“I check my bank account more than you check your Instagram” Kid Ink

Is the recent rally of European banks an opportunity or a trap? A minority investor told me on Friday that “every time I buy banks, they are going up, but then I lose everything.” He did not understand the volatility and risk , especially when the press would not stop talking about banks “healthy” balance sheets and adequate results.

Let’s start with a general consideration. No, European banks are not fully cleaned up. They continue to accumulate more than 900 billion euros of non-performing loans (NPLs), and generate a return on net assets below their cost of capital. That is, they lose money.

It is true that valuations are not exaggerated, at 0.8 times price to adjusted book value, which is not expensive if you estimate a 9.9% ROTE (return on tangible assets) in 2017 and a dividend yield of 5.4%. The question is whether that ROTE and yield is achievable or sustainable.

European banks are trading at almost a 40% PE discount to US banks, but this discount is justified by the high exposure to European sovereign risk, the burden of NPLs and the very low profitability (Net Income margin is almost zero). In fact, the mistake investors make when talking about “value” with respect to US banking may lead to losses, because that discount has existed since 2001 and has moved close to an average of 20-30%, justified by lower profitability, less flexibility and the valuation of their loans with debatable criteria (instead of valuing them at market-to-market).

But there are positive elements as well as caution. The excess liquidity is at record levels since the European Central Bank Quantitative Easing started, and already reaches 1.3 trillion euros, showing the weakness of the program and its low effectiveness. Negative interest rates have sunk banking profits, with historic declines in consensus estimates. But that monetary ruin is about to end.

Rates are already rising and that means that an increase of 1% can improve EPS of banks by up to 17% , according to the average consensus sensitivities (Bloomberg).

60% of European banks now have more than twice the core capital than in 2012, which means that they are much more healthy, although the problems are not over. In addition, European banks have more than double the amount of short-term liquid assets than in 2012, which can be used for divestments and to undertake capital strengthening.

Today, deposit rates are negative and that is devastating for the financial sector. A higher deposit rate would improve the spread, and this is particularly beneficial for banks in peripheral countries. According to Morgan Stanley, a rise of 70 basis points in the deposit rate would raise the earnings per share of peripheral banks by more than + 15%. Interest rates would remain extremely low, so the impact on the economy would be non-existent, but financial repression would not jeopardize the sustainability of the banks.

Risks should not be ignored.

Today, banks are rallying due to different factors. The positioning of investors is extremely cautious and underweight in the financial sector and even more so in Europe, which can lead to significant capital flows to banks when that negative weighting is reduced in the portfolios.

The banks’ rally is based on a bet on an increase in inflation that may disappoint those who play to it now that oil remains in a lateral-bearish trend and underlying inflation expectations are not being revised upward.

In addition, this rally in banks is supported by another non-fundamental external expectation. The bet that the European Central Bank will aggressively change its monetary policy. All the indicators tell us that it should, that it is urgent and that maintaining it does more harm than good, but we must not forget the risk of maintaining financial repression and real negative rates because European governments are unable to tolerate on increase in cost of debt of 50 basis points. It is important, at least, to know that the rally in the stock market is explained by an inflationary bet and increases in rates in addition to the supposed cheap valuation (banks are always “optically cheap”). Because that “reflation trade” can reverse very quickly.

Let’s not forget another factor. With higher rates and inflation, non-performing loans rise as well, as companies continue to suffer from overcapacity and tax increases.

Banks demanded the ECB’s monetary expansion program, until they realized in horror that negative rates shattered their balance sheet and income statement. The monetary expansion that they applauded until their hands bled almost sent them to the cemetery.

It is not wrong to say that the banking system is much healthier than it was four years ago . Nor is it a lie to say that its structure of balance sheet and profitability is extremely fragile, and that its core capital ratios can evaporate with a small change of the cycle. Therefore, to assume that the era of  huge provisions is over is to be very optimistic. To think that there are no additional capital needs is reckless.

The combination of valuation, improvement of the cycle in Europe, change of monetary policy and return to a certain sanity with interest rates are factors that put banks’ head above water.

As a good friend, investor in the financial sector, once told me “you do not buy banks, you rent them”. Cycles are getting shorter and the challenges of the financial sector are not over, so active trading is recommended.

