Category Archives: Europe

Europe

The End Of Earnings Recession in Europe?

Europe, Global Economy, On the cover, Sin categoría

It seems that the earnings season in Europe is showing us its kind face after more than six years of disappointments and constant downward revisions (read). The earnings recession has been evident in domestic turnover, tax bases and the ability to repay debt, which did not improve in Europe despite the low interest rates – because cash generation was deteriorating more quickly.

According to Morgan Stanley, out of the 75 companies that have reported – although it is only a small part, 15% of the market capitalization – 43% have beaten estimates by 5% or more, while only 29% have disappointed. The rest were”in line” with expectations. So far, these have been the best results of the past 6 years.

Faith in earnings recovery is centered on four pillars:

. Better commodity prices – which helps oil companies and electricity generators -,

. improvement in the performance of banks with more inflation and less provisions,

. upward revisions of global growth

. …and widespread margin improvement.

There are still many results to analyze, but it is worth noting that this recent improvement is promising, albeit not without risks.

– It is true that a little inflation would help the financial sector to get their head above water and breathe a little. Banks are trying their own medicine. They spent years demanding monetary expansion and now they suffer the collapse of margins due to negative real interests. But the European banks’ writedown trend is far from over, and the burden of NPLs (non-performing loans), which exceeds €200 billion, still require a large number of capital increases. The recent results by Deutsche Bank show that the pain is far from over.

– The recent increase in commodities has not generated the positive results that consensus expected in energy. The results of the large European conglomerates are, so far, quite poor, with only one exception, Total, that has been doing its homework for many years.

– We have to pay attention to the negative surprise in the earnings of Consumer Staples, a 7% negative surprise and 5% overall decline, as European growth expectations come mainly from the hope of higher consumption.

Of course, analysts and investment banks are encouraged by the increase in inflation. However, we have to pay more attention to core inflation, since we may encounter a stagflation problem if prices rise due to food and energy while the economy remains anemic.

In any case, we must highlight the good news. If the positive surprise in earnings is maintained until the end of the results season and extended to 2017 guidance, we could be facing the end of the earnings recession, which is an essential factor to believe in a true recovery.

If this profits recession is not reversed in 2017, we could face a much greater problem. Why?

If profits do not start to grow in Europe in 2017, the “tailwind” effect of low interest rates and cheap commodities will dissipate before companies have improved their ability to reduce debt.

European companies can be the positive surprise of 2017 despite the political turmoil and the likely ECB tapering.

Many investors tell me all this does not matter, because European stocks are cheaper than the US market. Let me give a warning. It’s almost always the same. Apart from the fact that the composition of the indices is very different -technology and high added value in the US compared to low-growth banks and conglomerates in Europe-, investors must remember that when US companies have excess cash and liquidity, they buy back shares and increase dividends. European companies, the vast majority, don’t.

We have to follow the earnings trend. It’s tedious and less sexy than talking about political conspiracies, but without an obvious and unquestionable improvement in corporate profits, the European rebound will be nothing but a mirage… again.

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

Graph courtesy Morgan Stanley

Oil and Frexit: Two Concerns in a Complacent Environment

Energy, Europe, Global Economy, On the cover, Sin categoría

We cannot deny that we are in an environment where global growth and leading indicators show more positive prospects than expected. We have gone from fear to hope – as we explained here – and the US data once again shows strength after the declines seen before the elections. Add to that an increase in expectations of oil demand and the improvement in manufacturing index in Europe.

However, there are two risks. Inflation is mostly coming from energy import costs, and the risk of default from France is rising in the face of the threat to “leave the Euro”

The report of the IEA (International Energy Agency) published yesterday shows us positive and negative data.

