The Daily Update - Portugal upgrade and potential 'Cexit'

S&P upgraded its rating for Portugal's sovereign debt from sub-investment grade, to BBB-. The rating agency previously moved Portugal's rating to junk back in 2012 after the country received a EUR 78bn bailout package in 2011, as it was unable to sustain its massive debt load. S&P cited the ‘solid progress (Portugal) has made in reducing its budget deficit and the receded risk of a market deterioration in external financing conditions’ as the reason for the upgrade. Moody’s and Fitch maintain Portugal’s long-term rating at junk.

Portugal’s economy has improved, alongside the broader EU; latest figures show that unemployment stands at 8.8%, which is below the regional average and the lowest level since 2009. Unemployment was as high as 17% back in 2013. Economic expansion for Q2’17 was recorded at 2.9%, the highest level in a decade. However, as with other developed economies, Portugal continues to struggle with lowly inflation.

It is no surprise that the benchmark curve has tightened considerably after the rating announcement, the yield on the 10-year rallied to levels not seen since the beginning of 2016. Also the benchmark 10-year is trading ~195bps wider than 10-year Bunds (at time of writing), the tightest level since the beginning of 2016. Portugal’s 5-year CDS has also tightened to ~135bps, to give some perspective, it was trading more than twice as wide at its peak in February. However, this is still pretty high, considering Turkey is only 25bps wider (at time of writing).

Despite the upgrade to investment grade, the country's hugely unsustainable debt level at 125% of GDP is one of the many concerns which prevents us from adding Portugal to our investable universe. Over the last couple of years the debt burden has floated around 130% of GDP and according to Moody’s is therefore one of the highest levels in the Ba1 space. The rating agency calculates that Portugal’s debt affordability, a measurement of interest payments to revenues, was as high as 10% last year; while Italy stands at 8.4% and Spain’s is 7.4%. Non-financial corporate debt is also higher than peers, at roughly 178% in Q1’17; thus a barrier to growth. The banking sector also remains a huge concern despite authorities’ steps to counter ~18.5% NPL ratios (Q1’17). That  aside, Portugal will not feature in our portfolios for some time as we still only assign the country 1 star on our NFA model and the curve does not offer sufficient risk-adjusted returns.

Across the border, Spain could face an independence referendum in just 13 days, after the Catalonia regional parliament approved the referendum vote. According to the bill, independence would be declared within 48 hours if the majority vote ‘yes’. And Catalonia would immediately ‘exit’ the EU and have to follow the same accession procedures as those member states who joined in 2004’, said EU Commission President Jean-Claude Juncker. Madrid is trying everything within its means to prevent the ballot from going through, with claims that it will not be accepted as a legal referendum. There have been reports that the Spanish government could go as far as cutting the electricity supply at the polling stations and possible brute force to ensure no-one can vote.

Catalonia’s economy contributes ~20% to Spain’s GDP currently. According to Spain’s economy minister, Luis de Guindos, Catalonia’s economic growth would shrink by 25-30% and unemployment double. As Catalonia would not be part of the EU, it could suffer export tariffs on as much as 75% of its products and services. Also, if the yes vote does go through, it will put Spain's Baa2/BBB+ ratings under pressure. We do not invest in Spain due to its low 2 star NFA ranking, and unattractive expected returns, however, we will continue to monitor the outcome over the next two weeks.

Please read this important information before proceeding. It contains legal and regulatory notices relevant to the information on this site.

This website provides information about Stratton Street Capital LLP ("Stratton Street"). Stratton Street is authorised and regulated by the UK's Financial Conduct Authority. The content of this website has been prepared by Stratton Street from its records and is believed to be accurate but we do not accept any liability or responsibility in respect of the information of any views expressed herein. The information, material and content provided in the pages of this website may be changed at any time by us. Information on this website may be out of date and may not be updated or removed.

The website is provided for the main purpose of providing generic information on Stratton Street and on our investment philosophy for the use of financial professionals in the United Kingdom that qualify as Professional Clients or Eligible Counterparties under the rules of the United Kingdom Financial Conduct Authority (the "FCA"). The information in this website is not intended for the use of and should not be relied on by any person who would qualify as a Retail Client. Products and services referred to on this website are offered only at times when, and in jurisdictions where, they may be lawfully offered. The information on this website is not directed to any person in the United States. The provision of the information on this website does not constitute an offer to purchase securities to any person in the United States (other than a professional fiduciary acting for the account of a non-U.S person) or to any U.S. person as such term is defined under the Securities Act of 1933, as amended.

The website is not intended to offer investors the opportunity to invest in any Alternative Investment Fund ("AIF") product. The AIFs managed by Stratton Street are not being marketed in the European Economic Area ("EEA") and any eligible potential investor from the EEA who wishes to obtain information on the AIFs will only be provided with materials upon receipt by Stratton Street of an appropriate reverse solicitation request in accordance with the requirements of the EU Alternative Investment Fund Managers Directive ("AIFMD") and national law in their home jurisdiction. By proceeding you confirm that you are not accessing this website in the context of a potential investment by an EEA investor in the AIFs managed by Stratton Street and that you have read, understood and agree to these terms.

No information contained in this website should be deemed to constitute the provision of financial, investment or other professional advice in any way. The website should not be relied upon as including sufficient information to support any investment decision. If you are in doubt as to the appropriate course of action we recommend that you consult your own independent financial adviser, stockbroker, solicitor, accountant or other professional adviser. Past performance is not necessarily a guide to the future. The value of investments and the income from them may go down as well as up. An application for any investment or service referred to on this site may only be made on the basis of the offer document, key features, prospectus or other applicable terms relating to the specific investment or service.

Where we provide hypertext links to other locations on the Internet, we do so for information purposes only. We are not responsible for the content of any other websites or pages linked to or linking to this website. We have not verified the content of any such websites. Such websites may contain products and services that are not authorised in your jurisdiction. Following links to any other websites or pages shall be at your own risk and we shall not be responsible or liable for any damages or in other way in connection with linking.

By using this site, you should be aware that we may disclose any information that we hold about you to any regulatory authority to which we are subject, or to any person legally empowered to require such information.

This website uses cookies to improve user experience, by clicking the "I Accept" button below means you consent to the use of cookies on our website.