European stocks take hit from political risk in Italy, France
- End-of-the-world hedges remain in high demand
- Europe pains: an Italy problem
- Sign of a China banking overhaul?
Europe earnings driven by EM mining exposure: Goldman Sachs
“Europe has benefited from a turn in earnings revisions recently. However, we find the turn has been very concentrated. It is largely driven by European companies with EM exposure or China exposure and more specifically mining stocks, not consumer exposed EM stocks,” Goldman Sachs analysts wrote in a February 22 research note.
Dead-cat bounce day on the S&P
Department stores are the top-performing sector in the S&P 500 with a nearly 5% gain, followed by general merchandise stores and apparel stores. The department-store gain follows a 25% decline in the sector’s index price since December 8. Oil and gas drilling and financials, two of the hottest sectors since the elections, were all down about 2%. Nothing to see here, folks. Keep moving. — David Goldman
Le Pen has a pensioner problem: Citi
Citi analysts wrote in a Febrary 24 report that “Le Pen’s priority is to regain monetary sovereignty, which would likely require the re-introduction of a national currency. But this is difficult to sell to French voters since a majority (68%) supports belonging to the euro area according to the Eurobarometer survey carried out in November (see Figure 4). With 75% of voters being 35 years or older, a strong habit of saving and a higher than the EU average level of household wealth as a percentage of disposable income, few voters would envisage haircutting themselves by a significant amount to introduce a new Franc. The prospect of a return to previous habits of regular currency devaluations in the decade that preceded the establishment of the single currency is unlikely to appeal to pensioners, who represent a sizeable proportion of the electorate, and whose participation rate in elections tends to be elevated.”
China responds to mixed messages from White House
On Thursday US Treasury Secretary Steve Mnuchin gave every indication the White House would back away from accusations that China is a currency manipulator. That was before Trump had a chance to chime in later the same day. They are the “grand champions” of currency manipulation, Trump said of China in an interview with Reuters on Thursday. Chinese Foreign Ministry Spokesman Geng Shuang responded Friday that “[t]here is no basis for the continued devaluation of the renminbi, […] But we are the grand champions of economic development,” Ben Blanchard reported for Reuters.
China and N. Korea: the more things change, the more they stay the same
Jane Perlez wrote for The New York Times on Friday that China-North Korea relations have gone downhill fast, culminating in a bitter rebuke of China published by North Korean state media this week. Chinese observers noted the unusually harsh tone coming from a North Korean state reliant on consistent support from its powerful neighbor, but China may still be unprepared to publicly renounce the Kim regime. The Chinese Foreign Ministry reassured that the two countries are “friendly neighbors,” while playing down the revelation that VX gas was used in the suspected assasination of North Korean leader Kim Jong-un’s half brother in Malaysia.
End-of-the-world hedges remain in high demand
The price of gold continued to rise and the yield on Treasury Inflation-Protected Securities (TIPS) continued to plunge as investors piled on risk hedges. This contrasts with a mild pullback in U.S. stock prices. Two different kinds of expectations are at work. You may not think you’re going to die tomorrow, but you’ll pay up for life insurance nonetheless, just in case. The vicissitudes of the Trump administration and the risks in European politics have made the “just in case” hedges a lot more valuable. Investors by and large remain willing to take on risk, but they also want to hedge against a prospective disaster. — David Goldman
Demographics may not be destiny, but it is deficits
As Robert Mundell explained a generation ago, chronic current account deficits are almost always the result of demographics. In the normal course of life, old people who have accumulated savings lend to young people starting families. Young people need homes and cars; old people need retirement income. The young generation supports the old generation, and that explains most of what happens in capital markets. The trouble is that sometimes the young people and the old people live in different countries. Countries with a faster rate of aging tend to have a lot of savings, but if they do not have sufficient young people, they cannot put those savings to work profitably. They need to lend money to young people in other countries to fund retirement.
The accompanying chart compares the percentage of population over the age of 65 to the current account surplus (as a percent of GDP) for the 40 largest world economies. Not surprisingly, the older the population, the higher the current account surplus (correlation coefficient = 59%, r-squared =35%, with significance at the 99.9% confidence level). The chart makes clear why “globalization” can’t be rolled back: world trade and capital flows put old and young people together as lenders and borrowers. But it does suggest that US President Trump is right about the US trade deficit: with a rapidly aging population, the US should be saving more, and a higher savings rate implies a lower trade deficit. If the US data point were on the regression line, it would be a small trade surplus. Of course, the young people in the world are in developing countries who don’t have the infrastructure to take in investment. Suppose a great economic power were to build the infrastructure they need to absorb investment? But now I’m talking about China, the Asian Infrastructure Bank and the One Belt, One Road infrastructure plan. — David Goldman
Xi’s old friends movin’ on up
Bloomberg reports today that old collegues of Chinese President Xi Jinping have been promoted to the top spots of the Ministry of Commerce and China’s economic planning agency, the National Development and Reform Commission (NDRC). He Lifeng, who will lead the NDRC, was previously tasked with overseeing the One Belt, One Road initiative, and, writes Bloomberg, was “among a handful of guests invited to the low-key wedding in 1987 when Xi and People’s Liberation Army singer Peng Liyuan tied the knot.” Zhong Shan, who was deputy governer of Zhejiang province while Xi was party chief there, will head up the Ministry of Commerce, tasked with facing off against a potentially hawkish Trump administration.
Germany-China bond grows stronger
Handelsblatt observes that China is now Germany’s top trading partner (France is second, the USA is third). The German trade association BGA commented, “In the face of the protectionist plans of the new US president, we can count on a future increase in German-Chinese trade relations.”
