JPMorgan Looking On The Bright Side Of Sovereign Debt Crises - Dealbreaker

JPMorgan Looking On The Bright Side Of Sovereign Debt Crises


JPMorgan equity strategist Thomas Lee put out a glass-half-full note yesterday titled "Corporates are the new "sovereigns": 22 stocks to own around sovereign default." Apparently there are a lot of companies who have their shit together more than Congress does:

Over the past year, an increasing share of US corporates are seen as having LOWER default risk than the US government. ... As of yesterday, 22% of US high-grade issuers (from the J.P. Morgan JULI index of 250 issuers) have a CDS spread inside that of the US government. This is up from zero a year ago. ... Note the composition of CDS spreads by industry. 42% of US industrials have a CDS spread inside the US govt, as do 38% of Healthcare companies.

Those percentages shouldn't be taken literally (that index is limited to large IG names), but still. If you're an equities strategist, that's great news for equity risk premiums!

Also good news is that we're doing a bit better than Greece:

As for Europe, this same trend is happening today. 100% of issuers in Spain, Greece, and Portugal trade inside their govt spreads. 60% of Italian corporates trade inside that of the govt.*

We're hoping someone can help explain this.

1. We kind of get it in Europe, where weaker sovereigns can't print money and so can and do default. But in the U.S. our debt is denominated in dollars and the government can always inflate it away. Right?

Historically, governments are considered the “best credits” as they can print money and tax entities and therefore prevent default. However, there is concern developing that governments voluntarily default – i.e., not pass a debt ceiling increase.

Oh. Right. But U.S. CDS probably wouldn't pay out much for a temporary let's-just-scare-people-a-bit debt-ceiling default. If you think that U.S. CDS is fairly priced, it's because you think there might actually be enough of a failure of political will in the next five years to cause a default where investors lose principal. Like the ratings agencies have been half-saying.

2. And actually it doesn't really make that much sense in Europe either, since there sovereign CDS is looking pretty worthless after Greece has defaulted without triggering CDS payouts (see Felix Salmon, Zero Hedge). But corporate CDS still seems normal, since Europe's banks and regulators are unlikely to rally to a "voluntary" debt exchange for the average bankrupt company. So why would you pay more for protection on Spain, which probably can't be triggered even if Spain defaults, than you'd pay for protection on Spanish corporates that might actually pay out?

* Again, the percentages are goofy as this is a pretty small sample (5 corporates in Spain, 4 in Greece, 2 in Portugal, 6 out of 10 in Italy) of internationally important IG names on the iTRAXX indices.