Looking at 2011 through the rear-view mirror, we need to acknowledge that it has been quite a formidable year. It started with the “Arab Spring” and ended – there is still another week to go – with the passing of Kim Jong Il, the North Korean leader.
In between, there were many extreme events of both the “Black Swan” type, such as the Fukushima disaster, and the politically self-inflicted type, such as the US debt ceiling debate and the five last chance summits to resolve the euro crisis.
All this made 2011 a challenging year for the markets. Many equity indices, especially in Europe, are significantly down from 2010, and volatility is almost back at levels last seen during the financial crisis of 2008. There doesn’t seem to be any end in sight.
It can be quite revealing to take a glimpse at what we wrote a year ago, so I pulled up the text, I wrote in 2010, “Unfinished business,” and was rather surprised that its first paragraph is still a perfect fit a year later, adjusting the outlook horizon accordingly: “With a week to go until New Year’s Eve, 2010 ends with many unresolved problems that will continue to affect the first part of 2011… The most obvious is the European sovereign debt crisis, or, as we prefer to call it, the crisis of the euro.
So far, European leaders have failed to address the underlying problem of the crisis: To really function as a currency area, the Eurozone simply needs much more economic, fiscal and social integration.
Instead, they have focused on reshuffling and guaranteeing governments’ debts with ever more complex schemes. Despite these band-aids, the debts refuse to disappear… Hence, we expect the crisis of the euro to continue making headlines in the first months of 2011.”
I continued by acknowledging the US debt problems, which are also still unsolved and are likely to remain unsolved in 2012, a presidential election year. I concluded with China’s struggle with its inflation issues. At least this last point has been dealt with in 2011, to the extent that now it is the Chinese growth outlook that worries many market participants.
Despite all the challenges that prevailed in late 2010, I thought 2011 would be a transition year, with at least a decent performance in the equity markets, since stocks had been fairly valued and in some cases even cheap.
I was proven wrong. Indeed, even technical analysts indicated that 2011 should be an outstanding year for equity markets, being the third year of a US presidential term. Since World War II, this period has delivered a 16% performance on average on the S&P 500, compared with 5% in the first year, 4% in the second, and 7% in the fourth. So much for inferring patterns without enough data points.
This is why we enter 2012 in a very cautious and conservative mood. Although equities are now even more attractively valued than in late 2010, we learned from 2011 that a state of unfinished business is not a healthy environment for aggressive investing.
Wednesday, December 21, 2011
Friday, December 16, 2011
16/12/2011: France’s latent power over the future of a common currency
The concept of any euro only makes sense if France participates. Thus, even in the unlikely scenario of a euro split and adapted to the economic strength of user countries, France plays a crucial role.
Every new European summit failing its chance to save the euro and finally resolve the European sovereign debt crisis raises the prospects of a possible breakup of the common currency. Don’t get me wrong: This is not our base case. We still assign only negligible probability to such a scenario. Nevertheless, we do consider that the consequences of such an event would be disastrous, so the risk, defined as likelihood times expected loss, is quite significant.
Numerous scenarios are currently discussed in the press about how such a breakup could proceed. They range from one or several countries exiting the euro to a full disentanglement of the common currency into seventeen new national ones. Often discussed is the split of the euro in two parts: a northern euro or “neuro,” and a southern euro or “seuro.” The neuro would take in all the strong countries of the Eurozone, and the seuro all the weak ones.
We see this among the least likely of scenarios. Why? Because the concept of any euro only makes sense with the participation of France. A neuro without France, including only Germany, the Netherlands, Austria and maybe Finland, would not differ at all from the good old Deutschmark. Before 1999, both the Netherlands and Austria were de facto pegged to the Deutschmark. Implicitly Switzerland also had such a peg, and Yugoslavia quite explicitly before it dissolved in the early 1990s. Therefore, the participation of France is crucial to make it something truly different.
