Yes, Virginia, there is potentially market-moving news from someplace other than Washington D.C.
German voters go to the polls on September 22.
If this were a U.S.-style Presidential election Chancellor Angela Merkel would win in a walk. Her personal approval rating stands at 65%. And her Christian Democratic Union party leads its biggest and nearest rival by 15 percentage points.
But this is a parliamentary election. And while Merkel will easily win reelection to her seat and while the CDU (plus its Bavarian sister party the Christian Social Union) is likely to take at least 40% of the vote, there’s a good chance that Merkel won’t win enough seats to form anything other than a coalition government. With the Free Democratic Party, a partner in Merkel’s current coalition government, looking unlikely to win the 5% of the national vote that’s required to gain any seats in the Bundestag, the shape of that coalition could get pretty strange with the most likely odd-bed follows being Merkel’s CDU and the opposition Social Democratic Party.
Whether that coalition—or any coalition–will be able muster the consensus needed to meet EuroZone challenges is likely to get a quick test too. Greece, despite progress toward producing a primary budget surplus (that is a budget surplus not counting interest on the national debt) looks like it’s going to need either a small bridge loan or a big bridge loan and debt reduction in late 2013 or early 2014. Portugal looms as an even bigger problem with the country needing to raise $15.8 billion euros ($21.4 billion.) It’s almost impossible for the country to raise that much in the bond markets meaning that Portugal will almost certainty need a second full bailout program at the end of 2013 or in early 2014.
Quite a set of challenges for a Chancellor who has run a campaign sort-of-promising, wink-wink that German taxpayers won’t have to pony up big money for more bailouts in 2013 or 2014 or 2015
And the bailouts aren’t the only challenge in the EuroZone that Merkel will face post-election and maybe not even the biggest. Read more
What to do about Europe?
It’s not quite as pressing a question as what to do about what could be the start of a breakdown in the U.S. market in Thursday’s, August 15, trading. Or what to do about a Japanese stock market that seems afraid to commit to a weaker yen. Or what to do about China where growth is either surprisingly strong or disappointingly weak.
But after data this Wednesday, August 14, indicating that the EuroZone had moved out of recession in the second quarter, what to do about Europe is an important question for investors?
Should you jump in—or add to weightings in your portfolio–on modest but hopeful GDP numbers? Growth for the second quarter was positive—but not by all that much at 0.3%. Take away the 0.7% growth in Germany and the 0.5% growth in France and the EuroZone would still be stuck in recession.
And if the answer is “buy” what stocks or kinds of stocks should you be targeting?
Let me give you some general framework for thinking about European markets (in the EuroZone and in the larger European Union) and stocks and then a couple of specific suggestions for stocks that I think fit the current situation.
My framework for thinking about European markets breaks down into three general statements.
First, remember that at 0.3% growth and the strong possibility of even weaker growth for the rest of 2013 we’re talking about a recovery that is even slower and weaker than that we’ve seen in the United States. Investors aren’t looking at strong growth so much as an end to declining growth. This isn’t the kind of strong growth that lifts all ships.
Second, the EuroZone was an export-oriented economy (thanks to Germany’s weighting as the largest economy in the EuroZone) before the euro debt crisis and it has become even more export-oriented since the crisis, as countries such as Spain and Portugal have decided that they have to export their way out of their recessions. This is important since a recovery in European economic growth is relatively less important to an exporter that is suffering falling or stagnant sales because growth is slowing in China. Many of Europe’s company have looked to emerging markets for growth in recent years—and now that strategy—sound in the long run—is taking a bite out of revenue growth in the short term.
Third, many European stock have already moved up in anticipation of an end to the recession. And in these cases you aren’t buying gems overlooked by everyone else. Stocks that have gained 40% to 50% in the last year aren’t uncommon in the markets of the region. And in beaten down sectors such as banking and alternative energy, you’ll come across stocks that are up 100% or more in the last 12 months. French bank Credit Agricole (ACA.FP in Paris and CRARY in New York) and Danish wind turbine manufacturer Vestas VWS.DC in Copenhagen) are two examples, up l06% and 289%, respectively. I’m not saying that you shouldn’t buy a stock just because it’s up 100%. I am saying that with a stock showing that kind of return, you should make sure that you think there’s more upside ahead for you.
