Saturday, December 31, 2011


Recession, unemployment and austerity . It's unlikely to be a great year but also unlikely to be the Armageddon that many commentators are forecasting.

The key question :
Dominating the performance of all markets and all asset classes is the question of whether the Euro can survive .My view ? The effect of a breakup would be so devastating that the common currency will probably hold together for the coming year. Some of the big investment banks are talking about a 25% drop in Euroland GDP if there were to be a disorderly divorce. This seems improbable. More likely would be a steep - 3-5%- fall in output, followed by a decade of zero growth and growing social unrest as unemployment levels rise to the mid teen.

To avoid this governments will engineer a fall in the €'s value relative to most other major currencies by lowering interest rates. This will help maintain jobs, boost Euroland
competitiveness , and ease the agony of disinflation as austerity measures take hold in Spain and Italy. A mishmash of ECB bank funding and IMF loans will help dull some of the economic pain in Portugal, Ireland and Greece. This combination of factors paves the way for higher, imported, inflation in France and Germany from 2013 onwards. Imperfect but at least a workable solution. Greece, which is now effectively dysfunctional at the economic level, may see a structured default and a temporary suspension from full Euroland obligations in order to keep a lid on social discontent. A full exit by Athens remains unlikely.

The major threat to this difficult scenario will come from France. The possibility that Francois Hollande, the Socialist candidate and possible victor in the May 2012 Presidential elections, will seek to water down the austerity measures could lead to a crisis in Franco-German relations . Markets would not respond well to this perceived back-tracking . The French triple A rating would certainly go and French bank shares might need government help in recapitalizing . On the downside , there's a 1 in 5 chance that things could move out of the politicians control with French ratings seriously weakened an Italian and Spanish debt refinancings becoming untenable.

The real pressure on Euro cohesion comes in 2013 when the Italian and Spanish electorates feel the full brunt of austerity with no end in sight and before the ECB printing presses are rolling at full tilt.

Bottom line . Expect the Euro to survive in 2012 but with extreme turbulence across all asset classes as the French Presidential election and its unguarded rhetoric unfold. Market volatility , particularly in the continental banking sector, may start as soon as the new trading year .

To follow later this week. The succession issues in Russia, the US, and Saudi Arabia. Why gold is weak. Oil as an insurance policy .

Wednesday, December 14, 2011

The world turning ?

Strange market action . Gold and the Euro down sharply as institutions sell anything to raise cash . Seems as if Europe, evaporating interbank lending, and eye watering funding stresses have all been forgotten. So passe , so 2011.

Yesterdays price action across asset classes seems to be saying that H1 2012 will all be about falling Chinese demand, fiscal restraint,a global growth slowdown, and commodity excoriation .Guess that means we're in a recession .

Look out for a $/€ exchange rate at 1.20 by mid-Q1. Great for tourism, German exports, and mediterranean farmers. Inflation is needed as part of a plan to prevent a €land meltdown.

Tuesday, December 13, 2011

Fact of the week

Eurozone exports in €bn H1 2011 to :

China : € 186.9
US : € 115.7
UK : € 187.4

Britain remains the biggest export market for the 17 countries in the Eurozone . Britain also runs a trade deficit of €72 bn with the € area.

Friday, December 9, 2011

Less to this than meets the eye .

What a peculiar summit .

The British hoped that in return for backing a new fiscal treaty Germanys Chancellor Merkel would allow ' opt outs ' for Londons financial markets . Prime Minister Cameron wanted UK banks to have capital requirements higher than the proposed EU legislation would allow . He was ill advised . Germany backed France . Already on the hook for a €100 bn refinancing programme , neither Germany nor France want to stump up the cash to recapitalize their banks to UK standards. In addition neither of them is keen to have the Eurozones main financial centre and its huge tax revenues remain ' offshore' in London .

The French President took delight in saying the British demands were ' unacceptable ' . This default position will go down well at home and substantially boost his re-election chances . The fact that this has nothing to do with the problem at hand is neither here no there . In the absence of any willingness by its partners to horse trade the UK has therefore been politically outmanouevered and now finds itself in spendid isolation . French diplomacy 1, British diplomacy 0.

