The end of triple-A

Allianz Global Investors | Frankfurt | Nov 04, 2011

If you think about how ratings have developed in the industrial countries over the past few months, you have to ask yourself the question: Is the end of triple-A near? And could the resolutions decided on the EU summit at the end of October reduce the political uncertainty premium at the markets? You will find answers in our latest Capital Markets Monthly.

Download

AllianzGI Capital Markets Monthly, November 2011 (pdf, 240 KB)

Capital Market Presentation November 2011 (ppt, 2.3 MB)

It is a paradoxical situation. While investors are increasingly looking for "safety", top-rated government bonds are becoming increasingly scarce. The United States has already lost triple-A status. Now France is also under close review by rating agency Moody's. If France loses its top rating, then Germany, the United Kingdom and Canada will be the only countries among the seven largest industrial nations (G7) to retain their AAA rating. At the same time, while the credit ratings of the industrial countries have fallen or at best remained steady since the onset of the debt crisis, the credit ratings of the growth countries have bucked this trend and are rising.

To regain the confidence of markets and lenders, structural reforms aimed at achieving more sustainable debt reduction and the stabilisation of financial markets must be implemented. Important steps in this direction were decided at a meeting of Eurozone government leaders in late October:

Greek government bonds are being traded in on a voluntary basis for new bonds that will receive a partial guarantee from the EFSF. This is expected to result in a 50 percent haircut, making the debt burden seem to be somewhat more viable, although the debt ratio in Greece is still likely to be around 120 percent in 2020 (currently 170 percent).
With its funding raised to more than 1 trillion euros, the EU bailout fund EFSF is being further strengthened in order to avoid possible contagion risks within the EU countries.
The recapitalization of banks is being promoted by, for example, requiring a core capital ratio for banks of 9 percent by the end of June 2012.

Despite these resolutions, volatility in the markets is expected to remain high in view of the uncertain outcome of the possible Greek referendum. As a result, fundamental factors in the corporate sector are now being largely ignored. With a view to the reporting season in the third quarter – over 70 percent of US companies have exceeded expectations – corporates have fared relatively well. And finally, valuations seem to have already priced in quite a bit of pessimism. Price/earnings ratios are in the single digits in many regions and dividend yields in Europe are twice as high as yields on German government bonds.