Europe pains: an Italy problem
We learn a lot about what’s motivating European markets by comparing two measures of risk — the cost of credit protection against an index of subordinated European bank debt (the ITRAXX “Subfin” index), and the spread between the yields on German and Italian 10-year notes. A year ago when European markets blew up, it was the Subfin index that moved the most, and the Italian government spread followed. This time around the Subfin index barely moved while the Italian government spread blew out. This tells us that there isn’t a generalized European financial crisis. German, French and Spanish banks are less vulnerable than they were a year ago. The problem is located in Italy’s dysfunctional politics and sagging economy. In other words: Don’t panic about global systemic risk. Italy is a problem but it’s a localized problem. — David Goldman
European market drop reflects on Italy
As the dust settles from today’s European market drop, it seems clear that Italy is the source of the problem. Although Italian spreads widened to Germany, other European countries’ bond yields (notably France, Spain and Portugal) fell more than Germany’s. It’s not a generalized but a localized, Italian issue. The Euro is essentially unchanged against the dollar, and the US market reaction to Europe’s drop is muted. — David Goldman
Germany’s downside if Merkel loses the September election
The Financial Times today profiles the leader of Germany’s “Die Linke” (the Left) party, the successor to East Germany’s Communist Party. If Social Democrat Martin Schulz beats Merkel, Germany for the first time will have a “Red-Red-Green” coalition (Social Dems, Die Linke, Green Party), and the Iranian-German Ms. Wagenknecht will be a minister in the government. She’s competing with Germany’s extreme right Alternative fuer Deutschland (AfD) for anti-immigrant votes.
Family planning troubles for China
The Chinese government has found that relaxing harsh controls on childbirth is not enough to spur on a new baby boom, a hard pill to swallow for a country facing a colossal demographic challenge. Gabriel Wildau writes today for the Financial Times that some local governements would like to institute subsidies to support the expense of raising a child today, but the prospect of aleviating China’s demographic problem are bleak. With rising costs of housing and education combined with expanding social security for the elderly, which would have traditionally been provided for by children, there are ever more incentives to keep the family small.
Gold up, TIPS yields down
Gold rose and TIPs yields fell deeply into negative territory. Investors are willing to take a negative yield (they receive less principal when the bond matures than they paid) as a kind of insurance: if the dollar collapses or inflation soars, TIPs will pay off big. Gold offers a similar kind of insurance, which is why the two assets trade together. — David Goldman
“Dark at the end of the tunnel” in Italy: Citi
In a Feb. 20 note, Citi warned, “Italian newspapers are today reporting that former PM Matteo Renzi is resigning from his role as secretary of PD and that such a move could cause a schism in the PD – one of the largest political parties in Italy (30% voting intention according to latest polls) which – more importantly – controls the majority of votes in the Lower House of the current parliament… i) macro is hardly improving; ii) there are two house of Parliaments with different (and not harmonized electoral laws); iii) no party is credited with more than 30% of votes (implying a hung parliament); iv) an anti-establishment alliance between M5S and Northern league cannot be excluded and – together – they might get control of the Parliament. We argue there may be dark at the end of the tunnel yet…”
High beta European EM equities take hit
High beta European emerging markets are getting hammered along with Germany. Turkey is down 1.2%, Poland down 2%, Russia down 1.3%, Hungary down 2.1%. US equity futures are down 88 points on the Dow.
Europe’s market plunge started with Italian bonds
The chart shows that the widening of the spread between German and Italian 10-year bonds (to the widest level in three years) preceded the sharp fall in Germany’s stock market index today. German fundamentals are strong: reasonable valuations, good profit growth, and a generous but sustainable dividend yield. Everything looks great about Germany except for its neighbors. — David Goldman
So much for that war with China
Dave Majumdar, the defense correspondent at The National Interest, reports that Russia and China already may have the ability to defeat US stealth technology through clever processing of radar signals. That means they can (or soon will be able to) shoot down F-22’s as well as the F-35. Practically speaking, it means that the Russians at some point will be able to deny the US air access to Syria, and that China will be able to sweep the skies over the South China Sea.
All Europe equity sectors down, bonds up
All sectors of the main European equity index are down, led by basic resources, automakers, banks, construction materials and chemicals. Even the defense sectors such as REITs and utilities fell as European bonds gained.
Sign of a China banking overhaul?
MNI writes today: “Guo Shuqing, most recently the governor of Shandong Province, replaced Shang Fulin as chairman of the China Banking Regulatory Commission (CBRC) on Friday, Chinese media reported. Some market analysts said the move reflected Beijing’s desire to jump-start financial regulation reform. Guo, who was appointed Shandong’s governor in 2013, has also served as chairman of the China Securities Regulatory Commission (CSRC), the head of the State Administration of Foreign Exchange, and as deputy governor of the People’s Bank of China (PBOC). Guo is known as a reformist and financial-sector expert who, during his 17-month stay at the CSRC, advanced more than 70 new policies to replace antiquated ones, significantly improving the overall environment of China’s capital market in doing so.”
European markets sag on political stress
European markets slumped today on political risk, with Germany’s DAX average leading the continent down with a loss of 1.4% at 7:00 a.m. The spread between Italian and German 10-year bonds widened to 2%, the widest since February 2014, as Italy’s political parties remained in chaos. French-German bond spreads were stable. There simply is no viable path out of the crisis for Italy. With government debt at 133% of GDP, Italy faces fines from the European Commission. Its enormous non-performing debt burden requires a state bailout of the Monte dei Paschi Bank and perhaps others, but that would mean losses for small bondholders under European Commission rules. The Italians are unwilling to go there, and Brussels is unwilling to accommodate them. The impasse represents a risk to the European outlook, along with the upcoming French elections. — David Goldman