Dark clouds over Bogota, Colombia

Charles Penty discusses a potential downgrade of Spanish banks by Moody’s for Bloomberg

Concerns over the health of the Spanish banking sector continue to increase, stoked today by rumors of a potential Moody’s downgrade as early as tonight. Spanish daily El Mundo reported that a billion euros ($1.3 billion) had been withdrawn from Spanish financial firm Bankia since May 9th. Worries over the health of Spain’s banks have pressured the economy as a whole, pushing yields on Spanish ten-year bonds to 6.3% this week. While the Spanish government is desperately trying to ameliorate the situation through policy designed to backstop faltering banks, markets have thus far taken little solace in these efforts. Like elsewhere in Europe, Spain (EWP, quote) will likely to continue to struggle until matters with Greece and its own banks are resolved.

Michael Patterson and Steve Gunnion address BRIC equities for Bloomberg

BRIC markets (EEB, quote) are on the verge of entering bear market territory, according to Patterson and Gunnion, as they have fallen almost 20% from their most recent highs. This drop in BRIC equity markets is a reflection of the uncertainty stemming from the euro zone. The MSCI Emerging Markets Index has fallen to a four month low. Like with other equity markets, traders and investors should hesitate trying to pick a bottom until you see clarity from Europe.

The main street of St. Petersburg: Neksky Prospekt

Despite a fairly resilient economic environment, the Russian market has underperformed both the iShares MSCI Emerging Markets Index (EEM, quote) and the S&P500 over the last year.

GDP growth in the first quarter surprised investors with a gain of 4.9% as consumers maintained their support on high oil prices and increased government spending ahead of the elections.

The economy has weakened slightly since the first quarter with both industrial production and fixed-asset investment declining significantly.

Despite an extremely weak export environment and falling oil prices, Russia has one thing going for it relative to other markets. The central bank maintained its refinancing rate at 8.0% for the fifth consecutive month even as global growth weakens and inflation falls to just 3.6% on an annualized basis.

Pricing pressures are well below the 6.1% pace set last year and are the lowest since the early 1990’s. This gives the monetary authorities a tremendous amount of room for stimulus should conditions further deteriorate.

While rates are also high in other BRIC markets like Brazil and India, quickening inflation may detract from economic performance.

Headline risks out of Europe and lower commodity prices may continue to push the index lower in the short-term, but investors should benefit from patience as the fund pays a dividend yield of 1.95% and trades around six times trailing earnings of stocks in the index.

Valuations are attractive versus that of around 13.5 times for the S&P500 and 10.0 times for companies in the broader emerging markets index.

Additionally, the market could still see a positive increase in sentiment leading up to a large sale of state assets expected in June of this year.

The Bankia headquarters in Valencia

According to a report from Bloomberg Businessweek, there will be sweeping downgrades imminently.

The government of Spain has denied that “there was a run on deposits at Bankia SA, the ailing lender it’s taking over.” Moody’s is said to be lowering the credit rating for 21 Spanish banks.  

Bloomberg noted that “The main drivers for Moody’s expected action on Spanish banks today are rising loan defaults, a renewed recession, restricted funding access and the reduced ability of the government to support lenders”, said one of the people familiar with the plans.

The euro zone crisis is far, far from over, particularly in the Spanish banking sector, despite misplaced optimism earlier this year after the Greek debt accord. 

The exchange traded fund for European financials, iShares MSCI Europe (EUFN, quote) has fallen more than 2.2%. Bankia SA has plummeted more than 25% today while Banco Santander (STD, quote) is off by around 1% and Banco Bilbao (BBVA, quote) is down by under 2%.

That Banco Bilbao and Banco Santander have not plunged like Bankia SA or even fallen as much as the EUFN is a positive sign for those who, like the ever hopeful little boy in the tale, determinedly look for a pony in the pile of horse manure. 

Indeed, the recent JPMorgan trading debacle resulting in the loss of at least two billion (if not much more) has certainly done nothing to restore investor confidence in the global financial system. However, the United States Federal Reserve under Chairman Ben Bernanke and other central banks are committed to protecting the financial system, which means there are opportunities in bruised European financials. 

If investors are, quite understandbly, leery of committing to a single Spanish banking stock such as Banco Santander or Banco Bilboa, the EUFN, at around $14.40, is close to its 52-week low of $13.71.

DE just lifted its guidance for its 2012 results yet again and now expects profit for the year to be $70 million higher than it did back in February.