Daniel Lacalle is a PhD in Economics, fund manager and author of Life In The Financial Markets, The Energy World Is Flat (Wiley) and Escape from the Central Bank Trap (BEP).

Image courtesy Google Images, starecat.com

” If I can not have you the way I want you, I do not want you at all ” Dr. Feelgood

Brexit has been launched. Mainstream consensus is going through the typical phases of anger (“this cannot be”), shock (“only uneducated, old, and fascists have voted exit”), denial (“it will be stopped by parliament or the commons”) and now we approach, slowly, to the phase of acceptance .

And there it is: Article 50.

The first thing we must be is intellectually honest and recognize that the estimates of an economic debacle post-referendum have not happened. The consensus estimated negative impacts if Brexit won the referendum that did not appear anywhere. The devaluation of the Pound is nothing more than losing the premium it reached with against the Euro on fears of the Eurozone crisis, and GBP-EUR trades at average levels of ten years. All other indicators, in the EU and UK, have been strengthening. Growth and job creation in the UK have been revised upward by the Bank of England and investment banks.

The UK economy continues to grow, with a 20bps increase over post-referendum estimates, bringing GDP growth for 2017 at 1.6%. In addition to the recent revaluation of the Pound against the Euro, we have seen a similar improvement in estimates for the European Union, where GDP growth expectations have been revised up to 1.6% for 2017 and 1.8% for 2018.

So all is good, is it not?

The truth is that all this happens because there was already a very independent framework in the UK and a dynamic economic environment that makes the risk much lower. But we cannot forget that the arrival in the US of the Trump administration adds an essential support to the UK that mitigates risks.

The fact that these concerns and doom expectations have not yet manifested does not mean that risks do not exist, especially in the face of a tense, long and hard negotiation in which both sides have very different positions. Add to all this the calls for referendums from Scotland and Northern Ireland. In the UK, oddly enough, many see a separate Scotland as a historic opportunity for Labor to disappear from the options of government in England, as Scotland is a stronghold of the left.

It seems that the process of reaching agreement can last between two and three years, a period that will surely be full of aggressive messages in the media.

The European Union will not want to leave a bad example of weak negotiation in order not to generate a domino effect, as it faces the rise of internal Euroscepticism. If the European Union was smart, it would use this opportunity to strengthen as an area of freedom, flexibility, attractive investment and global trade. If it falls into the mistake of using the excuse of Brexit to advance in what some call “more Europe” -which means more bureaucracy and interventionism-, the EU is bound to fail. More Europe should be more investment, better employment, and stronger growth,

More Europe should be more investment, better employment, and stronger growth, fewer taxes and burdens, not more committees, taxes, and subsidies.

Expect a couple of years of uncertainty, but let’s be honest in narrowing expectations, both optimistic and pessimistic ones.

Exports and imports

UK production only reduced 0.4% using official data, in the first months of 2017 , due to a decrease in the pharmaceutical sector of 0.9% due mostly to the uncertainty of the Trump healthcare plan, not from Brexit.

The UK trade deficit has fallen to 4.7 billion pounds in the three months to January. Exports have grown at the fastest pace in ten years in the quarter, reaching a record high, and imports have also skyrocketed. Therefore, the impact on trade that many predicted is nowhere to be seen at the moment. The UK is one of the biggest trading partners of the EU, and it will continue to be.

Who pays?

The United Kingdom is the second largest net contributor, after Germany, to the EU budget. That cost will have to be distributed among the others, and Spain, for example, would have to pay around 1 billion euros more per year.

Immigration

An extremely important topic. Net immigration from Europe to the UK has more than doubled since 2012, according to a report by Capital Economics, reaching 185,000 people. Total net immigration has also skyrocketed, reaching more than 320,000 people, compared with a historical average of 150,000, according to the British government.

The free movement of citizens and the rights of EU workers in the United Kingdom and those of the British in the rest of Europe will likely be the ace card used to accelerate negotiations. The UK does not want to outsource its immigration policy to the European Union, as it does not have a clear one or exercise leadership in the face of geopolitical challenges. Be that as it may, the days of the free movement of workers are over, and a policy similar to that of the United States could be expected.

