European Sovereign Debt: Value or Value Trap?

European Sovereign Debt: Value or Value Trap?
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Dim talk from noted value investors on the frailty of European debt has sent European Sovereign Debt: Value or Value Trap?even risk-loving players from the bullring into hibernation.  But those bedding down for a long winter’s sleep may have been lulled by the wrong fairy tale.   Either that, or they nodded off before hearing the end of the story.

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We all think we know the score: struggling European nations are insolvent and richer countries aren’t making it easy for distressed neighbors.  Failure to act boldly has shot confidence, signaling a death by 1,000 cuts.  Cynics use everything from precedent, to data estimates, to economic theory to promote a doomsday scenario.  Yet myriad investors are buying up European debt and there’s plenty of data to justify investor confidence.


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What Most Media Isn’t Talking About

There’s no lack of evidence that European debt may be a good buy—what’s missing are outlets willing to discuss it.    Much time is spent wandering through the forest of day-to-day news developments in place of stepping back to see the trees.


So, let’s look at a different forest: the United States in the 1980’s.  Ten-year Treasury bond yields rose to 15.84% in July 1981, taking upwards of a decade to return to the more palatable 7% range.  As Forbes aptly noted in a December article about glaring omissions from the Euro debt crisis conversation, disaster did not ensue at the end of this deflationary period: in its stead came a time of stability followed promptly by wealth-building economic growth.


The omissions don’t end there.  Countries such as France, Italy, and Spain all saw bond rates climb north of 7% during the 90’s.  In this case, Forbes notes, circumstances “did not create an unstoppable debt snowball—if anything, they slowed the growth of public deficits as governments thought twice before spending money they did not have.”


Even French President Nicolas Sarkozy has been quoted as saying “We want Greece to stay in the euro but we cannot wish for this if she does not want it herself,” as if a referendum or any other ideological decision could make it so.  In reality, miles of thick, red bureaucratic tape stand between any member country wishing to disentangle itself from the crisis and being able to execute such a change from a legal or practical standpoint.   According to CNN, “the legal framework governing the European Union only talks about a member state leaving the bloc – not the currency.”



Pessimism is the New Black

The very scarcity of equitable coverage gives rise to an important note: counterpoints to widespread cynicism are rarely seen in the public discourse.   “Financial markets are again gripped with pessimism and impatiently looking for more,” asserts the Washington Post.  And, check out InTrade: just four days after the start of the new year, a 66% chance that S&P will rate Greece in default before December 31st, 2012 and a 78% chance that France will lose its AAA rating before June 30th are already predicted (yet little mention is made of those who bet similarly against Greece and Italy via InTrade in 2011).

Why all the gloom and doom?  More than ever, the financially strapped news media (and attention-starved, brand-building pundits) need to get eyeballs and sell advertising to a shrinking group of skittish sponsors.  Incentives abound to make stale information seem fresh, to sensationalize aptly-noted threats, and to make as many mountains as possible out of molehills.  The result is consistent with decision making heuristics (namely, the frequency, or availability, effect).  The more extreme Euro debt crisis claims have snowballed into extraordinary popular delusions and a madness of crowds.


Notable Optimists

So, who has broken ranks from the lemming march, investing in distressed European bonds?  George Soros alone added $2B of MF Global’s liquidated $6B Euro debt portfolio to his personal holdings (the remaining $4B took just days to sell off to other investors).  Boaz Weinstein, founder of the $4.2B investment firm, Saba Capital Management has also spoken publicly of his investment in Greek sovereign one-year debt.  The initial German bunds offering didn’t sell quickly or completely, but the outlook is improving.  Besides, perspective should remind us how little else (European debt notwithstanding) is selling impressively in the current market.

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European Sovereign Debt: Value or Value Trap?

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