UPA INVESTMENTS PTY LTD
AFS LICENCE NO. 226360 MAY 2010
From th e Ed From the Editor…. VOLUME 8, ISSUE 5
Market Update bearish at the beginning of this year was
“regulatory risk” as governments used the
It has become very obvious to us that GFC as an excuse to increase the
Australia has done itself some very seri- breadth, depth and influence of govern-
ous and not easily fixed damage in the ment in business. This is somewhat stun-
eyes of global investors. This is exactly ning because the “real world” business
what we thought would occur. From experience in Government has never
what we can see there is no likelihood of been lower. As far as we can see the
a short-term compromise, despite the combined “real world” business experi-
Rudd Government’s approval rating col- ence of the Prime Minister, Treasurer and
lapsing. Treasury Secretary is the two year stint
Mr Rudd did at accounting firm KPMG.
The recent war of words between the
INSIDE THIS ISSUE
government and the resources industry There is a real potential upside to the do-
is genuinely damaging foreign investors mestic equity markets that they will rally if
perceptions of Australia. What on earth they get even a sniff that the Rudd Gov-
Market Update does an advertising battle achieve other ernment could be on the way out.
than to cement the view of foreign inves-
tors that we have completely lost our Despite overwhelmingly bullish broker
way in this country? and analyst sentiment at the beginning of
Spain in trouble? this year, we have remained concerned
With absolutely no sign of a compromise with the major macro issues of rising EU
on this resource super profits tax sovereign debt and a potential slowdown
(RSPT), let alone any genuine consulta- in Chinese growth. In addition, we have
tion process with the mining industry, we remained cautious on the outlook for the
should continue to see Australian mining Australian economy due to the stimulus
stocks locked in their new lower trading fade, regulatory intervention from Can-
ranges. The same goes for the Austra- berra, and the heavy handed monetary
lian dollar. This is unfortunate but we policy of the Reserve Bank of Australia.
just struggle to believe that governments We have also been sceptical of the very
can allocate capital better than the pri- bullish consensus earnings forecasts for
vate sector. We also struggle to believe domestic shares for financial year 2011.
that governments act in the true long-
term National interest; they act in the In the meantime, investors have now ac-
interests of what they believe will get knowledged the uncertain macro environ-
them re-elected. Interesting, the RSPT ment with a sharp rise in risk aversion
has backfired on them in the opinion and a global equity market correction.
polls and rightly so in our view. Subsequently the ASX 200 index has
fallen around 12% from the recent peak.
Whilst we are disappointed by the RSPT As a result, after the correction we be-
debacle we shouldn't be surprised. One lieve equity markets are now more rela-
of the key reasons we were outright tive of the risks to the global economy/
domestic regulatory risks. of over 2-3 billion Euros in outstanding
commercial paper. This is a bad sign.
The downgrade of Spain’s coveted AAA There has been massive inter-government
rating by one notch to AA+ is a clear indica- loans within the EU countries. The PIGS
tion that major macro issues remain. It have been the major recipients of credit via
would be easy to believe that the recent inter-government EU loans from France,
global equity correction has signalled the Germany and the UK. However, it appears
end of the EU’s problems. The reality is that the amount of short term government
however, that the sharp fall in equity mar- IOUs or commercial paper issued by banks
kets have merely signalled a belated inves- in Spain, Portugal and Italy has fallen sig-
tor willingness to finally acknowledge that nificantly. The implication is that the
“yes” we have a problem. Of course, the stronger EU banks are refusing to buy
ratings agencies will be the last to the party PIGS paper or to further extend credit to
as usual. PIGS banks.
The Spanish sovereign downgrade is a so- In addition the European Central Bank
bering reminder that the EU sovereign debt (ECB) is now attempting to sterilize the po-
crisis is far from ’resolved’. It is interesting tentially inflationary effects of its massive
to note, that while Spain has a 12% budget rescue program of buying distressed PIGS
deficit, its ratio of national debt to GDP is government bonds, by lifting deposit rates.
approximately 60%. This is relatively low As a result, EU banks are now lodging
compared to the rest of the PIGS which cash with the ECB rather than lending to
have sovereign debt levels of 100%. How- other banks. The recent data reveals that
ever, the difference is that Spain holds 40% bank deposits with the ECB are increasing
of Portugal’s sovereign debt. Therefore we rapidly with a rise of 7% in the past week.
think the key issue from the Fitch ratings Consequently the move to pledge deposits
downgrade is the acknowledgement by rat- with the ECB is having unintended conse-
ings agencies of a genuine contagion risk to quences for EU inter-bank lending and ex-
other EU nations. Importantly, Spain repre- acerbating the recent trend of EU bank
sents the first AAA– rated nation to have its cash hoarding.
credit rating downgraded. Make no mistake,
this is massive news and confirms our ex- Spain in trouble?
