Much Ado About Nothing New

Markets were again volatile on Thursday, with US markets falling roughly -1.6%. Most media headlines pointed to fears over Europe as the driver. And no doubt, investor angst over Europe remains high and is a likely culprit contributing to recent volatility. In our view, however, the volatility is in fact driven more by fears than any new fundamental, surprising developments.

Details of a Fitch report released late Wednesday on US banks’ exposure to Europe is a great example. The ratings agency said it would put US banks on watch should the PIIGS debt situation continue to deteriorate. And they noted a fracturing of the euro would be bad for banks. But this is a point most investors are keenly aware of by now—and is still one that looks highly improbable. On the more interesting side of the report, Fitch also noted aggregate net exposure of US banks to stressed markets totaled just $50 billion at the end of Q3 for the six largest US banks.

Perhaps realizing this, Fitch maintained its stable rating of the US banking industry, citing the data it did have context for: much stronger capital and liquidity positions relative to pre-2008 levels.Moreover, banks continue to be relatively profitable. Even in Western Europe, trailing 12-month profit stands at around $64 billion—lower than previous periods (mostly tied to write-downs of Greek debt), but profitable nevertheless.* And that’s a point often overlooked: Even as PIIGS concerns have swirled over the past year, eurozone banks' earnings(overall and on average) have been in the black.

Yields at a Spanish bond auction hit a euro-area record. Not terrific, but that spike has been telegraphed for some time. Spain sold €3.6 billion of 10-year bonds at a yield of 6.98%. Coverage was fine but not overwhelming at 1.5x. Last month, the same 10-year bonds sold at a yield of 5.43%, with coverage of 1.8x. Spanish yields have been climbing since the beginning of October as concerns mount over economic growth (Q3 GDP was nearly flat) and the incoming government’s (elections are this Sunday) ability to push through necessary reforms and austerity measures. However, the trend of government turnover in the European periphery suggests the incoming government (center-right Mariano Rajoy appears to be the front-runner) can accomplish more of the necessary measures his predecessor (socialist-party Prime Minister Jose Luis Zapatero) couldn’t. It’s important to remember that, assuming Spain can get its fiscal house in order, rates could also move down. And that isn’t an impossible or even improbable outcome—Spain is not Greece.

An interesting tidbit many may have overlooked: British bank Northern Rock was sold to private investors on Thursday. Recall, the bank was nationalized in 2008 following a quasi-run on deposits and the bank’s near-complete lock-out from credit markets. The deal represents a loss for British taxpayers—the buyer paid only £747 million for the bank, compared to the nearly £1.4 billion the British government was forced to inject into it in 2010. However, the total proceeds after various conditions are met could reach £1.03 billion. In our view, not a bad deal, although most US bank bailouts did end up turning a profit for US taxpayers.

Of course, the fact the last two days’ volatility has seemingly occurred amid little new fundamental news doesn’t make it feel much better. However, our view remains that it’s unlikely a new bear market is in the fore—particularly since, globally, many metrics point to continued economic reacceleration.

*Source: Bloomberg LLP, as of 11/17/2011