A seuro with Spain, Italy, maybe Portugal and Greece, but without France, doesn’t make any sense either. Why would Spain and Italy want to share a common currency? The exports of Italy to Spain represent 6% of all Italian exports; Italy exports twice as much to both Germany and France. In comparison, Spain’s exports to Italy represent 9% of all Spanish exports, while those to Germany are 11% and to France a whopping 19%. Hence, again, only a participation of France in a seuro would grant lasting credibility to this new common currency.France is on the verge of losing its AAA rating. Top French politicians including President Nicolas Sarkozy, alluded to this recently. Once this has occurred, as we’ve discussed here previously, Mr. Sarkozy’s strategy to follow Germany on its gloomy austerity path may seriously jeopardize his chances for reelection next year. He will need to exert pressure on his German partners to ease their rigid stance, either by allowing Eurobonds or a greater involvement of the European Central Bank to mitigate the current contagion. In this respect, France has far more negotiation leverage than it realizes or has recently exercised. Because wherever France shall go, the euro will also follow.
Every new European summit failing its chance to save the euro and finally resolve the European sovereign debt crisis raises the prospects of a possible breakup of the common currency. Don’t get me wrong: This is not our base case. We still assign only negligible probability to such a scenario. Nevertheless, we do consider that the consequences of such an event would be disastrous, so the risk, defined as likelihood times expected loss, is quite significant.
Numerous scenarios are currently discussed in the press about how such a breakup could proceed. They range from one or several countries exiting the euro to a full disentanglement of the common currency into seventeen new national ones. Often discussed is the split of the euro in two parts: a northern euro or “neuro,” and a southern euro or “seuro.” The neuro would take in all the strong countries of the Eurozone, and the seuro all the weak ones.
We see this among the least likely of scenarios. Why? Because the concept of any euro only makes sense with the participation of France. A neuro without France, including only Germany, the Netherlands, Austria and maybe Finland, would not differ at all from the good old Deutschmark. Before 1999, both the Netherlands and Austria were de facto pegged to the Deutschmark. Implicitly Switzerland also had such a peg, and Yugoslavia quite explicitly before it dissolved in the early 1990s. Therefore, the participation of France is crucial to make it something truly different.
A seuro with Spain, Italy, maybe Portugal and Greece, but without France, doesn’t make any sense either. Why would Spain and Italy want to share a common currency? The exports of Italy to Spain represent 6% of all Italian exports; Italy exports twice as much to both Germany and France. In comparison, Spain’s exports to Italy represent 9% of all Spanish exports, while those to Germany are 11% and to France a whopping 19%. Hence, again, only a participation of France in a seuro would grant lasting credibility to this new common currency.France is on the verge of losing its AAA rating. Top French politicians including President Nicolas Sarkozy, alluded to this recently. Once this has occurred, as we’ve discussed here previously, Mr. Sarkozy’s strategy to follow Germany on its gloomy austerity path may seriously jeopardize his chances for reelection next year. He will need to exert pressure on his German partners to ease their rigid stance, either by allowing Eurobonds or a greater involvement of the European Central Bank to mitigate the current contagion. In this respect, France has far more negotiation leverage than it realizes or has recently exercised. Because wherever France shall go, the euro will also follow.
Friday, December 9, 2011
09/12/2011: On European diets and Euro defibrillators
The difficult task for someone, who writes editorials for a weekly publication edited on Fridays, is that politicians have the unfortunate habit to come up with big decisions on weekends. Hence many outcomes speculated upon at the end of one week might be completely out of question at the beginning of the next one. We are currently once again at such a juncture. I am writing my editorial on this Friday 9 December, while European politicians are meeting for a summit, which might be again labeled summit of last chance.
Since Greece ignited the fuse of the European crisis eighteen months ago we had already numerous summits of last chances and plans to once and for all solve the crisis. Carole Sirou, the head of France research at Standard & Poor’s, mentioned on Monday in the aftermath of the rating agency’s announcement to put under review 15 of the 17 Eurozone countries, the eighteen European summits over the last two years, each of them disappointing investors, as one major reason for this decisions.
Churchill once said about Americans that they will always do the right thing, but only after exhausting all other options. Under pressure from rating agencies, with interest rates increasing, social tension mounting, impatient markets ready to sell all European sovereign debt, including the German one, we hope this time Europeans act like Churchill’s Americans and come with a credible solution. But what would a credible solution be?