And yet the shares have sold off 4.7% since the news hit the market yesterday morning.

This is a classic example of perfectly good — even great — stocks being thrown out in the rush to liquidate portfolios in a world seen as increasingly risky.

It’s also an example of the flaws in the binary “risk on / risk off” approach to the markets.

By definition, risk is not a binary all-or-nothing factor in investment decisions. It’s a continuum of probabilities, and smart investors build portfolios to get optimal exposure to the good outcomes while minimizing or hedging the impact of the bad ones.

It’s alright to incrementally adjust your risk profile to reflect a macro shift in the global environment, but once you’ve adjusted it, it stays in place. It doesn’t swing from zero to 100% risk or from “off” to “on” like a light switch.

But as long as other traders are acting that way, the rest of us get opportunities like DE. Right now, DE shares are down a stunning 17% from the $88 to $89 range they were in back in February.

Back then, we were looking at full-year earnings of maybe 8 penny a share less than what DE management is confident they can deliver now.

Is that extra 8 cents worth a 17% sell-off? Or do traders know something more about the global food markets that Deere, with its global tractor sales network, hasn’t seen?

If DE is that unaware of what’s going on in the global food market, then sure, sell the shares. But if the market is the one that’s off base, this looks like an entry point.

Shopping in Shanghai

However, its global small-cap counterpart, EEMS (quote) is down a slightly less dramatic 8.9%.

What’s the secret of small-cap stamina in the face of China angst and the euro’s pain?

If EEMS was an individual stock, we might suspect a lack of liquidity keeping traders who want to dump shares from doing so. Normally, EEMS trades only around 5,000 shares a day and has lately seen that turnover fade to a 1,000-share trickle — barely moving 0.1% of the float on a given session.

While that could indicate a buyers’ strike trapping existing shareholders in the fund while the paper losses in the portfolio build up, the reality is completely different.

Nervous traders have actually tried to get ahead of the curve, dumping as much EEMS as they can. In the aftermath, the fund is actually trading at close to a 2% discount to its underlying assets.

EEM, interestingly enough, is trading at a 1% premium above its constituent stocks, so if anything, sentiment on large emerging market companies is still a bit better than the situation really justifies.

And we can see the relative strength of global small-cap shares in the MSCI indices on which these funds were built. The indices reflect true native-market performance, so they’re not constrained by issues of liquidity in any U.S.-traded investment product.

It turns out that since the start of May, the MSCI EEM Small-Cap Index is down 7.50% in dollar terms. Its large- and mid-cap counterpart, the standard EEM, is indeed down close to 10%.

Going back, we see small emerging stocks outperforming in other periods of global market crisis like last summer. Both ends of the equity asset class lost ground and the spread was generally small — 1% to 2% — but if you’re looking for a safe haven in the emerging markets, you might want to rethink your love of the giants in EEM.

Remember, a lot of those companies are exporters, especially exporters of commodities. Those are the true economically sensitive names to suffer when the global economy turns south. And as you can see, the 1% to 2% adds up.

Cosan's Costa Pinto sugar cane mill and ethanol distillery plant at Piracicaba, São Paulo.

Based in San Paulo, Cosan is active in both production and distribution for products ranging from ethanol to candy. Growth has been strong. On a quarterly basis, sales are up by 33.20%. Earnings-per-share growth this year is up by 28.70.

For emerging market income investors, Cosan pays a 2.21% dividend, slightly better than the average dividend of an S&P 500 company. The price-to-earnings ratio of just 4.87 provides ample revenue to raise the dividend or initiate a share buyback program.

With a price-to-sales ratio of 0.29, Cosan is undervalued. Sales are increasing, too. For the past five years, sales growth has been 140.51% which should please even the most discriminating value investor.

At present, there is a global sugar glut. Agriculture around the world is weak with the global agriculture exchange traded fund (DBA, quote) close to its year low. That has the share price of Cosan down about 10% for the last quarter. It is also off 4.36% for the last week and 6.89% for the last month. Even with the bearish outlook for sugar producers, however, there is only a 0.37% short float for Cosan – a bullish indicator of the company’s strength. 

Cosan is trading around $12.70 per share and has a mean analyst target price of $17.76 over the next year. Investors should treat the low share price as an opportunity to accumulate a long-term position.

In the first quarter, much of what drove emerging markets upward was a simple allocation move as money flowed back into this asset class. Now that things have reversed, we have yet to see any parallel outflow — the funds are finally hanging on instead of jumping at the first sign of trouble.