Trade

Nearly half of UK exports go to the EU, but -disaggregated- of the 28 countries, 26 have huge trade surpluses with the United Kingdom. What does that mean? The EU, country by country, exports more to Britain than it imports. That is important, especially with the country that has the largest surplus with the UK, Germany.

The UK has a high deficit in trade in goods, but a huge surplus in services. All this means that the exit from the single market can have an impact, but that the solution for each other depends on a fast and specific agreement for the United Kingdom.

Financial sector

With the latest data available, the UK exports 19.4 billion pounds per year in financial services to the EU, a surplus close to 0.9% of GDP. This is a big stumbling block. It is not clear if financial institutions will have a passport to operate with the EU or if the finance sector will face limitations. The United Kingdom originates almost 20% of loans for EU infrastructure projects, according to the City report.

Regulation

According to Capital Economics and Open Europe, the cost to the UK of the 100 most expensive rules and regulations of the European Union is 33 billion pounds a year. Excessive bureaucracy and high taxes have limited potential growth and investment in Europe, particularly in the past eight years.

If the European Union does not take the initiative and begins to dismantle the bureaucratic ‘leviathan’ it has built, this cost will be a problem for many countries. But then, we must not miss out on the fact that the UK is already one of the leading countries in ease of doing business. Therefore, eliminating unnecessary regulation and bureaucracy is one of the aces up the sleeve to attract investment to the UK post-Brexit .

Foreign investment

The European Union accounts for almost 46% of foreign investment to the United Kingdom, mainly due to the purchase by multinational companies of other British companies. This flow is not expected to be reduced and, of course, could be easily replaced. European investment has already reduced in recent years and has been more than offset by other countries.

UK investment into the EU will not likely be reduced due to Brexit. If anything, it will increase, given the opportunity to develop activities within the EU and move part of some businesses abroad.

We are approaching a period of maximum uncertainty, but the opportunity is enormous. The European Union can come out of these negotiations strengthened, learning from its mistakes, reducing bureaucracy and attracting investment and capital. It is also an opportunity for the UK to thrive.

I believe Brexit is not going to be a zero-sum game. The challenges presented are only opportunities. If we take them, it is a chance to grow, be more prosperous, and regain leadership. If the bureaucrats see an opportunity to advance in the wrong union project, consumed by interventionism and high taxes, all Europeans will be guilty of our own failure. I believe that the European Union should leave its cave and become a world leader in trade, growth, employment and investment attraction.

Let us not fall into the mistake of thinking that the European Union is marvelous and the British are wrong, that the union must remain a bureaucratic dinosaur. As they say in England, “hope for the best, but prepare for the worst “, because the combination of arrogance and ignorance is very dangerous.

Daniel Lacalle is a PhD in Economics, fund manager and author of Life In The Financial Markets, The Energy World Is Flat (Wiley) and Escape from the Central Bank Trap (BEP).

Image courtesy Google Images, starecat.com

The European Union is 60 years old today, and it faces enormous challenges.

One wakes up every week with news about the European Union that do not help at all to improve its credibility and popular support. Brussels and the EU seem so detached from the reality of economies and citizens that their top leaders do not even blink or wonder if it is a good idea to say things like “taxes cannot be lowered” (Schaeuble), or that “Brussels dismantles the Spanish government’s excuses to resist raising VAT.” Thank you, Euro-bureaucrats.

It is very dangerous that a European Union, which has unquestionable advantages and must become a global power of growth and prosperity, puts obstacles and expels citizens and companies just to perpetuate a bureaucratic monster.

Brussels estimates that increasing VAT would “barely” affect low income families and that the increase in inequality – “only” of 2.6% – could be offset by social transfers. That is, raising VAT “barely” affects low incomes but, as it actually does and also increases inequality, they propose to mitigate it with more subsidies via spending. Bravo. Brilliant. .

For Brussels there is never a negative effect on consumption, employment or economic activity of raising taxes. It never questions government spending. And then they wonder why the EU grows less and has more debt and unemployment than its peers.

The reality, already demonstrated, is that increasing taxes has a direct impact on potential consumption, the purchasing power of families and, in addition, reduces the job creation potential.

Brussels should recognize that it has been wrong for years in its growth and employment forecasts, and analyze why. Applying a bureaucratic directed economy model everywhere impacts growth, prosperity and productivity.

