Eurozone Implosion Fears Overblown, as US Sustains Modest Recovery - Sean Maher

7/31/2019 Eurozone Implosion Fears Overblown, as US Sustains Modest Recovery - Sean Maher

1/6

SALES CONTACTSGuy Stille Tel: +852.2217.2853 Email: [email protected]

Quam on Bloomberg for Research Archive

Quam Financial Services Group34/F Gloucester Tower, The Landmark, 11 Pedder Street, Central, Hong Kong

Tel: +852.2847.2222 Website: www.quamsecurities.com

7 June 2012

Eurozone Implosion Risks Overplayed, as US Sustains Modest Recovery

Ive been reading a history of the last days of the Third Reich, and the Berlin Philharmonicsnal performance before their evacuation as the Soviet army advanced on the city was ofBrnnhildes immolation at the end of Wagners epic opera, which was the theme tune toNazism. While the Germans have shown an unfortunate mystical predilection for a bit ofGtterdmmerung, bringing Europe to its knees twice in a century,their taste in musicthese days runs more to the guy from Baywatch and Austrian rappers thanbattles to thedeath between Norse gods and in that, perhaps we should all nd hope. Back in the 1940s,before differential calculus and computers dominated macroeconomics, economies weremodelled using elaborate perpetual motion systems of containers, pipes and feedback valveswith water moving around them to reect the ow of money in an economy.

While that may seem quaint now, it remains a useful way to visualise the displacement

effect of capital movements around the global nancial system. Since 2008, it is as if thetable this system rests on is violently tilted every few months, with all the liquidity ushing fromthe risk asset to safe haven side and (partially) back again rather than nding the sustainableequilibrium beloved of economists. The core problem is that too much liquidity is pouringinto a system suffering a chronic shortage of creditworthy absorption capacity (andbanks are suffering a shortage of collateral they can repo). The combined FX reserves of Asiaand the oil exporters now approach $9trn.

Source: ECB, University of Osnabruck

This money enters the global real economy via bonds, suppressing risk-free rates and fuellingasset bubbles, originally in US/Eurozone real estate and more recently in Asian property.Reserves top 100% of GDP in Hong Kong and Singapore, and 50% in China, Malaysia and

Thailand. The BIS recently noted that reserve accumulation on this scale distorts the creditsystem. Bank credit is basically high-powered money supply; when it runs well ahead ofnominal GDP growth and monetary liabilities in the form of bank balance sheets grow beyond

Peripheral Defcits Funded By Germany


2/6



the ability of the sovereign to absorb them, we end up in the current crisis. The only solutionis to drain the system of excess private sector credit and debt to restore some form ofequilibrium, with offsetting scal and monetary infusions to avoid depression. That isthe task which the US is well on its way to achieving, Japan never quite achieved and Europe

is struggling to even comprehend.

The key to whether Europe escapes the Armageddon scenarios peddled to fund managersby commentators like Raoul Pal is Germanys perception of its national self-interest. Theeconomics profession and nancial pundits are largely tribal, with most adhering to adogmatic world view from monetarism, the notion that the money supply is at least a leadingindicator of aggregate demand (and probably deterministic) to the rather stern Austrian schoolof economics (think Marc Faber), and more specically the rather dubious Austrian theoryof the business cycle. Investing on the basis of what should happen by applying rigidintellectual preconceptions hasnt helped performance since 2008, given the key (andcrucial) role of policy intervention. What has worked is taking an agnostic view of the incentivesand constraints within that shifting policy framework.

Source: IMF

The one key tenet of economics that has survived the nancial crisis unscathed is thatof optimising outcomes within constraints, and whether looking at China or Germany,thats the right framework to help gure out policy options. By breaking down Eurosystempayment balances we can see just how much skin in the game Germany has in holding EMUtogether, with 650bn owed via peripheral national central banks from Athens to Madridto the Bundesbank, a net payment position that was in broad balance pre-crisis. TheLTROs essentially allowed core euro zone banks to exit peripheral sovereign debt holdings,which does have the advantage of making a Greek exit less traumatic (on the private sectorat least, the ECBs balance sheet would be shot to pieces) than commonly feared. The mostdangerous trend in the euro zone is that nancial institutions are increasingly tryingto match assets and liabilities by country, defeating the original purpose of EMU infostering integrated and more efcient cross-border capital markets, while a rising share of

cross-border risk is now assumed by the ECB and de facto by the Bundesbank.

