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Archive for the ‘Europe’ Category

Even cash is now at risk

Albert Edwards, the lead strategist at Societe Generale, has added some typically forthright (and witty) comments on the latest developments in Euroland. By making explicit the fact that both uninsured bank depositors and all classes of bondholder have been required to take part in the rescue/liquidation of the two largest Cypriot banks, the troika (EU, IMF and ECB) has highlighted the fact that cash itself is now officially potentially an unsafe asset. He wonders also (as do I) how long it will be before a Eurozone country finally decides that remaining in the single currency is not worth the trauma that staying in involves.

Most economic analysis concludes, probably correctly, how much more costly it would be for either a creditor or debtor nation to leave the eurozone system compared to struggling on within it. Indeed for Germany, despite becoming increasingly irritated by having to dip their hands into their rapidly fraying pockets, the crisis in the eurozone has been accompanied by the lowest unemployment rates since before re-unification in 1990. Read the rest of this entry »

Written by Jonathan Davis

March 27, 2013 at 5:42 PM

Fools rush in while wise men take their time?

The New Year has started well, with plenty of evidence that professional investors are continuing to rediscover their appetite for risk assets, with the price of equities, corporate bonds and high yield debt all heading higher. The charts for leading equity indices, including the S&P 500 and the FTSE All-Share, have been trending higher ever since Mario Draghi, the head of the European Central Bank, announced last summer his intention to “do whatever it takes” to prevent the eurozone from falling apart. He has every reason to be pleased with the response to his intervention, which to date has been effectively cost-free. Would it were always so easy! European stock markets, having been priced for disaster before, have led the way up as fears of the euro’s fragmentation recede. Volatility, as measured by the VIX, has meanwhile fallen to multi-year low levels. Read the rest of this entry »

Ruffer: the right question to ask

The estimable and splendidly ideosyncratic private client fund manager Jonathan Ruffer, whom I profiled a couple of years ago in The Spectator, has some thoughtful points on the prospects for Europe in his most recent monthly investment review. Here is a short extract, in which he points to the underlying frailty of the European project, about whose future he is not optimistic:

The Treaty of Rome in 1957 was a great moment for the peacemakers, but now its architects are dead, as are pretty much all those who felt the visceral despair in the darkness of the late 1940s. That hope has been replaced with a sort of Communism: power divorced from economics. Just as Russia could not keep control when the figures didn’t add up, nor can Europe. It is only a question of time. So, when does it all end? I think it is a mistake to try and guess. Observers of 1980s Russia fell into two categories: those who thought things would continue as they were forever, and those who could see the pressure, the inconsistencies, and imagined that the crisis would strike a week on Thursday. Nevertheless, it is striking on my return to find how far the status quo has shifted in Europe since March. It’s the same tune, to be sure, but the violins have been replaced by cellos.

Read the rest of this entry »

Written by Jonathan Davis

August 20, 2012 at 4:39 PM

Talking markets: Jim Rogers

Global investor Jim Rogers thinks that the world is heading for an economic depression unless political leaders finally grasp the nettle of the debt burden they have accumulated over the past decade. He is not optimistic about the outcome. Bankrupt countries such as Greece need to default – and soooner rather than later. The longer they leave it, the worse the eventual outcome will be. Hear more of this – and how Jim is seeking to protect his own wealth in these difficult times – in my latest podcast, a 30-minute interview with one of the smartest investors I know. It is available to download from the Independent Investor website now. An edited transcript will be available in the New Year.

Written by Jonathan Davis

January 3, 2012 at 5:56 PM

Forecasts be damned

If someone told you that the end of the world was coming tomorrow, and the day passed without incident, would you be inclined to believe the same person the next time they came out with a piece of radical advice? I doubt it.  Yet one of the wonders of markets and economics is how quickly even sensible investors will switch their assumptions about the future without missing a beat.

The latest example of this bizarre phenomenon was evident in the Chancellor’s Autumn Statement. The independent Office for Budget Responsibility, run by Robert Chote, a formidably bright former economist colleague of mine on The Independent, has drastically reduced its forecasts of future economic growth. They are radically different from the forecasts the same body presented just a few months ago. Yet by some magical process they are already being treated as gospel truth. Read the rest of this entry »

Written by Jonathan Davis

December 3, 2011 at 11:30 AM

The Eurozone crisis: not insoluble

The Eurozone crisis is a political mess that can only be solved by a political solution, which you don’t need a degree in politics to see is not proving easy, given the variety of interested parties involved – 17 eurozone member countries, 10 other EU member states and the governments of every other major economy on the planet also feeling the need to have their say. Much to the chargrin of some Eurozone leaders, voters too have to be consulted.

Given how many warnings there have been of the risk of a depression and financial meltdown if the Eurozone is not saved, the wonder is that financial markets have not been more affected than they have been by the failure so far to arrive at an agreed solution. The equity markets in particular have been surprisingly resilient. How can that be explained?

This is how one sensible wealth management firm, Saunderson House, is addressing the issue in its client comunications. Implicit in this view is that there will be an endgame in which the Eurozone survives, at least for now, without triggering an economic crisis, which must mean Germany eventually sanctioning some action by the European Central Bank once the various peripheral countries with the worst debt problems (Greece, italy, Spain) have their new governments in place. Read the rest of this entry »

Written by Jonathan Davis

November 21, 2011 at 1:45 PM

Market Review: 18 May 2010

Andrew Dalton, formerly of Mercury Asset Management, now running his own successful fund management firm boutique, provides Independent Investor with regular weekly market reviews. This is his take on last week’s market action in Europe, which has once again called the resilience of the euro project into question, and highlighted the dangers of policymaking errors.