With that in mind, this is a moment to get defensive but not paranoid. Stay exposed to emerging markets growth, where you still want to own the consumer in particular as the “commodity super-cycle” shows signs of fizzling.

The irony, by the way, is that the super-cycle is fueled by the consumer, who is demanding more and more food, fuel and stuff as billions of people move into the middle class. But that’s a bigger topic.

For now, stay the course with defensive global names that pay you dividends to wait. And for more exotic plays, don’t forget to watch the primetime Trading the Globe special Friday night (7:30 ET, CNBC).

Unilever (UN, quote) is a member of our Ambassador’s Index. The company is based in the United Kingdom but sells food, detergents, home and personal care products throughout the world.

Asia and Africa account for 40% of the business and the Americas are wroth another 32%, so euro exposure is low, but the stock is still off 10% from its highs thanks to the euro mess. The good news is that now the yield is up at a healthy 3.9%.

Procter & Gamble (PG, quote) needs little introduction, but few remember that 40% of the company’s revenue comes from Asia and EMEA, with another 23% coming from other non-U.S. markets. Dividend is up at 3.5% now, so it pays to wait.

Kimberly-Clark (KMB, quote) is not a cheap stock but it’s a great one. Hygiene products are a core global business and the dividend is now cresting above 4%.

Even Johnson & Johnson (JNJ, quote) is worth a look for emerging markets portfolios — after all, 70% of the company’s pre-tax income is international in origin. They’re making news today targeting Chinese opportunities for curing mental disease and cancer. Dividend is 3.8%.

As expected, people continued to remove their money from Greek banks in the overnight, putting pressure on the banks to remain liquid as the European Central Bank (ECB) will be cutting off funding to several Greek banks.

Australia however, did not fare as well the NIKKEI on the statement from former Reserve Bank of Australia (RBA) member Warwick McKibbin suggesting the RBA will wait until after the Greek elections before cutting rates again.

India’s markets tumbled during the overnight as the rupee fell and hit a record low against the U.S. dollar. Traders are fearful and becoming more and more risk averse because of the euro zone crisis, all the while facing their own concerns of India’s widening current account and fiscal deficits. Traders will be watching jobless claims data in the U.S. because as the U.S. job market recovers, so does India’s when U.S. companies expand and hire.

Turning to the global market driver – the U.S. – traders find sentiment is still negative and falling with the Dow down 10 days out of 11 and approaching a 6% slide.

U.S. traders continue to be apprehensive about stepping into the market given Greece and Spain’s inability to find a fiscal solution, and what little hope there is to rectify their economies slipping away each day.

Spain’s bond auction was more difficult to sell debt, sending yields higher. The latest data releases now show Spain has officially fallen into a recession during the first quarter of 2012.

A look at global companies to watch today:

Wal-Mart (WMT, quote) beats analysts’ expectations by reporting $1.09 per share versus estimates of $1.04

A look at key economic data to watch today:

The world will be watching U.S. economic data today which could be a pivot point in the current trend as well as giving traders insight into whether the Fed will need to step in.

The biggest release will be the Labor Department’s initial jobless claims report released at 8:30 a.m. EDT.  Analysts are predicting claims at 366,000 for the week ending May 12, slightly lower than the prior week’s 367,000.

The May Philadelphia Fed index is scheduled to be released at 10 a.m. EDT.  Analysts are looking for a climb up to 9.3 from April’s 8.5, with forecasts for the Conference Board’s Index of Leading Economic Indicators to rise 0.2% for April following March’s 0.3% increase.

At 10:30 a.m. EDT, the Energy Department will issue its weekly look at natural gas inventories.

Other economic data today:

Live Economic Calendar Powered by Forexpros – The Leading Financial Portal

Commodity Marker – Electronic Trading

Precious metals corner

Gold and silver extended their losses on Wednesday to the lowest level since December 2011 after the failed Greek efforts to form a new government, which caused even more traders to cut exposure to shiny metals and run to safety.

ETF holdings

Holdings in the world’s largest gold backed ETF, the SPDR Gold Trust (GLD, quote) slipped to 1,276.40  tons as of May 16.

The iShares Silver Trust (SLV, quote) held steady at 9,516.40 tons on May 15. SLV is the world’s largest silver backed ETF.

Fundamental outlook

Precious metals are trading slightly higher in early trading today. Look for prices to trade lower for the day on fears of a deepening debt crisis in Greece and the tough Spanish debt auctions.