So what would I suggest here? Read more
I can see a potential perfect storm brewing in China that could — please note that “could” — send chaos sweeping over global financial markets and economies.
I can see the conditions for the storm in place — just as during hurricane season we can see a tropical depression building in the warm waters between Africa and South America. The question now, as it is with any hurricane, is whether that depression will build into a weak storm — a Category 1 that lashes countries in its path with rain but doesn’t result in much damage — or turn into a Category 4 or 5 that leaves a wide swath of destruction in its path.
And, of course, there’s the important question of which countries lie in the storm’s most likely route.
At this point I’d say the storm brewing in China is likely to rise to a Category 2 and cause damage to China’s economy and stock market, as well as to stock markets and economies dependent on China’s economy for growth: including commodity economies such as Australia, Brazil and Canada; Asian trading partners such as Korea, Malaysia and Indonesia; and global export economies such as Germany.
Beyond that? Read more
The numbers and forecasts for economic growth are predominately negative today but global stock markets don’t much care since the news is that the European Central Bank will keep the money taps open.
Today the International Monetary Fund cut its forecast for global economic growth in 2013 to 3.1% in its semi-annual update of world economic growth. Back in April the forecast called for 3.3% growth. The IMF also cut its forecast for 2014 to 3.8% from 4%. The reduced forecast can be traced to emerging economies, according to the IMF, with slower growth in Brazil, Russia, India, and China. The IMF cut its forecast to 7.75% for China in 2013 (down 0.25 percentage points from April) and for 2014 (down 0.5 percentage points from April.) Japan is one of the few countries to get an upgrade—to 2% in 2013 from an earlier 1.5% forecast. The EuroZone economy will contract by 0.6% in 2013 (worse than the earlier 0.4% forecast.) Italy will take a worryingly big hit with its economy contracting 1.8% in 2013.
On the EuroZone periphery—otherwise known as Greece—the IOBE economic think tank in Athens has forecast that Greece’s economy will shrink by 5% in 2013. That’s worse than the previous forecast for a 4.6% contraction.
And all the way across the globe in China the rate of inflation at the consumer level picked up to an annualized 2.7% in June from 2.1% in May. Food prices rose at an annual 4.9% rate, up from 3.2% in May. Although the June inflation rate is still well below the government’s 3.5% target, the move higher reduces the odds that the People’s Bank will move to reduce interest rates in order to stimulate the country’s economy.
But none of this macro economic bad news seemed to faze markets focused on the prospects of continued cash flow in Europe. In what may have been a slip of the tongue, Joerg Asmussen, a member of the six-member executive board at the European Central Bank, said in an interview that the central bank would keep interest rates low for more than 12 months. That went well beyond ECB President’s Mario Draghi’s pledge to keep rates low for an extended period. Draghi had pointedly refused to put a timetable to his pledge. (European ministers also agreed last night to extend a further 2.5 billion euros in bailout funding to Greece—in exchange for further cuts to public sector jobs by the Greek government. A further 500 million euros would be disbursed in October if Athens kept to its agreements.)
European stocks finished at their highest level in a month. The German DAX was up 1%. The French CAC 40 climbed 0.6%. The Spanish IBEX edged lower by 0.03% and Italian stocks in Milan were off 0.06%. In the bond markets the yield on Spanish and Italian bonds moved up slightly to 4.71% and 4.42%, respectively.
(I’m taking a couple of days to backpack part of the C&O Canal path with my kids. So I’m posting this early.)
As I look at the continuing Cyprus banking tragedy/farce, I keep thinking of Willie Sutton.
Sutton was a career bank robber—credited with 100 bank robberies—most famous for a quote attributed to him after reporter Mitch Ohnstad asked him why he robbed banks. “Because that’s where the money is,” Ohnstad wrote that Sutton said.
