Tags: Merkel | Fed | GDP | IMF

Continuity of No Change for the Eurozone

Tuesday, 24 September 2013 10:43 AM Current | Bio | Archive

I have my doubts if long-term investors have gotten any more enlightened information during the past seven days on where, in the near future, in the major developed as well as in emerging economies real sustainable (sound) economical recovery is taking place.

Probably the most important wake-up call for long-term investors, but also for traders, came last Wednesday when the Federal Open Market Committee decided to postpone tapering its quantitative easing. The main reason for not tapering last week was the remaining too important headwinds to the recovery because of reduced federal spending and rising mortgage rates.

Interestingly, and in sharp contrast to the disappointment of a vast the majority of markets participants all over the globe, on Thursday, Christine Lagarde, chief of the International Monetary Fund (IMF), openly expressed her support for the Fed's decision not to start tapering, noting that the Fed had done exactly what the IMF had repeatedly recommended since May.

In July, Lagarde said the Fed should begin tapering its bond-buying program at the end of 2013. So, the IMF doesn't see it as a question of "not to taper" but "when to start tapering."

Meanwhile, the IMF now expects U.S growth to slow down to 1.9 percent this year, down from 2.2 percent in 2012. For these estimates, the IMF took into account: 1) the impact of the sequester; 2) the expiration of the payroll tax cut; and 3) the rise in tax rates for high-income taxpayers.

In contrast, the Fed lowered its U.S. GDP growth estimates to 2.0 percent to 2.3 percent growth in 2013, down from 2.3 percent to 2.6 percent in June, and 2.9 percent to 3.1 percent growth in 2014, down from 3.0 percent to 3.5 percent in June. Its longer-run GDP growth estimate stands now at 2.2 percent to 2.5 percent, which is practically unchanged from June, but nevertheless not hinting yet any form of sound "escape velocity."

Interestingly, the IMF also says growth "could" pick up to 2.7 percent in 2014 if the United States applies a more moderate fiscal adjustment than is planned now, and if we see further strengthening in the housing market. Yes, here we go again with all those "ifs."

The Fed also now expects an unemployment rate in 2013 in the 7.1 percent to 7.3 percent range, and in the 6.4 percent to 6.8 percent range in 2014, while in the longer run it expects a 5.2 percent to 5.8 percent unemployment rate.

In case the Fed should "only" take these latest data into account for when it should start tapering, which of course is not the case, then one shouldn't expect tapering to start before 2014. Anyway, it's a fact the Fed will start tapering somewhere in the near future and it doesn't matter, certainly not to me and in the context of the long-term investor, if it's a couple of months earlier or later.

And then on Sunday we had the German elections that resulted in a clear win (strongest showing since 1990) for Chancellor Angela Merkel's Christian Democratic Union (CDU) party, which is associated with the Christian Social Union in Bavaria, with 41.5 percent of the votes, but that resulted in 311 seats, which is four seats short of a 315-seat absolute majority. So, to establish a stable government, Merkel will be obliged to look for, if possible, a solid and supportive coalition party for which only the "Green Party" and the Social Democratic Party (SPD) are eligible.

With what we know so far, it looks like neither of the possible coalition parties is ready to destroy themselves in view of the next elections within four years by becoming now the coalition party of Merkel's government, which occurred to the SPD when they shared government rule with Merkel in a so-called "grand coalition" from 2005 to 2009.

Already, SPD leader Peer Steinbruk said Monday he would not serve in such a "grand coalition" government again.

That said, I also can't see that Merkel and the majority of the German voters will change their attitudes of refusing further bailouts, not to mention forgiving debt or accepting joint liability instruments like the eurobonds.

Yes, concerning the eurozone all investors should be prepared for a continuity of no change and if any change would take place it would surely be small and at an extremely slow pace. Besides, we should also expect a third Greek program (and a fourth), a second Portuguese program (and a third) and so on. In the end it will be that most of the problems will be revolved and very little will be resolved. I wouldn't build on such a foundation.

I also think it would be helpful at some time in the future for understanding German politics to take notice of the fact that only in February of this year a new conservative euro-currency-skeptic German political party called Alternative for Germany (AfD) was founded. This party got 4.7 percent of the total 43.7 million valid votes, which was not enough to jump the 5 percent hurdle for entering the German Bundestag. By the way, AfD got 5.6 percent of the votes in what was before the reunification called "Eastern Germany."

In my opinion, long-term investors should not get enthusiastic at all for a smooth political riding that would allow deep structural reforms during the next four years in Germany and because of that in the eurozone and the European Union as a whole.

Yes, eurozone troubles will be back on the font burner earlier than most expect now.

For the moment, long-term investors would do well to put Italy back on their radar screens. To mention only one problem among many others, on Monday, Italian Economy Minister Fabrizio Saccomanni, who is a former high ranking Bank of Italy official, said he would resign if the coalition government flouted the EU deficit spending limits of 3 percent in favor of tax cuts. In simple words, really nothing has changed and probably we are bound for early elections within a few months or somewhere in early 2014.

I certainly wouldn't buy the hype that the eurozone is back from recession notwithstanding, at least for the time being, we see somewhat better Purchasing Managers' Indexes.

To put it all in context, here are some of the latest IMF growth estimates for 2013 GDP growth: World, +2.9 percent; eurozone, -0.6 percent; Germany, +0.3 percent; France, -0.2 percent; Italy, -1.8 percent; Spain, -1.6 percent; United Kingdom, +1.1 percent.

Finally, at this moment, at least to me, it's completely impossible to know if the U.S. debt ceiling debate will become a stumbling block for the country or not. So, let's remain calm and wait to see what happens.

As far as the stock markets are concerned, I still expect a protracted long and deep broad-based correction.

Technically speaking, one of the indexes I follow is the KBW Bank Index (BKX), which topped on Aug. at 66.17 and thereafter made a lower high relative to the Dow Jones Industrial Average and the Standard & Poor's 500, made new rally highs last week, which is a developing negative divergence.

On Monday, banks and financials were down hard. Remember, in 2007, it was the financials that led the downturn. The question now is if the BKX is definitively turning down.

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I have my doubts if long-term investors have gotten any more enlightened information during the past seven days on where, in the near future, in the major developed as well as in emerging economies real sustainable (sound) economical recovery is taking place.
Tuesday, 24 September 2013 10:43 AM
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