A Lethal Cocktail
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
After years of uninterrupted domination, the old guard at Spain’s Ibex 35 stock index – two mega-banks Banco Santander and BBVA, oil giant Repsol, telecommunications behemoth Telefonica, and utility Iberdrola – is beginning to lose it.
Today the big-five’s combined capitalization represents 45% of the ibex 35’s total capitalization. This may seem like a ridiculously high percentage for five companies compared to most other stock markets, but it is actually its lowest share in decades. Over the last 15 years, the big five’s combined share has averaged 60% and at times even reached as high as 65%.
There are many reasons for this change, including the rise of relative newcomers. Of particular note is the spectacular growth of Spain’s clothing giant Inditex, whose brands include the world’s biggest fashion retailer, Zara, and whose owner, Amancio Ortega, is now the world’s second richest man. Inditex has a market capitalization of €92.7 billion, compared to Santander’s €59.5 billion!
The other main reason for the big five’s shrinking market share is their sinking share prices. Telefonicá and BBVA’s shares are at their lowest point since 2013. Santander’s shares, which have suffered the debilitating effects of countless capital expansions, haven’t been this low since 2012. As for Repsol, the last time its shares plumbed their current depths was in the 1990s. The only member of the big five to escape this rout is Iberdrola.
One thing that all of these companies have in common is their massive exposure to emerging markets — in particular Latin America, whose commodity-rich economies are now suffering the fallout from dwindling Chinese demand. In the aftermath of Spain’s real estate collapse, when opportunities at home were almost non-existent, Latin America’s fast-growing economies were a godsend to many of Spain’s biggest companies. But they are fast becoming a curse.
The profit forecast for 2016 and 2017 for firms listed on Latin America’s four biggest stock markets — Brazil’s Bovespa, Mexico’s IPC, Argentina’s Merval and Chile’s IPSA — had dropped 26% from the previous estimate. By far the worst pain is being felt in Latin America’s biggest economy, Brazil, which is facing its deepest and longest recession in decades.
Brazil’s enduring travails could be particularly bad news for Spain’s biggest bank, Santander, for which the Latin American economy was once the biggest source of profits but in October was relegated to second place behind the UK. That said, Brazil’s contribution to Santander’s profits (19%) still dwarfs that of Spain (13%). And instead of reducing its exposure to Brazil’s increasingly fragile economy, Santander recently doubled down on its bet, forking out €4.7 billion on the acquisition of the remaining 25% of its Brazilian unit [read: Is Brazil About to Drag Down Spain’s Biggest Bank?].
For Telefonica, meanwhile, Brazil provides (or provided) 23% of its gross earnings. Respol is also deeply involved in Brazil, with operations in the Campos basin. It was among a number of firms to discover deep offshore deposits in Sapinhoá last year. To drill there, however, the company has a break-even price of $50 per barrel, $16 above the current price of Brent crude. And that’s after divesting €6 billion of its assets.
Iberdrola also has its share of Brazilian headaches, most notably the Belo Monte hydroelectric mega-project. Its partners in the project include the Spanish company Abengoa, which is on the verge of becoming Spain’s biggest ever corporate insolvency and stopped paying its invoices in Mexico and Brazil weeks ago, leaving Iberdrola (and hundreds of other companies) high and dry.
The emerging market risks of Spain’s second biggest bank, BBVA, lie elsewhere — primarily in Turkey and Mexico. In the case of Turkey, a country that is undergoing social, political and economic upheaval, BBVA began its operations there in 2011 when it spent €5 billion to acquire 25% of the country’s biggest listed lender, Turkiye Garanti Bankasi AS (GARAN), from the Turkish group Dogus and General Electric.
Since then, the Turkish Lira has lost close to 50% of its value. That didn’t stop BBVA from forking out an additional €1.99 billion in July 2015 to acquire an extra 15% of Garanti — just when fear over emerging market risks and Turkish political instability was reaching fever pitch!