With over 40% of German exports exposed to the rest of Europe (and probably over 50%taking into account the indirect impact on sales of German machine tools and luxury cars inChina etc. driven by European end demand), the vast vendor nancing scheme within

7 June 2012 Page 2 of 6

German Trade Surplus Has Generated EMU Instability


3/6



the euro zone which saw German banks fund peripheral construction booms and tradedecits over the last decade can only be switched off if German domestic demand, likeChinas, is boosted to compensate.

Its even conceivable that they think tough love will work, and thatthe weaker countrieswill see nominal wages and costs fall so dramatically that they would move into large externalsurpluses with the rest of the world, thereby restoring economic activity. German economistsoften claim that radical structural reforms with a re sale of assets would draw a wave ofinward direct investment, nancing the current-account decit in the short run, and generatenew economic activity in the longer run. That assumes crucially that those investors retainfaith in EMUs sustainability, which is clearly no longer the case . Austerity in the contextof private sector deleveraging exacerbates both economies and banks which in turn raisesunemployment and the output gap and lowers government revenue, creating a vicious circle.Since 2007, the nancial balance of the private sector shifted dramatically from decittowards surplus across the euro zone periphery, by 16% of GDP in Spain for example.Meanwhile, Germanys economy is only 1% larger than it was four years ago and mediocre

demand in the core reinforces economic weakness in the periphery (although there are somepositive signs from Germany, in terms of property prices waking from their torpor and real wagerises accelerating).

Very little that has transpired economically in the euro zone over the past couple ofyears is much of a surprise, although the fact we havent reached a denouement yet is. Backin the 10th May 2010 Weekly, I noted that: Even with a debt restructuring, Greece will be indeep trouble, forced to provoke a deep slump just to close the primary, non-interest decitthealternative is a devaluation, which means leaving the euro either by agreement or unilaterally,even though that would leave the country with net external liabilities of at least 70% of GDPwhich clearly implies immediate default. In fact, Ive long believed that a two tier eurozone was inevitable, split along the dangerous productivity fault line between north

and south, with Germany leading a core scally integrated bloc that was economically

coherent. Countries like Portugal and Greece have little to offer the world in the way of tradedgoods and services, andtheir best hope would be to attract tourists and capital from NorthernEurope with a competitive exchange rate reecting their low productivitythe IMF/EU austerityplan is a recipe for a deationary death spiral (including up to a 10% nominal wage drop by2012) without exchange rate exibility.We have recently seen the political repercussionsof that death spiral; its conceivable that the Germans are trying to make life so unbearablefor some of the peripheral economies that they will leave EMU voluntarily, thereby reducing theeuro zone to that coherent core I wrote of two years ago, but there is no real constituencyin the country for a return to the Deutschemark or nationalism.

US Data Soft But Broadly Resilient, as Ination Expectations Rise

Its intriguing that with a global equity selloff suggesting imminent deation, 5-yr-5-yrforward implied US ination expectations have risen in recent weeks to just under 2.8%(versus 2% during last autumns panic), while amid the Spanish solvency panic, eurozone 2-yr swap spreads are still just over 80bps (versus almost 120bps pre LTROs). On a3-mth moving average basis, implied US 5-10 year ination expectations in May were 2.5%,and to avoid any technical distortions from negative TIPS yields, the Fed household surveymeasure is also near its highest point of recent years, so we remain a long way from thedeation scares that have characterised previous bouts of risk-off behaviour.

The major US data series released over the last week were weaker than expected (non-farmpayrolls, unemployment, manufacturing, construction, factory orders and auto sales), but inline with my warning back in March of a likely loss of momentum, and the US economyremains quite a distance from a cliff edge. The May ISM Composite Index of industrial

sector activity fell to 53.5 from an unrevised 54.8 in April. Most series fell including production,supplier deliveries and inventories. The employment component also fell to 56.9. However,the new orders component rose to its highest level since April 2011 driven by domesticdemand, with the separate index of new export orders falling sharply to 53.5 on weakening



4/6



BRIC demand. Exports are 14% of US GDP, and euro zone exports are only about $200bna year, or the same as trade with Mexico. The price index fell sharply to 47.5, its lowest levelin six months.