Demand growth revised upwards to +1.6 mb/d

  • OPEC production is down 1 mb/d y/y
  • Non-OPEC output is down 0.4 mb/d y/y
  • OECD stocks fall at a rate of 800 kb/d in 4Q.
  • This is balanced by high absolute level of stocks.
  • and US supply growth revised up by 0.1 mbd, now forecast to grow 520 kb/d Dec ’17 vs Dec ’16

Oil demand has been revised upwards to 1.6 million barrels a day by 2017, which indicates that after years of anaemic economic growth and poor demand, it can be a signal a global of improvement. But we must be cautious, given the high level of inventories and the likely seasonal effect. At the moment, OPEC production cuts may seem like a “success”, but as it happens, US production continues to pick up. In addition, the response from consumers happens faster, with substitution and technology accelerating. The world cannot afford an oil shock because of a short-term policy of producers.

It has always been said that the world goes into crisis when the oil burden – the cost of importing oil over total GDP – exceeds 5%. It is rather the opposite, energy overpricing is triggered by the inflationary effect of stimulus policies, and overcapacity and debt remain, triggering a crisis.

At the moment the rise in oil prices comes because producers cut supply, but the impact of these incorrect decisions always generates a response from consumers that accelerates the substitution and diversification of non-cartel producers.

What is the problem? For consumer economies it will have an impact on growth. Imports soar, competitiveness is eroded… but there is some hope. Just as the 2016 oil price recovery did not reduce Spain or Europe’s growth – in fact, it was better than expected – it should not be a recession-leading factor in 2017 as prices remain low. The fact that oil is below $ 57 a barrel (Brent) and is anchored in a very narrow trading range despite the production cuts, shows us that the marklet is very well supplied.

Frexit. The biggest bankruptcy in history?

A couple of days ago, David Rachline of the National Front in France, decided to go to the manual of unicorns ‘Made In Varoufakis and Podemos‘ and state that “the debt of France is about 2 trillion euros, about 1.7 are issued under French law, which means that they can be re-denominated.” Easy, isn’t it?. Your loans in euros can be returned in French Francs … and he thinks – he says – that nothing will happen.

Nothing. Only the collapse of France’s pension and social security system, which is mostly invested in sovereign debt, the destruction of the savings of millions of citizens, and the bankruptcy domino of the French banks. Let us remember that more than 40% of France’s Government Debt is held by the French savers, pensions and institutions.

No amount of money printing would mitigate the impact of an effective default in France, and the contagion on the rest of the Eurozone.

The magic idea of ​​thinking that sinking the currency and defaulting is going to improve the economy is based on three lies:

  • That a default will not affect new credit and access to future financing. To think that they are going to default and investors will lend France more, and cheaper, is so ridiculous it can only be defended by a politician with a straight face.
  • That defaulting does not affect citizens. Not only are their savings and pensions destroyed, so are their deposits – by devaluation and the inevitable bank run -, but access to credit from SMEs and families disappears, even if they want to invent a thousand public banks printing papers.
  • That they can “contain” the brutal impact (which the National Front themselves expect) with a fictitious second currency that will be “closely pegged” to the euro while the transition takes place. A trainwreck in slow motion. It would collapse the Euro and the “closely pegged” currency as well.

If France were to carry out this atrocity, it would be the biggest credit event seen in recent history and, considering that the assets of the French banking system exceed the country’s GDP by more than three times, it would be an implosion that no serious person would think would go away printing French Francs.

Banks’ outstanding home sovereign and sub-sovereign securities represented 6.4 per cent of total assets in the EU as of February 2016, according to Standard & Poor’s… A credit event of the magnitude of France re-denominating its debt, and the subsequent contagion risk throughout the Eurozone, would lead French and European banks to collapse.

Someone should tell LePen that her plan has already been carried out. By Argentina. And its currency lost 13 zeros in 40 years.

It is terrifying to see that citizens are led to believe in these fake magical proposals to which the totalitarian populists have accustomed us. But it is even scarier to see that the European populists believe these ideas have not worked in the past because they were not implemented by them. The idea that economic imbalances caused by printing money without control is solved by printing even more money with much less control. Brilliant.

The good news is that crisis after crisis, each credit event after another, it becomes increasingly clear that the populists’ technical capacity to destroy the economy and plunge their citizens’ wealth with magical “solutions” is diminishing.

French candidates must warn of the devastating effect of these pyromaniac ideas.

