Category Archives: EU financial crisis

Brexit, sterling and the case for London stocks

July 6, 2016 By in Brexit, the UK, Uncategorized Tags: , , , , , Leave a comment

the UK stock market

I started to learn about the UK stock market in 1986, a scarily long time ago, when I took over management of a failing global fund.  I realized pretty quickly, though, that despite similarity with the US in language and accounting standards, London stocks trade on complex signals that are far different in kind from those I was familiar with in New York.  I ultimately decided that the large effort required to become proficient would pay too small a reward to justify making it.  So I remain more or less an innocent (read:  the dumb money) in that market to this day.

12% cheaper

Nevertheless, the large drop (about 12%) in the value of the pound against the dollar suggests to me that there will ultimately be a big post-Leave-vote equity investing opportunity in the UK.  If the government follows through on its plans to cut the corporate tax rate from the current 20% to 15% (something the EU would have opposed) and lowers interest rates as well, the potential would be substantially larger.

Two reasons:

Mexico

–Weak currencies most often mean strong stock markets.  The most striking example I can think of is Mexico in the 1980s.  Over that period, the peso lost 98% of its value against the US$.  Still, Mexican stocks were, in US$ terms, just about the best-performing in the world–outdoing the US stock market by a mile.

Three causes:  supportive economic policies by the Mexican government; currency decline gave Mexican exporters a powerful price advantage; and the currency collapse created substantial inflation, which prompted local investors to strongly prefer equities as a way of preserving the real value of their savings.

Yes, Mexico is an extreme, but stocks in the UK are now 12% cheaper in US dollars than they were a couple of weeks ago.  And the government appears to be preparing to implement significant economic stimulus.  So earnings prospects for many firms are substantially better.

currency markets lead the way

–currency fall typically comes in advance of stock market rise.  The lag may be months.  This is partly because the currency markets always seem to act far ahead of stocks and bonds.  It’s also because equity investors, particularly in Europe, want to see some evidence of earnings improvement–either actual results or management confirmation that the numbers are looking surprisingly good–before they are willing to act.

timing

The big question, I think, is not whether London stocks, especially multinationals or exporters, will do well.  It’s when the fallout from the Brexit vote will have fully played itself out in financial markets.  Given that European investors typically take the month of August off, and that the start of this annual vacation period is only a few weeks away, my guess is that this won’t be until close to Labor Day.

our neighbor’s house, banks and Grexit

June 29, 2016 By in Brexit, Uncategorized Tags: , , , Leave a comment

This post could also be titled, “Why bank stocks have never been my favorites.”

a mortgage loan story

There’s a house down the street from us that has been empty for the past seven or eight years.  It’s worth maybe $150,000.  The former owner stopped making mortgage and property tax payments in 2008(?), mailed the keys back to the bank that gave him the loan and left for another part of the country.

The local sheriff has seized the house for non-payment of taxes, which total maybe $20,000, and has tried to auction it off a number of times.  The minimum bid, which no one has offered, is the taxes owed.

Why no bidders?

The bank still has a lien on the house for the $300,000 mortgage it granted almost a decade ago when all the loan craziness was going on.

why I don’t like bank stocks

The bank is apparently still unwilling to recognize the loss it made on this loan.  I presume this is because if its books were scrubbed of all the similar dud loans it is carrying, the bank’s financials would look pretty awful.  So it pretends the loans are still good.  To some degree, but not totally, investors can see through the pretense and the bank’s stock (I don’t know which bank) probably trades at a discount to book value.  But the reality is hard to see from the outside.   This is why bank stocks make me uncomfortable.

from Brexit to Grexit

What does this have to do with Grexit?

Bank stocks throughout the EU plunged when the “Leave” side won in the Brexit vote.  That has very little to do with the UK, in my opinion.  But if Britain can leave the EU, so too, can Greece, whose economy has been moribund for close to a decade.  Leaving would allow Greece to devalue its currency and thereby give its economy at least a temporary boost.  That would only work if the country defaulted on its sovereign debt at the same time.  So default is a probable consequence of Grexit.  That would be very damaging to the EU banks whose vaults are stuffed with Athens-issued bonds.