The European Commission loves non-finalist taxes. The so-called “green” ones are a real joke. The consumer still pays the massive “green” subsidies, but they also pay for added “green” taxes. EU citizens pay twice. For the subsidies, and for being so mean as to use a car.

In spending and taxes, the pattern is always the same. For Brussels, to harmonize is raise taxes and spending. It does not question the economic suffocation that takes place in France or other countries. It demands the other EU nations to reach an average -always in tax burden and spending- that France increases disproportionately.

The reality is that, often, the recommendations of the European Commission do not seek to reduce imbalances and promote competitiveness, the creation and attraction of capital and employment. What they do is to perpetuate a “dirigiste” model copied from France that only generates stagnation and greater discontent.

Even in the document where the European Union “explains” why it is not a bureaucratic and excess spending entity, it “clarifies” that “states and local governments will continue to control tax increases” (note that it does not say “manage” or “cut” taxes, but only “increases”). Thank you. It also “explains” that it “only” spends 1% of the wealth of the countries, and that these countries – thank you – spend much more.

The European Union has many enemies, and – let’s be clear – some are at home. Those that defend and justify a model of increasing tax burden and higher interventionism as unquestionnable. Those of us who criticize the EU’s obvious mistakes want a European Union that solves them, not one that follows the ostrich policy of blaming others for its problems.

The tax burden in the European Union has reached historical highs – of 40% of GDP – while ease of doing business deteriorates due to bureacracy and massive regulatory burden. At the same time, while companies and families struggle, the bureaucrats in Brussels reject to make any change that allows the economy to breathe.

The best way to combat those who unjustly criticize the European Union is with actions. Lowering, not raising taxes, as citizens, companies and the ECB demand.

Against the voices accusing the EU of interventionist and bureaucratic, the EU must take action to improve efficiency dramatically and improve ease of doing business. Focus on the countries that grow and are world leaders, not equalize imbalances in a model that only creates stagnation.

We have a golden opportunity in the face of external and internal threats . It is not an opportunity to justify that “there is room” to raise taxes, nor an opportunity to confuse “more Europe” with “more bureaucracy”. It is not an opportunity to attack those who grow, have surplus and create jobs . It is a chance to drastically improve in economic freedom, ease of doing business, open market and increasing disposable income for families, letting job creators do their work.

The EU has in its hands all the tools to be better and more competitive. More Europe is not more bureaucracy.

The European Union cannot continue to settle for being a low growth, high debt, huge tax burden area, penalizing its citizens and companies, the same ones who have bailed-out the bureaucratic leviathan from the crisis.

If we do not wake up immediately from the comfortable deification of bureaucracy and fiscal robbery, the European Union, which is a project worth fighting for, will perish in the face of its own inaction. I do not want it to happen. But I assure you that, if it does happen, I will not blame the EU’s  collapse on the outside enemy excuse, when we have had in our hands all the tools to be stronger, better and more competitive.

Citizens and businesses are not ATMs to pay for political excesses, they are the clients of a European Union that must be at the service of the economic agents who contribute and create jobs, not at the service of bureaucracy.

Daniel Lacalle is a PhD in Economics and author of Life In The Financial Markets, The Energy World Is Flat (Wiley) and Escape from the Central Bank Trap (BEP).

The position of the European Union (Brussels) and some economic commentators on technology multinationals should not surprise us. However, it is totally wrong. It is a short-sighted view, oriented from an incorrect fiscal point of view, and it hides a bigger problem. Europe has lost the technology and innovation race, and it will not recover its position with fiscal repression.

However, using subterfuges of “tax fairness”, they try. We should remember that:

– Corporate taxes are not paid where goods are sold, but where the added value is generated. The European Union itself states that when a sale is made via e-commerce, the VAT on that product will be subject to the tax rate fixed in the country of residence of the company, not that of the consumers making the purchase. The same is true with the declaration of VAT itself. To debate now about alleged corporate tax avoidance is funny because the European Union fights tooth and nail to defend this completely logical fiscal policy for its multinationals and industrial conglomerates in their investments in emerging markets. Regardless, it attacks technological companies. Because they are not European monster dinosaur conglomerates?