Technicals on both gold and silver will continue to be under pressure and will remain in control until the headwinds in the euro zone fade.

Looking at the pre-market we find:

NTES      NETEASE INC ADR

CS           CREDIT SUISSE GROUP SPONS ADR         

HBC        HSBC HLDG PLC SPON ADR         

BBVA     BANCO BILBAO VIZCAYA SPON ADR       

The earnings calendar remains quiet for the remainder of the week with no names reporting on the Emerging Money Index until next week. Next on deck:

MBT – 5/21/12 before the bell.

Emerging Money Index Dividend Watch:

TEVA – 5/17/12

Bottom line: U.S. futures are suggesting a flat-to-lower open today after banking news from Greece. Speculation on the street is for liquidation of positions to flow money into Facebook. The euro zone turned red so look for the bias direction of the U.S. market at 10 a.m and again after the European close for signs of sentiment shift. The jobs report should drive the market in the beginning.

KFC in Beijing

Everyone in the market chatters on about YUM as the way into the breadbasket of Asia. From the company’s perspective, the world’s largest population is definitely the key to growth — same-store sales in China  jumped 14% last quarter while sales just about everywhere else trailed at a relatively sedate 5% growth rate.

As a result, the company is betting the franchise on China in particular, boosting its number of locations in the country by 3% between January and March while its once-hyped expansion into India stalls and the number of U.S. restaurants actually declines.

Unfortunately, while China now accounts for 50% more KFC and Pizza Hut locations than the rest of Asia — not counting India and Japan, which report separately — put together, the rest of Asia is stalling for the company. Store for store, YUM’s non-Chinese Asian operations seem to be growing only as fast as the U.S. region.

If China falters, YUM looks deeply overvalued compared to rivals like McDonalds (MCD, quote), which is also ramping up fast in Asia, although without quite so much hoopla on Wall Street. YUM is priced at over 22 times trailing earnings while MCD is currently trading at a P/E of 17.

But as it happens, local favorite Country Style Cooking (CCSC, quote) is reporting its first quarter today, and you’re looking at a P/E of maybe 3 there if the results go as analysts expect.

Is YUM growing its business more aggressively than CSCC? Not at all. While the Chinese chain is very small compared to YUM — which is building more new restaurants in China every quarter than CSCC has total locations — it offers extremely high intensity on a location-by-location basis, as well as growth off a much lower base.

Every 10 restaurants CSCC opens moves the growth needle 7%. It takes YUM 350 new locations to generate the same result.

Sure, CSCC may find itself surrounded and taken over by a vast rival and its profitability has stuttered as it expands. But in the former case, YUM has already proved its willingness to buy a local competitor rather than fight, so the M&A premium could be a nice reward in itself.

And in the latter case, while CCSC has posted the occasional bad quarter, the trend is recovering.

Petrobras building in Brazil

The company has had year-on-year sequentially lower earnings for the last two quarters with trailing earnings falling by 26.0% from the previous four quarters. Petrobras stock is now cheaper than any time since 2005.

Weak fundamentals and petroleum prices are not the only headwinds facing the company though. The shares listed on the NYSE are down over 35% since February 1^st while the company’s domestically listed common shares have fallen by only 25.3% over the same period. The difference in returns is a rapidly depreciating currency due to aggressive government intervention.

This week the Brazilian real traded its lowest since 2009 after having slid 6.5% over the course of this year, the largest decrease of 16 currencies tracked by Bloomberg.

While the government’s battle lines against the ‘currency wars’ were largely ineffectual last year, a series of rate cuts, increased taxes on foreign loans and dollar buying on the spot market have pushed the real continuously lower over the past two and a half months.

Besides the relative losses from a depreciating real for ADR investors, the company may be setting up for a disappointing second quarter report later in the year.

The company’s CFO, Almir Barbassa, said Tuesday that the company could face negative effects from currency movements due to its $76 billion in dollar-denominated debt. Quick moves in currencies often have a larger effect on companies due to reactionary policies and hedging by the company.

While the company did not disclose any currency hedging in which it participated earlier in the year when the real was strengthening, significant losses could be reported on the second quarter release.

Investors may see a slight reprieve from a bounce off lows in both the real and oil prices over the next few weeks, especially if global markets calm from recent unease. Shareholders should reevaluate estimates and positions later in the quarter as headline risk from currency movements and hedging come to light.