For the UK this situation is both unintended and unpredictable. The likelihood of a UK referendum on membership has just risen . Withdrawal no longer seems improbable . The effect of UK referendum on continued membership may lead to similar calls in Ireland, Finland , Greece and the Netherlands . Secretly some smaller European countries actually quite like having the British around as a counterweight to Berlin and Paris .

In the short term France is the big winner . British influence within core euroland has evaporated . The natural beneficiary is Paris which can now claim that it, together with Berlin , is the twin centre of European decision making. Smaller European countries may bristle at French bullying but have fallen in line . President Sarkozy's plans for re-election have been boosted and protectionism , Paris style, is once again on the front burner .

Germany has got what it wanted . Tighter political and fiscal union . All those profligate southern Europeans will have to save more and spend less. Berlin has also become the de facto European superpower and much of Euroland faces a decade, possibly two, of enforced austerity as it adjusts to teutonic rigour . Sound money but at what cost ?

So much for the politics but what about plans to save the €uro ? There may be enough in the promise of a treaty enshrined balanced budget 'golden rule ' to allow the European Central Bank to enter the market to buy Spanish and Italian bonds in size. There may also be enough willingness for the IMF to step in and lend a €200 billion helping hand to the Stabilization Fund. However , the agreements so far fall remarkably shy of the ' big bazooka ' that markets were hoping for. The question of paying down debt to the 60% level enshrined in the proposed new treaty will also require attention . For Italy this means not only an austerity package but the laying off of $850 billion of debt. Spread over 20 years that's a deflationary impact of about $50 billion a year .

Cynics must wonder what the impact of this austerity will have on the Italian political landscaope in two years time . What an EU without a strong free trade, open market proponent like the UK will look like is a question for another day . A treaty calling for fiscal austerity that is imposed without democratic legitimacy might also cause problems down the road .France is hoping that Germany relents in its pursuit of monetary rigour. The can has just been kicked down the road again .

Markets are likely to take their time to digest the outcome of the summit . The feel good factor at work at the end of the year may still drive equities higher . However, come the New Year investors will be looking for action not signals . The news headlines have focused on British exclusion . The real story is the lack of substance in addressing the Euro crisis and the danger of French style protectionism . The dollar looks more and more attractive .

Sunday, November 27, 2011

Things to watch out for this week.

Ludicrous as it may seem the possibility of a Eurozone break-up has risen sharply. Italian yields at 8% and Spanish yields at levels not far behind are quite simply unsustainable. The good news this Sunday evening is that at last the ruling elites in both Berlin and Paris seem to have woken up to how close to chaos we are.

The story going the rounds tonight is that after a series of intra-government meeting overs the weekend President Sarkozy will give a major speech ahead of the next EU summit on December 9th in which he will spell out direct and readily implementable steps to save the €. This will involve support for southern tier bond markets ( overdue ), access to a €580 bn IMF standby line and accelerated fiscal union within the 17.

The markets between now and December 9th can be expected to be turbulent with widespread selling of euro area assets by Asian and North American institutions . The new Belgian government ( also overdue ) is expected to announce a package of cuts totalling €15 bn by the end of next week while pressure is being exerted on Italys PM, Mario Monti , to start spelling out what steps he plans to take. A €20 bn austerity package is the minimum required from Italy.

A Franco-British summit on Friday will pave the way for treaty changes to allow the 17 Euro zone members to forge head .France can be expected to give ground on the proposed Tobin finacial transactions tax in return for promises that Britain will not be obstructive to the treaty changes required for fiscal union and the de facto development of a new inner tier .

Intraday volatility over the next two weeks may be extreme . Are this weekends signals rumour or reality ? If action doesn't follow along by the time of the EU summit then the markets reaction is likely to be brutal. The soluble is close to becoming insoluble .

Tuesday, November 15, 2011

Happy Thanksgving .

Considering what's happening in bond markets equities are holding up pretty well. Down just 2.8% since Fridays close . In the debt markets things are grimmer - spreads have widened and Italys north of 7% again, Spain at 6.32% and France at a € era premium over German bunds . The belief is that the ECB isn't going to press the button on unsterilized intervention - the big bazooka or silver bullet - until we're at one minute to midnight . We're not there yet .