So why did the EuroZone force bank depositors in Cyprus to pay almost 6 billion euros toward the bailout of the country’s banking system? Because that’s where the money was.
And that should be deeply troubling to anyone who lives in a country with a deeply indebted government. (And who doesn’t these days?) Looking at Cyprus, you don’t have to be paranoid to think “they” are coming after your money. That cynical conviction is a slow growing but very serious threat to global financial markets are they now exist.
Let’s start with Cyprus. In the days after the late night Sunday deal that “ended” the crisis with something short of the country’s immediate departure from the euro, Jeroen Dijsselbloem, the new Dutch head of the group of EuroZone finance ministers, set off a firestorm by saying that this deal would be the model for future bailouts. “What we’ve done last night is what I call pushing back the risks. If there is a risk in a bank, our first question should be ‘Okay, what are you in the bank going to do about that? What can you do to recapitalize yourself?’ If the bank can’t do it, then we’ll talk to the shareholders and the bondholders, we’ll ask them to contribute in recapitalizing the bank, and if necessary the uninsured deposit holders.” In the following days Dijsselbloem and other EuroZone officials attempted to walk back some of those comments by stressing that Cyprus with a banking sector eight times larger than its economy was a unique situation.
But frankly nobody much believed those “clarifications.” Cyprus clearly was a new “template.”
And that’s deeply disturbing—even if you don’t live in the EuroZone.
Of course, it’s deeply disturbing if you do live in the EuroZone because the deal violates so many of what everyone had thought were the basic rules of the euro. For example, the whole idea of a currency union is that the common currency is worth the same in every country in the EuroZone. Tell that to Cypriots who could only take 300 euros out of their banks when they finally reopened on Thursday, March 28. Tell that to Cypriots who can’t take more than 1,000 euros in cash out of their country. Tell that to Cypriots who can’t transfer euros out of their country. Today a euro is Nicosia isn’t worth the same as a euro in Berlin or Paris or Milan.
But it’s the deal itself—and the way it developed—that should be disturbing to people who live outside the EuroZone as well.
Like just about every “solution” implemented during the euro debt crisis this one was ultimately political. The “need” for a bail-in, for a contribution from someone in Cyprus toward the price of bailing out the country’s banking system, was the result of a political calculus that looked at what EuroZone taxpayers, and especially German taxpayers, could be expected to stand for without costing German Chancellor Angela Merkel her country’s September election.
Once that principle was established, then the issue became one of trading political pain within that formula. Initially the newly elected president of Cyprus Nicos Anastasiades proposed a formula that would have confiscated money from all bank accounts. That was a good idea, Anastasiades thought, because it would diminish the hit that the largest depositors in Cypriot banks would take. That would lessen the risk of alienating the Russian money that had become so crucial to Cyprus’s offshore banking industry. (Russia might even contribute to the bailout, the president apparently hoped.) This deal only went down in flames when EuroZone officials pointed out that it ran afoul of deposit guarantees for accounts of 100,000 euros or less.
The next bright idea out of Nicosia was to set up a national fund that could be used as collateral for loans (from the European Central Bank, it was assumed) to bail out the banks. And what would go into the fund? How about assets from national pension plans? This idea too went down in flames when the European Central Bank said it wouldn’t lend on that basis. (It’s not clear whether the bank was appalled at the proposal or feared that it would lose money it lent against this collateral.)
Against this background, the final deal looks—on the surface—like a model of fairness. Deposits under 100,000 euros remain guaranteed against loss. Only big depositors lose money and then only depositors at the country’s two biggest banks. The country’s second largest bank will be wound up with “good” assets being transferred to the country’s largest bank.
The deal also has the advantages that it gives Northern European politicians the ability to point to the pain being distributed in Cyprus to mollify voters who just might object to another bailout in the south of the EuroZone. (And it seems, once again, to make sure that the European Central Bank doesn’t take a loss—so far–on the emergency cash it lent Cypriot banks to keep the country’s banking system functioning.)
Yep, from some perspectives this is a pretty great deal.
