 

Besides the broader casual dining group, for Darden and Brinker this result is especially meaningful since those companies’ systems represent a large portion of the unit base from which the numbers are calculated.

 

Howard Penney

Managing Director

 

Rory Green

Analyst


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MACAU: FINALLY A DECENT WEEK (FOR LVS TOO)

Raising our June projection to HK$23-24.5 billion (14-22% YoY growth)

 

 

This week’s average daily table revenues (ADTR) increased 21% YoY to HK$750 million.  We are raising the top end of our full month June projection to HK$23.0-24.5 billion, which would represent YoY growth of 14-22%.  The June numbers continue to confirm our expectation of a June rebound from May’s disappointing 7% growth.

 

 MACAU:  FINALLY A DECENT WEEK (FOR LVS TOO) - macau1

 

LVS finally made a move toward justifying its big investment in Sands Cotai Central (SCC).  It’s only one week of data and 20% share is probably not sustainable – at least not yet – but this was a good week for LVS.  We’ve been writing that not only will June be better overall for the market but also for LVS.  LVS’s share thus far in June is way higher from the recent 17% share.  We expect the next few months to shake out in the 18-19% range for LVS followed by another step up later in the year when the additional amenities open.

 

MGM is also having a good month while SJM is the big loser so far in June.  Wynn’s performance continues to underwhelm.  Here are the numbers: 

 

MACAU:  FINALLY A DECENT WEEK (FOR LVS TOO) - MACAU2


MAY KNAPP TRACK

The Knapp Track release for casual dining trends in May suggests that casual dining trends sequentially slowed from April to May.  Comparing the Blackbox data to Knapp Track, we can infer that trends at Darden continued to slow through May.

 

Malcolm Knapp released his Knapp Track casual dining sales numbers for May this weekend.  The May 2012 comparable restaurant sales change was -1.3% and the comparable restaurant guest count change was -3.9%.  The sequential change from April to May, in terms of the two-year average trend in Knapp Track casual dining comparable restaurant sales, was -80 bps.  For Knapp Track casual dining guest counts in May, the sequential change from April was -85 bps. 

 

The comparable store sales growth decline in May was the second in three months and implies that casual dining is still a group that investors should handle with care.  We have been advocating a cautious stance toward the casual dining group since mid-April.

 

Takeaways

 

Darden is emerging as a stock that could be emerging as a short or, at least, a stock that should not be bought.  The Knapp-Blackbox spread has declined over the course of the last three months, indicating that Darden (not included in Blackbox data but included in Knapp Track).  The spread has gone from +0.8% in February to -0.5%, -0.6%, and -0.9% in March, April, and May, respectively.

 

Besides the broader casual dining group, for Darden and Brinker this result is especially meaningful since those companies’ systems represent a large portion of the unit base from which the numbers are calculated.

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS

Key Highlights

 

*  Spanish bank bailout expectations prompted across-the-board tightening for EU peripheral countries, EU banks and US global and credit-sensitive banks.

 

* On the other side of the trade, Germany's swaps widened (the only country in the EU to show this) as did swaps of US insurers, as expectations for low rates persisting longer than previously expected rose.

 

* Spanish bank bailout euphoria also rippled across junk bonds, leveraged loans and munis, with both indices showing improvement week-over-week.

 

* Our Macro team’s quantitative setup in the XLF shows 1.9% upside to TRADE resistance of $14.41 and 6.1% downside to TRADE support of $13.28.

 

Financial Risk Monitor Summary  

• Short-term(WoW): Negative / 3 of 12 improved / 4 out of 12 worsened / 6 of 12 unchanged  

• Intermediate-term(WoW): Negative / 1 of 12 improved / 10 out of 12 worsened / 2 of 12 unchanged  

• Long-term(WoW): Negative / 3 of 12 improved / 5 out of 12 worsened / 5 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - Summary

 

1. US Financials CDS  – Insurance swaps widened out last week, with 12 of 16 reference entities wider. On the other side were global banks and consumer lenders, which all tightened, reflecting anticipation of the Spanish bank bailout and expectations that a US "coupling" recession was less likely. 