Anyone hoping that this will all be resolved by Thanksgiving will be disappointed . Christmas ditto .

Friday, November 11, 2011

Framany .

A long, grinding, period of low or zero growth beckons - probably through to 2016. It should have been so easy. Recapitalize the banks, provide the ECB with a trillion € 'silver bullet ' and wait for the storm to pass by. It was not to be . Europes institutions were unable to act in a timely and decisive manner. Instead this crisis will rumble on for the next year while the politicians look for a solution .

Venal and incompetent. Two words that best describe Europes current crop of political leaders . Sarkozy and Merkels giggling press conference treatment of Berlusconi ( no matter what you think of him as an individual ) a shameful and immature way to treat another head of state. Scoundrel turned into scapegoat .After the non-event of the G-20 summit it can be seen that financial discipline has now begun to dissolve . The inability to resolve the Greek problem has caused the contagion to spread and the size of the problem to snowball. Plans call for Greece to grow at 2% p.a. to service it's debt but the country is actually shrinking at a rate of 5.9% annually .Iran is now its major supplier of oil .Next it's Italy's turn to be in the bond market spotlight. Soon it will be France. Spain , despite creditable attempts to reform , remains fragile. Spanish growth his disappeared in the latest quarter .Markets are hoping ( and on Friday surging ) that the possible confirmation of Mario Monti as Italian PM might yet enable order to be restored and provide time for the ECB to intervene decisively . President Napolitano a beacon of stability in this turbulent world..

For too long the € enabled credit to be mispriced . Germany and the Netherlands provided financing at artificially low interest rates to poorer southern European governments, corporates and individuals. The consequence of this has been massive debt and overspending in the ClubMed states , including France . A Greek, Portugese and Irish default becomes more probable with each passing day. Merkel and Sarkozy have publicly allowed that countries might leave the Euro. They are now discussing ring fencing the core - France and Germany - Framany - from contamination . What the Italians and Spanish will think of this remains to be seen. Britain as ever remains willing to criticize while offering nothing positive. No wonder the 26 other members of the EU sigh at Londons behaviour. It is however clear that the British electorate will never stomach the ' compulsion ' that is being imposed on the Greeks, Italians, Portugese and French . What happens to the Uk and the 50% of its output that goes to the continent if it decides to quit the EU ? What happens to Greek olive farmer subsidies if / when the UK, the Eu's #2 net contributor, leaves ?

The consequences fo all this ? After a decade of huge, seemingly interest free loans , the party is over. A wave of corporate, sovereign and personal defaults will eventually follow . A recession in Euroland is now probable in 2012 . France is asking the ECB to intervene more aggressively in bond markets but the stark reality of the numbers say that many countries are at the extreme limits of what they can pay . Unemployment is rising across the EU, export orders are falling and consumer confidence has evaporated . The UK mortgage market has effectively frozen up . Metro Bank extended only 100 mortgages in the last 15 months !

Three things stand out :

1) History teaches that after financial crises , credit growth remains feeble for years. Businesses that depend on credit, banks , consumer credit houses and property developers, suffer .
2) Emerging markets owe €3 trillion to EU banks. Much of this will not be rolled over. Asia and LatAm will slow down as the funds are repatriated in order to safeguard the core Euro area and the Euro .
3) Corporate forecasts for 2012 are blatantly optimistic. Bank balance sheets are contracting at an unprecedented post-1945 rate so working capital will be in ever shorter supply . In the US banks have written off only a quarter of the $326 billion of 2007 era subprime property losses. More deleveraging is to come .

History will note that we were so close to avoiding this downturn . It's not Armageddon but this half decade of zero growth will be a painful period fro Europe. The good news is that by 2015 90% of golobal growth will be outside the EU. Great news for the US, Australia and others. . For Europeans though ' a lost decade ' is as good a description as any of what's in store for them as they battle to save a functioning common currency .

In this environment investable corporate debt and high yielding, under leveraged, blue chips seem as good a place as any to be. Markets are buoyant in the expectiation that the ECB will prime the pumps with a € 2 trillion backstop announcment . If so , and the Bundestag will have to give its approval , Germany will have to pay . Then it's time to buy gold on inflation fears. The Euro will survive this crisis , the Eurozone and the EU as we know it won't .