Source: ISM Institute

The unemployment rate increased to 8.2% in May from 8.1% in April. Essentially, the joblessrate has held nearly steady during the last two months. The positive news is that the labourforce increased in May, after posting declines in March and April, lifting the participationrate to 63.8% from 63.6% in April. In addition, employment advanced 422,000 followingdeclines of 31,000 and 169,000 in March and April, respectively. At the same time, the broader

measure of unemployment which includes marginally attached workers moved up one notch to9.6%. The April and May payroll tally is on the soft side compared with the rst quarter averagemonthly increase of 226,000 jobs. Private sector payrolls advanced 82,000 in May, nearlymatching the 87,000 gain posted in April. The overall workweek was shorter in May (34.4hours) compared with April (34.5 hours), while the factory workweek also dropped in May (40.5hours vs. 40.8 hours) and factory overtime slipped slightly (3.2 hours vs. 3.3 hours in April)..Hourly earnings rose only 0.1% in May to $23.41, which puts the y/y increase at 1.7%, thesmallest increase since November 2010.

Source: BLS


PMIs Suggest Sluggish Rather than Sliding Growth

Workorce Participation Rate Improved in May


5/6



US personal income increased 0.2% (2.8% y/y) in April, down from 0.4% March; thatincluded a 0.2% rise (3.2% y/y) in wages and salaries. Among other income categories, rentalincome surged 1.0% (14.2% y/y), a tenth consecutive monthly gain of 1% or more. Dividendincome remained strong, rising 1% in April and 6.5% from a year ago, exacerbating overall

inequality trends given the concentration of equity ownership in the top income decile. Personalconsumption expenditures picked up to a 0.3% increase in April or 4% y/y. Durable goodspurchases rose 0.6%, resuming growth after a 1.4% decrease in March led by motor vehicles.The PCE chain price index was at in April after a 0.2% increase in March; its up 1.8% y/y. Thecore PCE price index, watched closely by the Fed, was also a bit slower in April, with a 0.1%increase following Marchs 0.2%; it is 1.9% up y/y. The personal saving rate was 3.4% in April,down from Marchs 3.5%; a year ago, the savings rate was 4.8%.The overall picture is at tofalling real earned incomes, offset by a falling savings rate to sustain consumption.

In fact, adjusted for ination, per-capita disposable incomes are currently at about thelevel rst seen in late 2006, although as Ive highlighted previously, the average hides awidening distribution as income inequality remains the key trend. The best hope near-term for

a boost to US retail spending will come from sliding energy prices. Overall, were stuck in thaton-going washboard recovery for both markets and the global economy, in which thepsychological scars of 2008 remain raw for investors, terried of being wrong footed bythe next systemic meltdown. The best way to play it is to be tactically exible, and tilt portfoliorisk weightings regularly based on what have proved to be the pretty reliable macro signals.Wagners melodramatic opera lasts an excruciating 19 hours, but it does eventually come to anendand so ultimately will the binary risk on/off frenzy gripping global markets as post crisisdeleveraging progresses tfully. In the meantime, if the Germans can create a comeback forthis guy, perhaps they can for risk appetite too

Author:

SEAN MAHERConsultant Strategist

Quam [email protected]

Tel: + 44.207.687 2213

http://www.youtube.com/watch?v=BGlBsIh3pIchttp://www.youtube.com/watch?v=BGlBsIh3pIchttp://www.youtube.com/watch?v=BGlBsIh3pIchttp://www.youtube.com/watch?v=BGlBsIh3pIc


6/6

W

eeklyInsight



Quam Financial Services Group34/F Gloucester Tower, The Landmark, 11 Pedder Street, Central, Hong Kong

Tel: +852.2847.2222 Website: www.quamsecurities.com

DISCLAIMER

Quam Ltd. (Quam) via its subsidiary companies Quam Securities Company Ltd and Quam Capital Ltd holds a license from the Securities and Futures Commission, Hong Kongand is a participant in the Stock Exchange of Hong Kong and the Hong Kong Futures Exchange. Our holding company, Quam Ltd, is an investment banker and an underwriter ofsecurities via its subsidiary companies. As a group Quam has Investment Banking, Advisory and other business relationships with a variety of companies covered by our researchanalysts. Our research professionals provide important inputs into the Groups Investment Banking and other business selection processes. Recipients of this report should as-sume that our Group is seeking or may seek or will seek Investment Banking, advisory, project nance or other businesses and may receive commission, brokerage, fees or othercompensation from the company or companies that are the subject of this material/report. Our Company, Group companies and afliated corporate members of the Global Alliancepartners (GAP), their ofcers, directors and employees, including the analysts and others involved in the preparation or issuance of this material and their dependants, may on thedate of this report or from, time to time have long or short positions in, act as principal in, and buy or sell the securities or derivatives thereof of companies mentioned herein.