 

Overall, swaps tightened for 15 of 27 major domestic financial company reference entities last week.   

Tightened the most WoW: WFC, MS, AXP

Widened the most WoW: PRU, UNM, XL

Tightened the most/ widened the least MoM: BAC, MS, RDN

Widened the most MoM: JPM, XL, MMC

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - American CDS table

 

2. European Financial CDS - French banks, still the canary in the coal mine, showed the biggest WoW improvement in swaps. Across Europe last week, 37 of the 39 reference entities we track showed spreads tighten. The median tightening was 4.7% (16 bps).  

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - European Financials

 

3. Asian Financial CDS -  Japanese, Indian and Chinese banks swaps were all tighter last week. Bank of China tightened by 55 bps to 173 bps. The median tightening was -12.2%. 

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - Asian Financials

 

4. Sovereign CDS – Expectations for a Spanish bank bailout led to tightening across the EU periphery. Portugal was down 110 bps to 1,071 bps, while Spain and Italy were tighter by 44 bps and 35 bps, respectively (to 526 bps and 569 bps). Interestingly, Germany's swaps widened by 5 bps - the only major market to widen. As the risk in the periphery gets transferred to Germany's shoulders, Germany's creditworthiness is starting to reflect the deterioration. 

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - Sov Table

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - Sov 1

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - Sov 2

 

5. High Yield (YTM) Monitor – High Yield rates fell 16 bps last week, ending the week at 7.93% versus 8.09% the prior week.

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - HY

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.66 points last week, ending at 1641.

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - LLI

 

7. TED Spread Monitor – The TED spread fell 1.0 bps last week, ending the week at 38.9 bps this week versus the prior week print of 39.9 bps.

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - TED

 

8. Journal of Commerce Commodity Price Index – The JOC index fell 1.5 points, ending the week at -15.2 versus -13.7 the prior week.

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - JOC

 

9. Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread held flat at 40 bps.

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - Euribor OIS

 

10. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - ECB recourse to the deposit

 

11. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1. Last week spreads tightened 16 bps, ending the week at 169 bps versus 185 bps the prior week.

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - MCDX

 

 

12. Chinese Steel - We use Chinese steel rebar prices to gauge Chinese construction activity. We look at the average Chinese rebar spot price. Steel prices in China fell 0.15% last week, or 6 yuan/ton, to 4,068 yuan/ton. Notably, Chinese steel rebar prices have been generally moving lower since August of last year.

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - Chinese Steel

 

13. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure.  Last week the 2-10 spread widened to 136 bps, 16 bps wider than a week ago.

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - 2 10  risk monitor

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.9% upside to TRADE resistance and 6.1% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - XLF 

 

Margin Debt - April: +0.93 standard deviations 

We publish NYSE Margin Debt every month when it’s released. NYSE Margin debt hit its post-2007 peak in April of 2011 at $320.7 billion. The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1. While this may sound complicated, the message is really quite simple. First, when margin debt gets to 1.5 standard deviations or greater, as it did last April, it has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period. We flagged this for the first time back in May 2011. The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. In other words, the last few months’ change in margin debt is the best predictor of the change we’ll see in the next few months. We would need to see it approach -0.5 to -1.0 standard deviations before the trend runs its course. There’s plenty of room for short/intermediate term reversals within this broader secular move. Overall, however, this setup represents a long-term headwind for the market. One limitation of this series is that it is reported on a lag.  

 

The chart shows data through April. 

 

MONDAY MORNING RISK MONITOR: GERMANY & US INSURERS WIDEN WHILE REST OF WORLD TIGHTENS - Margin Debt

 

Joshua Steiner, CFA

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser. 

 


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