On Jan. 13, 2012, the ratings agency Standard & Poor's issued a one-notch downgrade to France's credit rating, kicking off a series of sovereign debt downgrades that would eventually implicate all members of the euro zone (and — perhaps more ominously — the European bailout fund itself).
Generally speaking, the downgrades did not come as a big surprise; sovereign debt was already trading at yields that factored in the likelihood of a downgrade, particularly after the warnings issued by Standard & Poor's in early December. But the reality of the downgrade puts a cold light on the fact that sovereign debt issued by much of developed Europe — not just “peripheral” Europe — will likely be on shaky footing for some time.
We believe that, on balance, European markets will entail downside risks for much of 2012, with pressure coming in several forms. Keep in mind, for instance, that the euro zone economy seems very likely to contract in the first half of 2012, with peripheral countries contracting more deeply than the German and French economies. However, if there is a disorderly recession (involving a sovereign debt default or the eventual break-up of Europe's monetary union), the economic contraction could be much worse. In our view, it is also unlikely that European governments (nor those of other developed economies or the foreign-reserve-rich countries in the emerging markets) will introduce new rounds of stimulus. We believe that economic contraction in Europe could therefore be prolonged.
What's more, banks within the euro area will need to recapitalize more than 100 billion euros in debt by the middle of 2012 (this is according to estimates published by the Euro Banking Association, though many analysts believe the amount could realistically be as high as 300 billion euros). If banks choose to deleverage rather than recapitalize, the amount could likely climb further, reaching somewhere between 0.5 and 3.0 trillion euros. At the same time, the funding needs of euro-area governments could possibly climb north of 1 trillion euros for the year, while banks may see their funding needs climb to somewhere between 600 and 700 billion euros. (Funding estimates are based on sources that include the Euro Banking Association, Bloomberg, and Thomson Reuters). We believe these funding needs, together with challenging economic conditions, put the balance of risks in Europe to the downside.
By Ned Gray
On Friday, Jan. 13, 2012, the ratings agency Standard & Poor's (S&P) downgraded nine euro zone countries. The agency stated that "the policy initiatives taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the euro zone."
The full impact of the recent credit-rating downgrades is still unfolding and may create an additional level of uncertainty and volatility in the markets. When a country's credit rating is downgraded, the effect can be higher lending rates, stricter lending standards, and reduced access to capital.
S&P cut France's and Austria's top ratings of AAA by one level, to AA+. S&P also downgraded Spain's high grade (AA-) credit rating two levels, to an A rating (medium grade), and Italy's upper-medium A rating to a lower-medium BBB+. Other downgrades were made to Portugal, Cyprus, Malta, Slovenia, and Slovakia. Germany, the Netherlands, Finland, Ireland, Belgium, and Estonia were not downgraded. Germany is now the only top-rated (AAA) backer of Europe's bailout fund (the European Financial Stability Facility, or EFSF1) for troubled economies.
We believe investors have been expecting the French downgrade since S&P announced in December 2011 that a cut could occur. On Monday, Jan. 16, France sold 8.6 billion euros of short-term debt securities at yields that were only slightly lower than in the previous auction. Market reaction thus far seems subdued. The euro zone rescue fund (EFSF) was also just downgraded from its prime AAA rating to AA+ on Monday, yet it easily sold 1.5 billion euros of debt on Tuesday. Spain also had a successful debt auction on Monday and sold 4.88 billion euros' worth of bills.
The ratings agency Moody's Investors Service said Monday that "the stable outlook on France's AAA credit rating remains under pressure, with risks arising from the growing level of government debt and adverse developments in the euro zone." There are also concerns that France may have to provide support to its banks or to other euro-zone countries. Moody's is expected to announce its ratings during the first quarter of 2012. If a second ratings agency, such as Moody's Investors Service or Fitch Ratings, initiates a downgrade, it could possibly have a more negative effect.
Our international and global portfolios are underweight financials, with exposure that is much less pronounced versus peers.
The views expressed in each outlook represent the Manager's assessment of the market environment as of January 2012, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the manager's current views.
Investing involves risk, including the possible loss of principal.
Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies.
International investments entail risks not ordinarily associated with US investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.
Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
Certain statements made here are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (PSLRA). A forward-looking statement is a statement that is not a historical fact and, without limitation, includes any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain words like: "believe," "anticipate," "expect," "estimate," "project," "will," "shall" and other words or phrases with similar meaning in connection with a discussion of future operating or financial performance. In particular, these include statements relating to future actions, trends in our businesses, prospective services or products, future performance or financial results, and the outcome of contingencies, such as legal proceedings. The protection afforded by the safe harbor for forward-looking statements provided by the PSLRA are claimed hereunder.
Due to the uncertainty inherent in forward-looking statements, actual results or economic conditions may differ materially from those anticipated in the forward-looking statements.
Investors should not place undue reliance on forward-looking statements as a prediction of actual results. In addition, we disclaim any obligations to update any forward-looking statements to reflect events or circumstances that occur after the date of this document.
Fixed income securities can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder a issuer’s ability to make interest and principal payments on its debt.
The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. Delaware Investments has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services and should not be used as the basis for any investment decision. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. Delaware Investments and its affiliates may make investment decisions that are inconsistent with the recommendations or views expressed herein, including for proprietary accounts of Delaware Investments or its affiliates.
The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or funds to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or funds for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions.
Conflicts of Interest: Delaware Investments and its affiliates may have investment advisory or other business relationships with the issuers of securities referenced herein. Delaware Investments and its affiliates, officers, directors and employees may from time to time have long or short positions in and buy or sell securities or financial instruments referenced herein. Delaware Investments affiliates may develop and publish research that is independent of, and different than, the information contained herein. Delaware Investments personnel other than the author(s), such as sales, marketing, and trading personnel, may provide oral or written market commentary or ideas to clients of Delaware Investments or prospects or proprietary investment ideas that differ from the views expressed herein. Additional information regarding actual and potential conflicts of interest is available in Part II of Form ADV for Delaware Management Business Trust.