BBVA’s other key emerging market, Mexico, has been its biggest source of profits for well over a year now. The country’s macro conditions are significantly more favorable than Brazil’s or Turkey’s, especially given its much smaller exposure to the Chinese economy. But enormous risks still persist. U.S.-denominated corporate debt in Mexico is at its highest point ever, while the Mexican peso is at its lowest point ever against the dollar, making it very difficult to service this debt. Meanwhile, falling oil prices are creating huge fiscal pressures for a government long-accustomed to living off tax revenues provided by the country’s formerly publicly owned but now semi-privatized oil company, Pemex.
This week saw the price of Mexican oil plumb new depths while the peso suffered its worst opening week of the year since 1995, the year of Mexico’s Tequila Crisis, a long-forgotten event that at one point almost put paid to some of Wall Street’s biggest investment banks. They were eventually bailed out indirectly by the U.S. Treasury, the IMF, and the Bank of International Settlements.
Whether a similar fate could await some of Spain’s biggest banks and corporations today, it’s too early to say. What is clear, however, is that the global economy is far more interconnected and interdependent now than it was in 1995. It is also swimming — drowning? — in a much larger sea of debt. As such, the risk of contagion is significantly larger.
And with at least half of Spain’s corporate sector dependent for a large chunk of its revenues and profits on markets that face a very dangerous cocktail of economic conditions, Spanish investors would be well advised to pay close attention to what happens across the pond. By Don Quijones, Raging Bull-Shit.
After weeks of false promises, rampant speculation, and furious denials, Mexico’s biggest construction company, ICA, finally admitted that it will not pay the interest outstanding on $700 million of bonds. The company’s shares plunged 24% on the news. Read… Dollar-Debt Blows up in Mexico, Pushes Biggest Construction Firm toward Abyss
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‘To drill there, however, the company has a break-even price of $50 per barrel, $16 below the current price of Brent crude. ”
I’m pretty sure you meant “$16 ABOVE the current price”
thanks. fixed.
I suppose I should refer back to something Mr. Don Quijones has said to be on subject, but my question is simple and is kind of on subject. Why should one who’s home, vehicles and all other real assets are paid for, has more cash than he’ll live long enough to spend, care what upheaval this so-called all for one and one for all economy usher in? And please don’t say for future generations. Jesus said, “Follow me, and let the dead bury their own dead.” My translation of that is, “Someone should do something. I would, but I have to find a new dentist. My old one made so much money in the markets that he closed his doors and moved to the Virgin Islands.”
While I am well on the way to financial independence, I would need a few more good years to achieve it otherwise a belt tightening will be in order to limp along with what I have if the financial dam breaks tomorrow. I think many of Mr Quijones’ audience have a stake in the system, even if they do not like it. I suspect that many professionals in Spain and Latin America work hard but may not have gotten big enough paychecks to save a lot of money.
Also, if there is a “collapse”, having cash in its own right will help but I don’t think it solves all problems. Lots of businesses would close and it may be harder to get the services we need for our “just in time” lifestyle.
I am a 100% supporter of this site and those few others like it. It is wonderful to have a place where we can keep of with “what & why”, but I believe it’s worth mentioning every now and then, that a lot of Main Street people made a small fortune as well as Wall Street people during these years of excessive manipulation.
Yes many on Main St have done well the past few years as I am aware from my work. I have done fine too. I am not sure it is a good idea to think one’s money though will solve some of the problems that could come in a collapse. Better to hope for steady downturn or other ways to digest the losses.
I fear if the manipulation becomes unglued, many cannot cash in their chips. Even if I have cash in a bank, that is essentially a loan to the bank. If as in this article banks are at risk of insolvency, my loan to the bank may not get paid back.
I think it is great to have paid off homes and vehicles and sleep much better on account of that. It feels sorta priceless to go into what may be a crazy year with very low overhead.
Peak oil is here. Peak oil will not lead to higher oil prices, instead it will lead to a global economic contraction. The global economy can only grow with oil at $20 per barrel so the economy will start to contract and gravitate towards this price ?
Do we even have a contracting economic model ? How will our financial institutions handle a contracting economy ?
Yoshua, “contracting economic model”.
I have been doing this since 2008/9. My goal, which I should achieve this year, is zero debt, out of long term investments in a corrupt stock market and cutting overhead to the bear minimum.
It appears this is what the wise are doing as demand for consumer goods and bigger/more is better becomes more the norm. Self imposed austerity until we move to a monetary system not controlled by the central bank debt masters.
