Investment Contrarians

Why the Spanish Debt Downgrade Could Be an Opportunity

By for Investment Contrarians |

Federal ReserveThe latest downgrade on Spain’s sovereign debt by Standard & Poor’s should not be a surprise to anyone following the financial crisis in the eurozone. Standard & Poor’s also stated that it has a negative outlook, meaning that there are still large risks to Spain going forward. Again, with what we’ve seen in the eurozone during this financial crisis, this is not a surprise to me.

With unemployment at approximately 25%, Spain is far from a recovery. The negative market sentiment, permeating through Spain and the eurozone, is directed toward the Spanish government’s unlikely ability to rein in their budget deficit and develop an economic structure that will return the nation to growth.

Let’s be honest; as I stated, this is not a surprise to anyone who has followed the eurozone over the last couple of years. With the continuing spread of the financial crisis from one country to the next, along with Spain’s lack of control over its spiraling budget deficits and its lack of a growth plan, the results were quite evident.

However, one might be surprised to hear that I view this, at least over the short term, as a potential bullish opportunity within the eurozone due to the financial crisis. The reason is that this is an additional push for the Spanish government to go to the European Central Bank (ECB) for help. The ECB is ready to initiate a Spanish bond-buying program, if Spain were to ask for aid. Spain is hesitant, as this would mean additional austerity measures.

For the short-term trader, having the ECB step in to buy bonds is obviously bullish, just as it has been extremely bullish in America, buying treasuries and mortgage-backed securities ahead of the Federal Reserve. In fact, one of the most profitable trades over the last couple of years has been in U.S. debt markets ahead of the Federal Reserve. While this certainly isn’t a long-term trade, purchasing Spanish debt before the ECB does should be quite profitable.

The only problem in this thesis is that it doesn’t consider the election in Catalonia on November 25. Catalonia is the wealthiest part of Spain. The people of this part of Spain are fed up with supporting the lower productivity levels of the rest of the country. The sentiment is echoed among many parts of the eurozone. As the financial crisis has spread, the wealthier and more productive parts of the eurozone are now balking at supporting the free-spending nations. I can understand the sentiment, as I wouldn’t want to support someone who is irresponsible with money forever.

If the newly elected Prime Minister of Catalonia wins with the mandates to secede from Spain, this could be a new and unknown chapter in the financial crisis within the eurozone. This would then cloud the waters, making the next step for the continent unclear. Because of this uncertainty, I would certainly avoid the Spanish markets until the election is concluded. After that, positioning oneself ahead of the central bank has historically been a profitable trade, at least in the short term.

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