Tuesday, February 10th, 2015


Even the Greeks agree that Greece is not large enough to shake the foundations of the Eurozone, which is why their new finance minister is overtly threatening his counterparties with the impact of contagion, if Greece is forced out of the euro. We thought it would be interesting to look at our models to see whether investors are taking the threat seriously and which countries it affects most. We now have two ways in which we can track this: our Eurozone country bond model and our new Eurozone country equity model.

Let’s look at bonds first. Greece has been bottom of our Eurozone bond model ever since October 2014, and the model currently recommends a 99% underweight. The rest of the periphery has been at, or close to, the top of the rankings for the whole of the last six months. Italy and Portugal have each had a two/three week period when they have fallen into the middle of the table, but it has not lasted long. Ireland and Spain have been #1 and #2 respectively for the last six months, until the beginning of this week, when Spain fell from #2 to #4.

This could, of course, be the same sort of problem which Italy and Portugal suffered from, a period of nerves, followed by a rally and the restoration of its normal position in the rankings. However the scale of the fall is much greater for Spain than it was for Italy or Portugal. At the beginning of the year, our model was recommending an overweight position of 72%, but this had fallen to 25% by last Friday – a drop of 48 percentage points. The biggest drawdown suffered by Italy was 35 percentage points, and for Portugal it was 38 pp. Furthermore, we cannot say that the decline in Spain is over, though clearly situation could improve rapidly if investors thought that the risk of contagion from Greece was reduced.

The ranking for equities is quite different, with Belgium and the Netherlands in the top two places – as they have been for months – and Germany as the newly promoted #3. Greece is, of course, bottom of the list and Portugal is #10, with Austria as #9 – thanks to its exposure to Ukraine. Most countries have held their positions unchanged (plus or minus one) for the last six months, but there are two exceptions: Germany which has been moving steadily up the rankings ever since the euro began to depreciate against the US dollar, and Spain which has fallen from #2 in August 2014 to #8 as of last Friday. The recommended exposure has fallen from 49% overweight to 28% underweight, a move of 77 percentage points. No other country has suffered a remotely similar decline in its score over the same period.

Our bond and equity tables clearly suggest that Spain is the country most at risk of contagion from Greece. No other country has suffered a larger reduction of its recommended weight for either equities or bonds and the combined total is by far the largest. Of the other two suspects, Italy does not have a general election this year, and Portugal, which votes in September, does not have a new radical left-wing party like Syriza or Podemos. Spain has both and investors appear not to like the combination.

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