Saturday, October 15, 2011

Signs of life .

Markets have been feeling happier since we last posted . Europes political paralysis has given way to the first signs that a number of European Banks will be recapitalised and that steps will be taken to defend the Euro. These interim measures will be followed, sooner rather than later, by steps to integrate eurozone fiscal policy and issue mutually guaranteed eurobonds. There are a host of legal and political obstacles to cross before the necessary treaties are signed but this is what will eventually happen.Smaller countries may complain but Merkel and Sarkozy recognize the obvious.

For investors these measures provide reassurance that the world will not fall into a steep recession. They do however come at a cost . Banks will have to take a 50% hit on their Greek ( and possibly Irish and Portugese ) holdings. This will mean they have less to lend which will in turn accelerate the slowdown in credit growth to the wider economy. The eurozone's banking system has $2.1 trillion worth of exposure to Portugal, Ireland, Italy, Greece and Spain. Assuming that another 30% has to be written off then $630 bn has to be found from somewhere. In short it is hard to see much GDP growth in Europe at a time when banks are having to preserve their capital base by reducing the availability of credit.

This leaves investors in a strange position . Armageddon is unlikely to happen but we are heading towards a new world in which growth remains elusive as banks deleverage. After the recent strong rlief recent rallies expect upside momentum to fade a little from here . However there is more good news out there . US growth seems to be re-emerging , albeit feebly; European survey data is likely to surprise and show that Q3 was a quarter of growth, the private bond market is creaking back into life ( Deutsche Bank issued 2 yr paper ), Asian exports have not collapsed and the Chinese government has stepped into buy bank shares on the secondary market .

Blue Chip Stocks with a good dividend yield continue to be an asset class that should be added to if there is another , Jeremiah driven , bout of indiscriminate selling.

Sunday, September 25, 2011

A new Europe.

So after another week of dismal markets the outline of a solution for Europes woes finally becomes clear.

1) Greece will be allowed to go bankrupt in an orderly manner . In practice this means that French banks will need to be hastily recapitalised in order to absorb the losses on their investment portfolios. Expect a flurry of announcements to this effect over the coming week. Between them G20, the EU and the IMF will have to raise a firewall of around 2 trillion euros.

2) In order for France to retain its triple A rating there will need to be cuts in government spending . The rights to health and pension benefits that exist today are unaffordable and were never meant to be universal. Theses cuts are impossible to implement ahead of the Presidential election next year but implemented they will need to be. Spain has already begun the process, the UK is well advanced, Italy continues to deny the obvious . The pain there will be all the greater when it comes . Put simply, the european electorate face a decade of reductions in their 'rights' and wealth . Even supposedly virtuous Germany has government debt equal to 82% of GDP - up from 39% two decades ago . German banks share many of the weaknesses of their French counterparts.

3) Governments will accept higher inflation . This makes it appear as if economies are growing while at the same time boosting nominal tax receipts.

The questions posed by these changes are enormous :
  • How do governments explain to their citizens that there is no more money left ?
  • How will Britain react to a two speed Europe in which eurozone economies are increasingly centrally run ? If a referendum was held on the issue would the country really vote against staying in the EU ?
  • How does Italy try to reduce debt levels from its economy destroying 120% levels ?
  • How are jobs for the young to be created in a world that faces a decade of stagnation ?
  • With the financial services sector due for tighter regulation and overall contraction what will replace the tax revenue this component of the economy generates ?
  • What happens when everyone tries to generate lower exchange rates to to protect their domestic economies and boost exports?
  • How do French politicians sell Germanys ascendancy to their own electorate ?
Markets are set to heave a collective sigh of rlief that the Greek problem has been ringfenced. The investment , social and political terrain going forward will be very different .

Saturday, July 23, 2011

And I thought I'd seen it all .

Yesterdays FT carries a report citing the Chinese Governments Foreign Exchange authority and its call on the US government not to default on its debt . Communist China calling on the capitalist US to stand by its financial obligations ! And I thought I'd seen it all .

Monday, June 27, 2011

The Monday morning fact .

America's $14 trillion debt is growing at a rate of $40,000 a second . At the time of writing there are are no plans to rein it in . The phrase ' in denial ' seems apposite .