Fisher Investments Editorial Staff
Developed Markets, Investor Sentiment, Market Risks

We’re Not Out of the PIIGS Pen, Yet

By, 06/15/2010

Story Highlights:

  •  Moody's further downgraded Greek debt to Ba1—hardly surprising news since Greek bond yields have remained stubbornly in junk territory.
  • Stabilizing credit markets and improving economic data could help ease market jitters over PIIGS.
  • Notably, the recent stock market correction—against a backdrop of robust corporate profits—has stocks cheaper now compared to bonds than they've been since the bull market began.
  •    A bull market is not a straight shot up—more cases of jitters can emerge to test investors and shake stocks—but remember corrections are short-term and sentiment-driven by nature.

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PIIGS sent markets into a bit of a tailspin in recent months. And on news Moody's downgraded Greek debt further to Ba1—the highest junk-level rating—US markets (markets in Europe and Asia were closed when the downgrade was announced) gave up early gains and finished slightly down Monday. That Greece was downgraded to junk is hardly surprising. The market's been telling us Greek debt isn't investment grade for a while now as interest rates have remained stubbornly in high yield territory. But while PIIGS' situations have not completely turned around, there are reasons to believe PIIGS overall are making progress.  

Foremost, credit markets are stabilizing, indicating fears of widespread country defaults are diminishing. After rising a bit in May, US dollar LIBOR has been flat for two weeks, and three-month EURIBOR is now only 0.7% above its March low. The European Central Bank said there was zero demand in its foreign exchange swap program last week, indicating plenty of US dollar liquidity in Europe, while PIIGS governments saw strong demand for €22.1 billion of debt sales at non-alarming rates. 

European economic data continues to improve, dispelling (seemingly unwarranted) fears of a PIIGS contagion and, encouragingly, coming in above expectations in many cases. Eurozone April industrial production rebounded 0.8% month-over-month—a 9.5% rise over the previous year vs. a consensus forecast of 8.7%. Germany's April manufacturing orders surged 2.8% over the prior month (vs. an expected -0.5%) and by almost 30% vs. the prior year. Spanish April home sales rose 17.6% year-over-year, vs. 9.0% in March. 

Notably, the recent stock market correction—against a backdrop of robust corporate profits—has stocks cheaper now compared to bonds than they've been since the bull market began. As of the end of May, the forward S&P 500 earnings yield (the inverse of the P/E ratio) was 7.9%, compared to 3.3% on 10-year US Treasuries. The spread shows stocks are trading at the cheapest level relative to bonds since March 2009.* Bloomberg and Barclays reported similar findings looking at stocks vs. highly rated corporate bonds. At a time when most folks think stocks are risky, this is very bullish. 

Investors may not be completely out of the PIIGS pen, but continuing positive fundamentals show fears the entire world has somehow taken on Greek-like qualities are unwarranted. A bull market is not a straight shot up—more cases of jitters can emerge to test investors and shake stocks. But corrections are short-term and sentiment-driven by nature. Eventually, fear should give way to positive fundamentals and the bull market should continue. Those who fall prey to the freak-out stories will likely declare the correction the start of a new bear market, but it'll take more than a frightful story to morph this bull into a bear. 

*Global Financial Data, Inc., Thomson Reuters. As of 5/31/2010.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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