Last week investment attention remained firmly fixed on the problems in Europe. Chancellor Merkel suffered a significant defeat last weekend, which highlighted the lack of support from German voters for a Greek bail out. There were various dissenting voices behind what has hitherto been determined official support for the euro. One German law maker suggested that Trichet should step down because the ECB had bought Greek debt. President Sarkozy threatened at one point to pull out of the euro zone.

Deutsche Bank suggests that Greece might not be able to repay its debts and Paul Volker, in London, suggested that the euro zone might disintegrate. There were riots in Greece and Ireland and strikes are now scheduled in Spain. The unemployment rate in Greece in May will probably be around 13% and over 20% in Spain – and that is before the proposed fiscal drag is applied. Both Spain and Portugal announced cuts in public expenditure.

The €750 billion EU/IMF rescue package a week ago was intended as a once-and-for-all method to solve the EU crisis. It was designed to prevent bond market defaults within the EU and dampen the massive interest rate risk spreads that had opened up for Mediterranean government bonds over recent months. The problem, of course, is that the rescue package, although necessary in the short term, does not address the bigger, long term structural problems.

Over the course of the last week, markets focussed on these longer-term structural problems. The truth is that there has been massive divergence between EU budget deficits, unit labour costs, current account deficits, etc. The EU took only a first small step towards addressing those deeper fundamental problems last week when Spain and Portugal proposed 5% pay cuts for public sector workers.

The establishment of the euro zone in 1999 presupposed that the various countries linked together in monetary union would experience roughly similar fundamental trends. However, that has not been the case. In the last 11 years, fundamentals among EU member nations have diverged significantly, creating the pressures now apparent among the laggard deficit countries of Greece, Portugal and Spain.

The divergence can be seen between Germany at one end of the EU spectrum with its stronger unit labour cost trends, resulting in large current account surpluses, much of which is from rest of the EU. While at the other end of the spectrum, the Mediterranean economies have had weaker unit labour cost trends and much larger budget and current account deficits than Germany.

With 11 years of divergence, Mediterranean governments have backed themselves into unfinanceable deficits and are now forced into belated action. Benefits and wages may have to be cut as much as 30% over the next few years. The bailout out packages can only prevent default in the near term but in the longer run these countries require smaller budget and current account deficits. They need to become more like Germany.

Private capital is now unwilling to fund those on-going Mediterranean budget deficits, and those economies, therefore, are faced with the necessity of bringing wages and benefits down swiftly in nominal terms, since they are unable in practice to raise their productivity sufficiently quickly to close the gap with Germany. Perversely, of course, German industrialists have been the great beneficiaries of the euro. Their southern European competition has become increasingly unable to compete with them, because they have not been able to benefit from regular, if disguised, devaluations against the Deutschemark. Germany has been running an increasingly large trade surplus with the rest of Europe.

Much of Europe now risks having to go through a second recession to right the imbalances. It is difficult to avoid the conclusion that the rest of Europe either has to compete with Germany within the euro or still go through similar austerity measures even if they leave the euro – truly an unattractive choice. Northern European members of the Euro zone, of course, have concomitant obligation to pick up an enormous bill to maintain the euro and, meanwhile, allow the ‘quality’ of the ECB’s balance sheet to deteriorate. In recent months, that fact has caused the euro exchange rate to trade more like a Greek euro than a German one. A European recession would be a major negative for the world economy and trade cycle.

If this were all, the situation indeed would be gloomy. The correct response, of course, is to stimulate growth not foster depression. The ECB will remain under pressure to ease monetary policy both by cutting rates and increasing the size of its balance sheet – quantitative easing. Germany should grow faster. Indeed, it should be noted that the Euro zone economy has been recovering, interest rates in Europe are close to zero and are likely to remain so. The euro has declined almost -20% in the last quarter and global growth is strong.

The world is growing elsewhere. The US continues to grow as is much of the rest of the emerging world. Indian imports in the year to date are up at an annualised rate of 79%. French industrial production is up by 7.8% and ISI’s Truckers survey of commercial traffic in the US has risen a remarkable 39.9% from its recession low. There are steady and incipient signs that US employment is in an up trend. ISI’s Permanent Employment Companies survey increased again last week by 0.8% to 42.9%. This is versus its recession low of 16.1%. And the ISI Temporary Employment Companies survey remained at a strong 61.6%.

We have assumed that the tighter fiscal policy is, the looser monetary policy needs to be. A policy mix of “tight fiscal and loose monetary” is generally positive for asset prices. On a net basis, we have had nothing in Continental European equities for some weeks. For US dollar based accounts, we have wholly hedged any non US dollar positions back into the US dollar. For sterling based and euro based accounts, we have increased our exposure to the US dollar. We have raised our cash levels but we have not yet abandoned the view that a primary trend in equities is intact. However, we have to acknowledge the risk of political disruption and administrative incompetence. Nowhere are these two possibilities more on show than in Europe.

Europe will have to resolve its problems. Ultimately, we expect a fiscal union and possibly a two tier Euro zone. Europe has never addressed the lack of a fiscal union effectively. Without fiscal union, the core EMU countries are effectively giving a credit card to the weaker countries that lack discipline and are too eager for growth at any cost.

Ultimately some countries will have to take a leave from monetary union. Without the option of devaluing their “own” currency, there is no other option than outright default. Therefore, an option that allows devaluation, combined possibly with austerity policies, may be a more realistic option. From the perspective of bond holders, this is just default in disguise. You lend people euros and get back something less.

The likely outcome is that the euro will survive but the fixing process will take time, which will also mean that relative to the US dollar and other regions of the world, Europe will be weak, which is what the market is reflecting.

Written by Jonathan Davis

May 19, 2010 at 5:42 PM