As long as they are in control it will continue the decline in financial security for the bulk of humanity.
Ditto for me, particularly as I became informed about peak oil. My understanding is that petroleum is an unusually convenient concentrated energy that took millions of years to make and is of a finite supply. Humanity found this energy 150 or so years ago and used it to get people off of labor intensive farming into numerous specialized roles that advanced our standard of living and exploded our population. While steps have been taken to transition us off this to something more sustainable, these steps may be too small and timid in the face of an impending sharp falloff in oil production rate.
Thus, learning to get by and even be happy with a more frugal and less energy intensive lifestyle looks to be the way to go.
We’ve still got a few centuries of oil/gas/coal left in the ground, not counting technological advancements to use it more efficiently and cleanly, in addition to renewables and nuclear…running out of energy should be the last thing to worry about in today’s world. The earth will add another 2 billion humans over the next 30 years, making the global economy more inclusive is vital for world peace.
There is no practical limit to the amount of coal- but as the Chinese are discovering there is a limit to the amount of clean air.
I’m not an enviro greenie type- but I think China could be heading for a coal induced catastrophe.
I mean 100, 000 dead overnite,
It is incredible that the US and Canada are still using coal when nat gas is dirt cheap and cleaner.
Coal should be banned
Am I missing some current events here? Last time I checked, $50 would be about $15 HIGHER than the current price of Brent crude, not lower.
Damn, Kevin, good catch. Thank you. Completely my fault of course.
“Why should one who’s home, vehicles and all other real assets are paid for, has more cash than he’ll live long enough to spend, care what upheaval this so-called all for one and one for all economy usher in?”
Because if the wrong kind of world is the result of this or any upheaval, you will very likely be outnumbered by those who have been considerably less responsible than you.
And they just might try to take all your stuff.
Perhaps even with the help of the government.
The vicious circle is now complete and can only spin faster and faster until the global consumer gets some money to spend.
The demise of the Western consumer has affected demand for Chinese products and their Keynesian infrastructure investment has run out of money due to the length of the downturn in the West.
The lack of demand for Chinese products and the end of its Keynesian, debt fuelled stop gap has fed back into global commodity prices.
This is affecting commodity producers in Latin America and Africa.
Spain and Portugal are massively invested in Latin America.
The vicious circle is now complete.
Yes, it’s global and everything is connected. At the center of it all is Europe with zero growth, still mired in the euro crisis and the crisis will continue since it can’t be fixed.
Don Quijones
“Santander’s shares, which have suffered the debilitating effects of countless capital expansions, haven’t been this low since 2012”
I may be completely wrong here but I think Santander’s shares are now trading back near 1996 (or 20 years ago) levels. Or am I all incorrect when I am looking at the charts? I did consult not only Yahoo, CNN, & Google Finance, to check these price levels too. Stockcharts.com seems to have that information incorrect, (as far) as I can tell.
John M
John, that’s good thinking, and I’m glad you bring it up because that same issue now arises on a daily basis in the media with oil…. And this is important.
If you look at a weekly chart to find out when the prior low point was, you run into a problem. A weekly chart only shows the last trade of the week. So if the price dipped during the week and then recovered at the end of the week, the weekly chart will only show the last trade, and you miss the dip and the actual low point.
I think that’s what you’re looking at. For the week of July 20, 2012, it shows €4.19. But that was the close at the last day of that week. Today it closed at €4.08.
If you go to a daily chart, you will discover that on July 24, 2012, shares closed at €4.038. They might have been even lower intraday.
I hope this answers your question.
And the most recent low point for oil (WTI) was Dec 23, 2008, a Tuesday before Christmas. On Dec 26, 2008, a Friday, WTI jumped, and the last trade of that day made it into the weekly chart. So we still have not reached the low of Dec 23, 2008, though just about all media outlets, including the WSJ, look at weekly charts, draw a straight line across and end up further in the past.
Weekly charts can be treacherous.
Wolf
I did check my sources and consulted with Worden Charts those folks of TC2000 fame & Freestockcharts.com . Either way I suspect that Deutsche Bank BBVA & Santander Banks are all in for a big slide (if not bankruptcy)