It is sad to see that there is still someone out there who believes that sinking the currency and defaulting will make us richer and borrow at lower costs. It shows us that we did not explain currently our past generations that Santa Claus does not exist.

 

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

 

France. Europe’s biggest problem… and its solution

Europe, Global Economy, On the cover, Sin categoría

Forget about Brexit or Trump. The big problem that threatens the European Union is France.

The French elections are much more important to the future of the EU than any other global geopolitical event.

On Monday we will know in detail the economic programs of the main candidates, but unfortunately, we can imagine that most promises will come on the side of increasing imbalances and magic solutions. Announcing reforms that are not followed and continue with an unsustainable model of stagnation has become the norm.

Of course, Le Pen promises to get out of the Euro in an orderly fashion, which is like saying that you’re going to stab yourself gently. A joke. Proponents of populism always try to solve structural problems destroying the country, devaluing and decimating the middle class with rampant inflation.

France is both the big problem and the solution for Europe.  An unsustainable economic model that presidential candidate Macron himself has called “sclerotic“.

A huge part of the problem is a public sector that exceeds 22% of the workforce and accounts for almost 48% of the budget, with one of the largest public expenditures of the OECD – the seventh largest in the world. But that would not be a problem if the country grew and improved its international position. The serious mistake is that this model of “directed economy”, socialist no matter who wins, has led to stagnation for more than two decades, high debt and excessive deficits for a leading economy and, in addition, France has been losing positions relative to Germany, its main comparable.

The other challenge is that, in order to finance this huge public expenditure, it always raises taxes, with a tax burden that is the highest in the Eurozone. A labour market rigidity and tax burden that limits growth, business creation, employment and competitiveness.

Despite constant tax increases, the country continues to miss its deficit targets because the economy, after a few brief quarters of hope, falls again and again into stagnation.

France has not only seen its exports lose weight globally, but its neighbour Germany reach a record historical trade surplus while reducing unemployment to all-time lows. That is, almost full employment.

The worst is that the massive labour rigidity does not protect,  and youth unemployment remains above 24%, France’s unemployment rate is double that of Germany or the UK, and it creates fewer jobs than any of its comparable economies. The government itself recognises that between 1998 and 2015, labour costs have risen by more than 50% but productivity has barely grown by 20%.

It is worrying and at the same time sad that much of the French parliament, instead of analysing the weakening economic power versus Germany or the world’s leading countries, prefers to justify itself stating that peripheral countries fare worse.

On Thursday I was in a conference on the Brexit opportunities with representatives of the main cities bidding to attract capital from the process, Frankfurt, Paris and Dublin. The representative of Paris, when asked about labour rigidity and high taxes, could only respond diplomatically, saying that France offered “security.” A member of the audience later commented “security that taxes will rise”.

But France is also the solution for Europe. It has all the ingredients to carry out a revolution like the one that Schroder carried out in Germany, taking the country from being the “sick man of Europe” to the leader of the continent. It can set in motion a real reform plan that puts France in par with leading economies, not justifying itself with the data of the worst performers.

If France recovers its economic leadership by putting competitiveness, attracting capital, strengthening disposable income, cutting axes and spending slack, and eliminating the perverse incentives of the dinosaur conglomerates, it will save Europe.

If France insists on remaining in denial, and ignore the imbalances that separate it each year further from the leading economies, it will destroy the European Union. Because, meanwhile, the “aristocrats of public spending” and the governments of the periphery compare themselves with France, as always, in how much spending and taxes have to rise, with the slogan that “we are below average.” An EU average that disproportionately rises because of France, and leads others to perpetuate, with the applause of populists, wasteful spend, debt and becoming a tax hell. Meanwhile, France perpetuates its stagnation with the excuse that the periphery does worse. It looks like a competition of students to see who fails more exams, only to blame the teacher.

If France thinks that denying reality and perpetuating an unsustainable model will be solved with magic solutions of printing money and devaluing, it will fail -again- and destroy the EU with it.

No, the problem of Europe and the euro is not Brexit nor Trump. It’s France. The problem, and the solution.

 

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

Article published in Spanish in El Español.

Cartoon courtesy Globecartoon.com, Chappatte