But reverse that perspective and look at this deal from the point of view of someone with money in a Cypriot bank.
Let’s not focus our attention on the average Russian oligarch who was using Cyprus as a way to hide money or business activities from authorities in Moscow and elsewhere. Initial money flows suggest that some of that money got out of the country in the days before the deal. And I’m pretty sure that the managers of this money weighed the risk of putting cash in Cyprus against the risk of depositing it elsewhere.
Let’s instead look at the average Cypriot account holder or the average Cypriot business with money at a bank on deposit against future capital needs or future needs to pay bills. That account holder woke up to a crisis that threatened the safety of the country’s banks and then, surprise, got presented with a new set of rules. The big one, of course, is that money in some bank accounts would be confiscated to pay for a banking bailout.
Today the politicians are promising that these new rules are stable—and that the government won’t need to extend these measures to other banks and other account holders. But that’s clearly no more believable than the government’s projections that this deal will only cut 3.5% off of the country’s GDP in 2013. 10% looks like a more reasonable figure. And if the economy tanks to that degree, anyone with any experience of the way the euro debt crisis knows, more Cypriot banks will need more cash, the government will run even more deeply in the red, and Cyprus will be back looking for more bailout money.
And if in this stage of the crisis politicians in Cyprus and in the EuroZone were willing to change the rules so they could go “where the money is,” it’s a reasonable fear that they’d be willing to change the rules again in any renewal of the crisis.
And now that this willingness to go where the money is has been established in Cyprus, do you think it hasn’t entered the political calculations in Madrid or Rome or Athens or Lisbon or Paris? Governments in these countries now have to consider the very real possibility that they will be asked to go where the money is should they need a banking bailout or further support for their government debt. You can bet that these governments are hoping as hard as they can hope that European Central Bank president Mario Draghi’s promise to do whatever it takes to defend the euro continues to work its bond market magic. Because if it doesn’t, they know post-Cyprus, that the list of what they might have to do to win EuroZone support for an actual bailout contains some pretty unpalatable measures.
Savers and investors in these countries are facing a new calculation too. In the light of the kinds of things in this deal—and the even more draconian measures proposed by the government in Nicosia that didn’t get into this deal—what banks can they trust? What financial institutions are safe? And most importantly how much can they trust their own governments not to go after their financial assets in the next crisis?
So far, the money flow numbers suggest, these worries have produced modest shifts from weaker domestic-only banks to stronger internationally diversified banks. But it’s early yet and I don’t think we have the data to indicate the full extent of any Cyprus effect.
And any Cyprus effect won’t fully kick in until a new crisis—somewhere else—demonstrates that Cyprus is, as Dijsselbloem said, a new template.
It is, unfortunately, not just a new template for the EuroZone either.
It’s hard to honestly confront the budget deficits and the deficit trends in the United Kingdom, Japan, and the United States and say “That can’t happen here.” Oh, not tomorrow or next week, maybe, but sooner than any of use would like to think.
In the U.S. budget debate, for example, you can hear snippets of talk about the need to “reform” the mortgage tax deduction. The talk isn’t about doing away with the deduction entirely but instead about a need to cap it and put some limit on the size of the mortgage deduction that can be claimed against taxes.
That’s never been on the table before in even this kind of glancing way.
I wouldn’t argue that all attempts to go where the money is are bad. The current system of guarantees for this and tax breaks for that is arbitrary and illogical. It’s a reflection of the power of lobbies and constituencies.
But the danger here, as I think Cyprus illustrates, is that we continue to slide down a slippery slope toward a future where every “solution” to a very real set of interlocking global crises seems like an arbitrary grab at this or that pool of money. That, as Cyprus illustrates, threatens to create a crisis in which no one feels any savings or investment is safe from tomorrow’s change in the rules. (How about all that tax-deferred 401(k) and IRA money, for example?)
At the extreme that would lead to a day when we’d all be out in the backyard in the dark of night burying our gold. And no one would call us paranoid. You aren’t paranoid if “they” really are out to get you.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did not own positions in any stock mentioned in this post as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/