Our sales people, dealers, traders and other professionals may provide oral or written market commentary or trading strategies to our clients that reect opinions that are contrary

to the opinions expressed herein, and our proprietary trading and investing businesses may make investment decisions that are inconsistent with the recommendations expressedherein. We may have earlier issued or may issue in future reports on the companies covered herein with recommendations/ information inconsistent or different those made in thisreport. In reviewing this document, you should be aware that any or all of the foregoing, among other things, may give rise to or potential conicts of interest. We and our Groupmay rely on i nformation barriers, such as Chinese Walls to control the ow of information contained in one or more areas within us, or other areas, units, groups or afliates ofQuam. This report is for information purposes only and this document/material should not be construed as an offer to sell or the solicitation of an offer to buy, purchase or subscribeto any securities, and neither this document nor anything contained herein shall form the basis of or be relied upon in connection with any contract or commitment whatsoever.

This document does not solicit any action based on the material contained herein. It is for the general information of the clients of Quam. Though disseminated to clients simul-taneously, not all cli ents may receive this report at the same time. Quam will not treat recipients as clients by virtue of their receiving this report. It does not constitute a personalrecommendation or take into account the particular investment objectives, nancial situations, or needs of individual clients. Similarly, this document does not have regard to thespecic investment objectives, nancial situation/circumstances and the particular needs of any specic person who may receive this document. The securities discussed in thisreport may not be suitable for all investors. The securities described herein may not be eligible for sale in all jurisdictions or to all categories of investors. The countries in which thecompanies mentioned in this report are organized may have restrictions on investments, voting rights or dealings in securities by nationals of other countries. The appropriatenessof a particular investment or strategy will depend on an investors i ndividual circumstances and objectives. Persons who may receive this document should consider and inde-pendently evaluate whether it is suitable for his/ her/their particular circumstances and, if necessary, seek professional/nancial advice. Any such person shall be responsible forconducting his/her/their own investigation and analysis of the information contained or referred to in this document and of evaluating the merits and risks involved in the securitiesforming the subject matter of this document.

The projections and forecasts described in this report were based upon a number of estimates and assumptions and are inherently subject to signicant uncertainties and con-tingencies. Projections and forecasts are necessarily speculative in nature, and it can be expected that one or more of the estimates on which the projections and forecasts werebased will not materialize or will vary signicantly from actual results, and such variances will likely increase over time. All projections and forecasts described in this report havebeen prepared solely by the authors of this report independently of the Company. These projections and forecasts were not prepared with a view toward compliance with publishedguidelines or generally accented accounting principles. No independent accountants have expressed an opinion or any other form of assurance on these projections or forecasts.

You should not regard the inclusion of the projections and forecasts described herein as a representation or warranty by or on behalf of the Company, Quam/GAP, the authors ofhis report or any other person that these projections or forecasts or their underlying assumptions will be achieved. For these reasons, you should only consider the projections andforecasts described in this report after carefully evaluating all of the information in this report, including the assumptions underlying such projections and forecasts. The price andvalue of the investments referred to in this document/material and the income from them may go down as well as up, and investors may realize losses on any investments. Pastperformance is not a guide for future performance. Future returns are not guaranteed and a loss of original capital may occur. Actual results may differ materially from those setforth in projections. Forward-looking statements are not predictions and may be subject to change without notice.

Quam does not provide tax advice to its clients, and all investors are strongly advised to consult regarding any potential investment. Quam/GAP and its afliates accept no liabilitiesfor any loss or damage of any kind arising out of the use of this report. Foreign currency-denominated securities are subject to uctuations in exchange rates that could have anadverse effect on the value or price of or income derived from the investment. In addition, investors in securities such as ADRs, the value of which are inuenced by foreign cur-rencies effectively assume currency risk. Certain transactions including those involving futures, options, and other derivatives as well as non investment-grade securities give ri seto substantial risk and are not suitable for all investors. Please ensure that you have read and understood the current risk disclosure documents before entering into any derivativetransactions.

