Wednesday, February 27, 2013

Investing along national lines should continue to pay off

I have a new blog written in German which focuses on developments in the German economy as well as German economic policy matters:

I have been convinced that the multi-year outlook for various developed market economies is very different and accordingly investing along national lines should pay off. This has been the case ever since the financial crisis broke out and country views should continue to guide investment decisions for the next few years.  

Germany: I have been looking for Germany to outperform for quite some time (see for example: There is more to celebrate for Germany dated Nov 10, 2009). Germany enjoys an easy monetary environment amid record low real yields and a relatively high credit availability. Furthermore, at current exchange rate levels, German corporates can continue to gain market share. The fiscal deficit poses no threat and amid ongoing growth, sovereign debt levels can fall. Hence, no fiscal tightening is necessary. Additionally, some of the factors which held growth back since the mid 90s have disappeared or reversed (most notably a large drop in public sector employment, a sharp  drop in construction activity and declining immigration). Public sector employment has been stabilising, construction has been growing again and immigration is on the rise. These factors mean that while average/trend growth was depressed between 1995-2009, it can increase again. Risks for the German economy stem mainly from the political side. Following the elections in autumn this year, the political landscape might change towards a less economy friendly environment (higher taxes, more regulation).
Austria & Belgium: The financial crisis/ Eurozone sovereign crisis has burdened Austria & Belgium especially via their banking sectors. However, the stabilisation in Eastern Europe, the liquidity provision measures by the ECB, most notably the 3y LTROs, and the systemic backdrop provided by the OMTs and the ESM have significantly reduced the banking woes in these countries. Furthermore, fiscal deficits do not pose a threat as the primary balance is close to 0% in both cases. With the help of the very low sovereign bond yields, fiscal deficits should remain under control with no further savings measures necessary and debt-GDP ratios should be able to shrink over the medium term. Hence, Austria and Belgium profit from an easy monetary and neutral fiscal environment and do not suffer from significant structural problems. Their sovereign bonds should do relatively well vs. the rest of the semi-core markets over the longer term.

However, there is a large group of Eurozone countries which faces a difficult longer-term environment. Greece, Portugal and Spain continue to face adjustment recessions to restore competitiveness and reduce fiscal deficits which will restrain growth. But also Italy, France and the Netherlands find themselves in a difficult position. Italy and France need to restore competitiveness of their industrial sector and both economies suffer from very rigid labour markets. In the case of Italy, political uncertainty has been rising amid the election gridlock. As Italy has a large primary surplus, it does not need more fiscal austerity. Rather structural reforms are needed to restore competitiveness and increase trend growth. France, on the other side, needs more fiscal savings measure to bring back the deficit and stabilise debt-GDP ratios. The combination of a lack of competitiveness for the private sector coupled with significant and ongoing austerity measures will depress French growth for quite some time. In the case of the Netherlands, the private sector is over-indebted. Given that unemployment has risen from 5% in mid 2011 to 7,5% in January this year and as the housing market has entered a correction (house prices are down by 9,6% yoy in January), consumer spending should be weak going forward and also hold back business investment. Furthermore, the state needs to lower its fiscal deficit which will only aggravate the cyclical downturn. The short-term outlook for Greece Portugal, Spain, France and the Netherlands is for weak growth, the longer-term outlook remains most challenging for France (as so far they have not done anything to restore competitiveness). In the case of Italy, the situation is uncertain. Amid the political gridlock, political and hence economic uncertainty is rising. This should have a negative effect on business investment and households' consumption of durable goods. On the other side, should a relatively stable government be formed, then Italy could move back to low but positive growth. Most likely such a new government will not be able to drive through more austerity measures (which are not necessary anyhow) and significant structural reforms (which would be necessary). The net effect would be that Italy should be able to move back to a low but positive growth environment over the course of this year.

Elsewhere in Europe, I have been bearish on the UK economy for a long time (see for example: Revisiting the UK: not much good news dated August 18, 2009 ). The UK is suffering from the weakness in the financial sector where its economy is highly exposed. Furthermore, the UK’s oil sector output has dropped by approx. a quarter over the past four years and is in steady decline. Aggravated by the government’s savings measures, the economy has been failing to grow. Furthermore, while the trade-weighted GBP has dropped by approx. 20% since before the financial crisis, this was not mirrored by an improvement in the current account. Rather to the contrary, the current account deficit is larger than before the crisis and the weaker GBP was mostly reflected in higher inflation. A further easing in the monetary environment will only result in another weakening of GBP and in the end, the BoE will be almost the only net-buyer of Gilts. Ultimately, the BoE will be holding these Gilts forever (or cancel them with the Treasury). Hence, the money created by the quantitative easing measures should be seen as a permanent increase in base money and is unlikely to be absorbed again.

In the US, the situation is very different. While the fiscal deficit is relatively high and the Fed continues to conduct QE as well, the situation of the economy is much more favourable. The economy has recovered the lost output from the financial crisis. A key driver might be the increasing oil & gas output which also puts significant downward pressure on the current account deficit. Furthermore, the housing market has turned the corner. If the politicians don’t overdo it with fiscal tightening, then the economy should soon find its way back into a higher growth environment which then will also depress the deficit. Hence, I am optimistic with respect to medium-term outlook for the US economy (though in the near-term, economic data might disappoint amid the fiscal tightening).