When looking at the tax contribution of multinationals, using a localist vision detracts from their global benefit. For example, Google paid more than 18% in corporate tax in 2016, almost €4 billion euros, 80% in the USA, where the company is headquartered and where it generates most of the added value, its technology, and systems. However, it generates almost 38% of its total employment abroad, investing in start-ups and established businesses up to 40% of the total, which generates a multiplier effect throughout the global economy.

But, above all, this misguided attack on technology giants shows the failure of the European model, which has subsidized and perpetuated its industrial conglomerates by putting barriers to the creation, innovation, and growth of the technological sector. Now, the EU finds that it not only has no leaders in the technological race but that it did not “protect” jobs nor tax revenues.

– The EU forgets the very important positive impact on employment, quality of jobs, indirect taxes and change in the economy growth pattern that these companies create. Why? Because they are American. If they were French, German or Rent-Seeking sectors, they would be receiving tens of billions in subsidies.

It is no surprise that, according to a Linkedin ranking, the most desired companies to work are Google, Salesforce, Facebook, Apple, and Amazon. Google is a clear example, whose more than 60,000 employees enjoy a better quality and pay (more than 30% above than the average of their similar jobs in the countries where it operates). Meanwhile, some people in Brussels hope that jobs and higher wages will be achieved subsidizing unions.

The European Union spends more than 1% of its GDP on “employment policies” which include huge government spending in inefficient programs and massive subsidies to obsolete sectors. It also generates thousands of pages of regulation to “protect” its so-called “national champions”, which in turn are also accused of paying little taxes because they go from ruinous acquisition to ruinous acquisition in their empire-building quest for inorganic growth. While in the OECD, the average expenditure on active employment policies does not exceed 0.6% of GDP, and in the US it is 0.15%, in Spain it was 0.9% in 2011 and in France, it exceeded 1.5% of its gross domestic product. What if we spent less on those useless grants and subsidies that have proven to be inefficient, and started to facilitate the implementation and creation of new technology leaders?

– The EU’s short-sighted analysis of technology giants also forgets the impact of certain services that are free for users and financed with advertising. For example, a search engine. Or Google Maps. A study by Hal Varian quantifies an impact of 800 billion US dollars created by a search engine due to savings, efficiencies, possibility to compare products by consumers and choose the cheapest, as well as the impact of advertising services.

We should not only ask ourselves why does the EU put barriers to companies that create better jobs and with greater benefits, but to analyze very seriously why the error of “protecting” the so-called national champions lingers on. First, because they do not need it, they have their well-deserved niche, but they are mature businesses and, by definition, wary of change. Second, because we are suffering the consequences of rejecting investments and capital that supports a stronger growth pattern. The European Union should ask itself why Skype was created in Estonia and not in Brussels.

In addition, we forget the multiplier effect in the non-technological economy. A study by ITSOS shows that SMEs grow and create jobs up to three times more those that do not use those digital services which, in addition, are free for the user.

If we really considered the fiscal, employment and growth issues in a serious way, we would support big technology companies, letting them grow in our countries because the tax effect in corporate and income taxes from their contribution to the real economy is much greater. The multiplier effect is very evident in Ireland. The country, with an attractive fiscal policy, has cut its deficit by 12 points, eliminating it, and unemployment has fallen to 6.6% with youth unemployment at 15%, the lowest since 2008. All this, without reducing public services. But, instead, Brussels thinks that the problem is that “technology companies do not pay taxes”. It is untrue, to start with. They all comply with the rules of the country. The real problem is that perpetuating obsolete dinosaurs is useless.

The European Union has a very important challenge, which is to become the engine of change and progress that it deserves to be. Because the process of the democratization of technology and the new patterns of growth is unstoppable.

Looking at multinationals from a myopic perspective, only leads us to lose the future. If we take into account the immense market that is Europe and the enormous potential of its influence in the world, we should think more about doing what the US does and less about copying Japan. Do you remember the technological “keiretsu” giants that were going to sweep the world in the early 90’s? Exactly. Neither do I.

In Europe, we need more FANG (Facebook, Amazon, Netflix and Google) and less bureaucrat-gang.

Daniel Lacalle is a PhD in Economics and author of Life In The Financial Markets, The Energy World Is Flat (Wiley) and Escape from the Central Bank Trap (BEP).