Friday, May 28, 2010

Spain will decide where stock markets go

At this point in the European debt crisis, world attention has shifted from Greece to focus entirely on Spain. This is because the outcome in Spain's banking sector will determine the direction of stock markets around the world for the next few weeks.

At the centre of attention are Spain's 45 regional savings banks, which have 50% of the country's bank assets. These regional banks are called cajas. The collapse of one such bank, CajaSur, caused panic in the markets on Monday, as investors feared other Spanish banks would follow.

The cajas provided cheap loans in the 1990's, which helped to cause a property boom in Spain. However, the subsequent collapse in the housing market has resulted in a non-performing loan ratio of about 10 per cent in bank loans to property companies. Combine the questionable health of the cajas with the country's 20% unemployment rate, and Spain becomes potentially the next shoe to fall.

If very few cajas in Spain go bankrupt, a significant rally in risk-assets can be expected. However, if the Spanish banking sector is devastated, banking industries in the rest of Europe will be impacted. Thus, stock markets in North America would enter into a much deeper correction. In fact, a correction of 20% to 30% can be expected.

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