I like to compare the Eurozone with a very heavy man, who is in the middle of a heart attack, surrounded by doctors, who are telling him that he should go on a diet and lose some weight. While this is a very sound advice in the longer run, which everyone would agree with, it is not tackling the fact that just in this moment the patient has a heart attack and that a shock from a defibrillator would be an appropriate mean to make sure he’s not dying.
It is clear that a long term solution of the Euro crisis is needed in the form of more fiscal discipline, which implies both more austerity and loss of sovereignty from the Eurozone countries. But such a plan, which President Sarkozy and Chancellor Merkel alluded to last Monday is incomplete without tackling the short term issue of stopping the Eurozone contagion; more concretely of ensuring that interest rates on the sovereign debt of Eurozone members, which haven’t bee rescued so far are not reaching unsustainable levels. Here only one institution could do the trick, the European Central Bank, either directly or indirectly through the International Monetary Fund, the European Financial Stability Facility or a yet to be created new institution.
If we get those two elements in the plan than it could give a relief, which would last longer than the ones the last plans achieved but we would just be at the beginning of solving the whole crisis. If we don’t get those elements or something close to it in one form or another, than we should brace for markets, which might again run havoc.A diet without defibrillator will be not credible to stop the crisis in the short run. A defibrillator without a diet will be not credible to solve the crisis in the long run.
Since Greece ignited the fuse of the European crisis eighteen months ago we had already numerous summits of last chances and plans to once and for all solve the crisis. Carole Sirou, the head of France research at Standard & Poor’s, mentioned on Monday in the aftermath of the rating agency’s announcement to put under review 15 of the 17 Eurozone countries, the eighteen European summits over the last two years, each of them disappointing investors, as one major reason for this decisions.
Churchill once said about Americans that they will always do the right thing, but only after exhausting all other options. Under pressure from rating agencies, with interest rates increasing, social tension mounting, impatient markets ready to sell all European sovereign debt, including the German one, we hope this time Europeans act like Churchill’s Americans and come with a credible solution. But what would a credible solution be?
I like to compare the Eurozone with a very heavy man, who is in the middle of a heart attack, surrounded by doctors, who are telling him that he should go on a diet and lose some weight. While this is a very sound advice in the longer run, which everyone would agree with, it is not tackling the fact that just in this moment the patient has a heart attack and that a shock from a defibrillator would be an appropriate mean to make sure he’s not dying.
It is clear that a long term solution of the Euro crisis is needed in the form of more fiscal discipline, which implies both more austerity and loss of sovereignty from the Eurozone countries. But such a plan, which President Sarkozy and Chancellor Merkel alluded to last Monday is incomplete without tackling the short term issue of stopping the Eurozone contagion; more concretely of ensuring that interest rates on the sovereign debt of Eurozone members, which haven’t bee rescued so far are not reaching unsustainable levels. Here only one institution could do the trick, the European Central Bank, either directly or indirectly through the International Monetary Fund, the European Financial Stability Facility or a yet to be created new institution.
If we get those two elements in the plan than it could give a relief, which would last longer than the ones the last plans achieved but we would just be at the beginning of solving the whole crisis. If we don’t get those elements or something close to it in one form or another, than we should brace for markets, which might again run havoc.A diet without defibrillator will be not credible to stop the crisis in the short run. A defibrillator without a diet will be not credible to solve the crisis in the long run.
Friday, December 2, 2011
02/12/2011: Europe’s French swan
The race against time to save the euro has now seriously started. The dismal bund auction last week, the Italian interest rates now stuck above 7% and the Spanish ones close to those levels, despite new elected and non-elected “technocratic” governments, the spread between German and French bonds widening to levels last seen in the early 1990s and Moody’s announcing that even Germany is not safe from downgrade: all this point to the endgame.
Famous British editorialists are becoming almost hysterical. Wolfgang Münchau writes in the Financial Times of Monday 28 November: “The Eurozone has 10 days at most.” Ambrose Evans-Pritchard tops it the same day in the Daily Telegraph: “What we know for certain is that Europe’s current policy settings must lead ineluctably to ruin and perhaps to fascism. Nothing can be worse.” The German newsmagazine Spiegel runs its cover with a broken one euro coin in front of a gloomy dark sky asking: “What now?”