This report/document has been prepared by Quam/GAP, based upon information available to the public and sources, believed to be reliable. No representation or warranty, ex-press or implied is made that it is accurate or complete. Centrum has reviewed the report and, in so far as it includes current or historical information, it is believed to be reliable,although its accuracy and completeness cannot be guaranteed. The opinions expressed in this document/material are subject to change without notice and have no obligation totell you when opinions or information in this report change. This report or recommendations or information contained herein do/does not constitute or purport to constitute invest-ment advice in publicly accessible media and should not be reproduced, transmitted or published by the recipient. The report is for the use and consumption of the recipient only.This publication may not be distributed to the public used by the public media without the express written consent of Quam. This report or any portion hereof may not be printed,sold or distributed without the written consent of Quam. Neither this document nor any copy of it may be taken or transmitted into the United States (to US persons), Canada, or

Japan or distributed, directly or indirectly, in the United States or Canada or distributed or redistributed in Japan or to any resident thereof. The distribution of this document in otherjurisdictions may be restricted by law, and persons into whose possession this document comes should inform themselves about, and observe, any such restrictions. Quam nor itsdirectors, employees, agents or representatives shall be liable for any damages whether direct or indirect, incidental, special or consequential including lost revenue or lost protsthat may arise from or in connection with the use of the information.

This document does not constitute an offer or invitation to subscribe for or purchase or deal in any securities and neither this document nor anything contained herein shall formthe basis of any contract or commitment whatsoever. This document is strictly condential and is being furnished to you solely for your information, may not be distributed to thepress or other media and may not be reproduced or redistributed to any other person. In particular, neither this document nor any copy thereof may be taken or transmitted into theUnited States, Canada or Japan or distributed, directly or indirectly, in the United States, Canada or Japan or to any US person.

The distribution of this report in other jurisdictions may be restricted by law and persons into whose possession this report comes should inform themselves about, and observe anysuch restrictions. By accepting this report, you agree to be bound by the fore going limitations. No representation is made that this report is accurate or complete. The opinions andprojections expressed herein are entirely those of the author and are given as part of the normal research activity of Quam Securities Company Ltd and are given as of this dateand are subject to change without notice. Any opinion estimate or projection herein constitutes a view as of the date of this report and there can be no assurance that future resultsor events will be consistent with any such opinions, estimate or projection. This document has not been prepared by or in conjunction with or on behalf of or at the instigation of,or by arrangement with the company or any of its directors or any other person. Information in this document must not be relied upon as having been authorized or approved bythe company or its directors or any other person. Any opinions and projections contained herein are entirely those of the authors. None of the company or its directors or any otherperson accepts any liability whatsoever for any loss arising from any use of this document or its contents or otherwise arising in connection therewith.

Important Information Regarding the Distribution of this Report in the United KingdomThis report has been produced Quam Securities Company Ltd and is being distributed in the United Kingdom (UK) by Seymour Pierce Limited (SPL). SPL is authorized and regu-lated in the UK by the Financial Services Authority to carry out both corporate nance and investment services and is a member of the London Stock Exchange. Although QuamSecurities Company Ltd is under separate ownership from SPL, Quam Securities Company Ltd has appointed SPL as its exclusive distributor of this research in the UK, and Quam

Securities Company Ltd will be remunerated by SPL by way of a fee. This report has not been approved for purposes of section 21 of the UKs Financial Services and Markets Act2000, and accordingly is only provided in the UK for the use of persons to whom communications can be made without being so approved, as detailed in the Financial Servicesand Markets Act 2000 (Financial Promotion) Order 2005.

ECONOMICS&STRATEGY Quam Group is a founding member of Global Alliance Partners (GAP), an international network of local nancial in-

stitutions with ofces in 25 countries, a total of $40bn in AUM and which has completed $22bn in corporate nancetransactions. GAP aims to leverage cross-border capabilities covering private equity, stock broking, research, fund

management and investment banking. Other leading members include Reliance Capital (India), KT Zmico (Thai-land), Seymour Pierce (UK) and Capital Partners (Japan).

www.globalalliancepartners.com

Eurozone Implosion Fears Overblown, as US Sustains Modest Recovery - Sean Maher

Documents

Transcript of Eurozone Implosion Fears Overblown, as US Sustains Modest Recovery - Sean Maher