pectations that further downgrades to AAA
credit ratings are possible this year. The EU banks, particularly the PIGS, re-
main heavily dependant on short term fi-
The problems of the European Union (EU) nancing which renders them very vulner-
and the Euro are both structural and long able to any reduction in bank lending. As a
term. While it appears a Lehman-style EU result, there is a possibility of a major EU
financial meltdown has been averted, we credit crunch similar to the height of the
believe a secondary sovereign debt effect— GFC when world bank lending ground to a
a long period of stagnant EU economic standstill. More importantly, in contrast to
growth is now becoming a real possibility. In the US banks, the true health of the EU
this regard, the Fitch downgrade was sup- banking system remains very unclear. As
ported by an expectation that Spanish evidenced by the Spanish debt downgrade,
growth would remain anemic given the gov- the inter-related nature of EU indebtedness
ernment’s pledge to cut government spend- heightens the risk of contagion. We do
ing by a massive 7.7% in 2011. need to keep a close eye on these events
as they unfold.
More importantly however, it appears the
EU is now lurching towards a potential There have been fears recently that Span-
credit crunch. The latest data from Dealogic ish banks are struggling to raise funding,
reveals that EU banks are shunning govern- and the country could soon be forced to
ment paper and hoarding cash. In the past request a Greece-style emergency bailout
month, the PIGS banks have posted drops package.
VOLUME 8, ISSUE 5 PAGE 3
According to the French newspaper, Le Monde, budget deficits under control should be penal-
Spain’s Treasury secretary, Carlos Ocana, ised, and perhaps even be expelled from the
strongly denied rumours that Spain was negoti- eurozone, an idea that France is resisting.
ating for a bailout package, saying that Spain
did not need any additional financing from inter- Spain is the fourth largest economy in the eu-
national institutions. However, Ocana did con- rozone, and any problems in Spain would
cede that some Spanish banks were being re- quickly impact France and Germany. Accord-
fused loans in the international inter-banking ing to the latest report from the Bank for Inter-
market; “It’s definitely a problem”, he said. “The national Settlements, French banks have
way to restore confidence is to introduce reso- $248 billion in exposures to Spain, while the
lute and concrete measures”. exposure of German banks is $202 billion.
The French banks are heavy lenders to Span-
Worries about a Spanish debt crisis were also
ish non-bank companies, while more than half
fuelled by comments from Francisco Gonzalez,
of German bank loans were to Spanish banks.
chairman of Spain’s second largest banks,
BBVA, who said that Spanish sovereign debt Concerns over Spanish debt also overshad-
worries were impacting private borrowers. "For owed figures that showed eurozone industrial
the majority of companies and financial institu- production grew for the 11th consecutive
tions in Spain, the international financial mar- month in April, with year-on-year growth rising
kets are closed," he said. to 9.5%. But the growth was concentrated in
the stronger economies. Greece’s industrial
Concerns over the Spanish banking system
output has dropped 6.4% in the past year,
have been simmering since last month when
while Ireland, Portugal and Spain still have
the Bank of Spain took control of CajaSur, a
lower output than a year ago.
small Spanish savings bank which was con-
trolled by the Catholic Church. This drew atten- Spain had previously argued that its debt is
tion to the precarious financial state of other not a problem, as government debt only ac-
Spanish savings banks, many of which are counts for around 55% of the country’s GDP,
heavily exposed to the ailing Spanish property compared with more than 115% for Greece. In
market. addition, the Spanish government has intro-
duced additional austerity measures to reduce
And markets are likely to stay on edge in com-
the budget deficit by a further $18.3 billion and
ing weeks, as they wait to see whether Spain
has proposed measures to reform the coun-
can raise the $US20 billion it needs to refi-
try’s labour markets.
nance debt that matures next month. Increased
jitters over Spain’s financing problems have ****************************************************
come at a time when relations between the two Information in this Newsletter is drawn from vari-
most important eurozone economies – Ger- ous sources, including extensive and comprehen-
sive research by Southern Cross, Bloomberg and
many and France – appear to be deteriorating. the local press.
German Chancellor Angela Merkel and French ****************************************************
President Nicolas Sarkozy met recently in a bid
to hammer out a joint approach to eurozone PLEASE NOTE THAT THIS IS NOT ADVICE TO BUY
debt crisis. France is pressing strongly for a OR SELL SECURITIES IN ANY OF THE COMPANIES
MENTIONED IN THIS NEWSLETTER AND WE
common European economic government for STRONGLY RECOMMEND THAT YOU SEEK OUR
the 16 eurozone countries, which would have SPECIFIC FINANCIAL ADVICE BEFORE MAKING
its own administration. ANY DECISION.
Germany is deeply opposed to introducing a
new layer of administration. Instead, it wants Doug Henderson
eurozone members to introduce tough austerity Authorised Representative
programs to reduce budget deficits, and it has UPA Investments Pty Ltd
proposed that countries that fail to get their
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