New solutions leaked during last week-end and likely on the table at the next European summit on 9 December, like the introduction of Eurobonds for a “core Eurozone” or the involvement of the International Monetary Fund to channel European Central Bank funding are too complex and too cumbersome in an environment, where market participants are asking for quick fixes involving the ECB.
… and then there is the huge Damocles sword over the Eurozone: the possibility of a rating downgrade of France, losing its AAA. This event would precipitate the euro crisis in a completely new dimension.
Not that this downgrade is unexpected. It is not a black swan. Currently we are forecasting that France will lose its top rating within the next two years. With French interest rates rising quickly, it could happen sooner rather than later. However, if it would happen before May 2012, i.e. before the Presidential elections in France, then France’s reaction is likely to become a 180 turnaround from the policy followed so far. This is for me the French swan.
Nicolas Sarkozy the incumbent President will run again and despite current rather weak poll numbers he has a fair chance to get reelected given that he is an excellent campaigner. His campaign will run on two axes: 1) law and order and 2) economic and fiscal responsibility. France losing the AAA rating would seriously tarnish the fiscal responsibility narrative and would certainly be used by Mr. Sarkozy’s rivals. They are already now pointing to the fact that under his Presidency France’s debt increased by 500 billion euros.
In my view after a first outraged reaction bashing markets and rating agencies in the same vein US President Obama reacted after the US lost its AAA, the French government might well take the stance of becoming the defender of the Mediterranean countries instead of shadowing Germany, as it does now.
A rift between Germany and France is very likely to become the beginning of the end of the euro crisis. Either with France’s weight the supposedly “weak” countries get then at least some relief from the European Central Bank or under French leadership they might consider other options leaving Germany alone with his strong euro, its psycho rigid European Central Bank and a deep recession. The French swan could well be the one singing the demise of the euro.
Famous British editorialists are becoming almost hysterical. Wolfgang Münchau writes in the Financial Times of Monday 28 November: “The Eurozone has 10 days at most.” Ambrose Evans-Pritchard tops it the same day in the Daily Telegraph: “What we know for certain is that Europe’s current policy settings must lead ineluctably to ruin and perhaps to fascism. Nothing can be worse.” The German newsmagazine Spiegel runs its cover with a broken one euro coin in front of a gloomy dark sky asking: “What now?”
New solutions leaked during last week-end and likely on the table at the next European summit on 9 December, like the introduction of Eurobonds for a “core Eurozone” or the involvement of the International Monetary Fund to channel European Central Bank funding are too complex and too cumbersome in an environment, where market participants are asking for quick fixes involving the ECB.
… and then there is the huge Damocles sword over the Eurozone: the possibility of a rating downgrade of France, losing its AAA. This event would precipitate the euro crisis in a completely new dimension.
Not that this downgrade is unexpected. It is not a black swan. Currently we are forecasting that France will lose its top rating within the next two years. With French interest rates rising quickly, it could happen sooner rather than later. However, if it would happen before May 2012, i.e. before the Presidential elections in France, then France’s reaction is likely to become a 180 turnaround from the policy followed so far. This is for me the French swan.
Nicolas Sarkozy the incumbent President will run again and despite current rather weak poll numbers he has a fair chance to get reelected given that he is an excellent campaigner. His campaign will run on two axes: 1) law and order and 2) economic and fiscal responsibility. France losing the AAA rating would seriously tarnish the fiscal responsibility narrative and would certainly be used by Mr. Sarkozy’s rivals. They are already now pointing to the fact that under his Presidency France’s debt increased by 500 billion euros.
In my view after a first outraged reaction bashing markets and rating agencies in the same vein US President Obama reacted after the US lost its AAA, the French government might well take the stance of becoming the defender of the Mediterranean countries instead of shadowing Germany, as it does now.
A rift between Germany and France is very likely to become the beginning of the end of the euro crisis. Either with France’s weight the supposedly “weak” countries get then at least some relief from the European Central Bank or under French leadership they might consider other options leaving Germany alone with his strong euro, its psycho rigid European Central Bank and a deep recession. The French swan could well be the one singing the demise of the euro.
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