 

Brexit, Grexit and Lehman

June 28, 2016 By in Brexit, Uncategorized Tags: , , Leave a comment

Just about two weeks ago, Finnish finance minister Alexander Stubb called a British vote to exit the EU Europe’s “Lehman moment,” meaning it would signal the onset of an economic catastrophe similar to the one that shook the world when we found out that the US investment bank Lehman Brothers was bankrupt in 2008.

How apt is the comparison?

…not much at all.  In fact, I think it’s kind of crazy.

Lehman

US and EU banks spent the middle of the last decade creating increasingly exotic and risky derivatives based on packages of home mortgage loans.  When there were no mortgages left to grant that might have any prayer of being repaid, the banks manufactured even more preposterous securities based on mortgages that far exceeded the mortgagees ability to repay, and where the amount lent exceeded the value of the property by a lot.  When the music stopped in 2008, institutions like Bear Stearns or Lehman, whose audited financials showed them with billions of dollars in shareholders’ funds, were filled instead with worthless mortgage-backed securities and were actually bankrupt.

That wasn’t the bad part.

Commerce around the world is based on trust and on the financial soundness of banks.  Firms normally send goods to customers in advance of being paid.   They get a bank IOU on shipment, which they can cash in either on delivery or shortly after.  When companies realized that the middleman bank could possibly declare bankruptcy while goods were still in transit and they were holding trade IOUs–meaning they would be unsecured creditors in a bankruptcy proceeding, to be paid at best a small fraction of the IOU amount, and even that a long time in the future–they stopped sending any merchandise   …to anyone.  World trade came to a standstill.

Just as bad, enterprise control software systems showed managements right away how large the losses were that they were incurring by not being able to sell anything.  They responded with mass layoffs of employees.  That made the economic situation even worse.

In comparison, Brexit is a walk in the park.

Grexit

Of course, the rhetoric of Stubb and other pro-Remain politicians is one of the reasons for the panic that has seized financial markets once the “Leave” result was returned.

The only possible point of comparison I can see is that Brexit could lead to Grexit, Greece exiting the EU.  So far, the austerity regimen imposed by the IMF and the European Central Bank on Greece, when that country confessed to have falsified its national accounts for many years and to be unable to service its government debts, has created nothing but misery for Greece.  Leaving the EU and devaluing its currency would be an alternate solution to Greece’s financial woes.  Were it to do so, however, Greece would likely default on its sovereign debt.  That would hurt the EU banks who still hold large swathes of it.

 

more Brexit

June 27, 2016 By in Brexit, Uncategorized Tags: , , , , 2 Comments

–At the open in London last Friday, the first time UK stocks could react to the “Leave” vote on Brexit, the benchmark FT 100 index plunged by about 10%, to a low of 5788.  It spent the rest of the day recovering something more than half those losses.  Today, the index is inching lower again, something I suspect will eventually result in a test of the Friday lows.  If I were forced to make a bet, I’d say the index ultimately bounces off that low rather than falling further. During this time, the market will likely also reorient itself to favor beneficiaries of Brexit and penalize losers from it.

I’d prefer to stay on the sidelines and watch.

–To me, the more striking–and probably more permanent–feature of the market reaction to Brexit is the close to 10% fall in sterling that the “leave” vote has triggered.  This offsets some of the harm done to exporters by placing them outside the walls of the EU, and thus subjecting them to the extra costs of tariffs and regulatory red tape.  But it also means an immediate drop in the standard of living of ordinary citizens, by raising the price of imported food, clothing and fuel.  We can look to Japan, which is suffering from double the UK level of currency decline, for insights into what this implies.

–It’s already appearing that Brexit will be a less cut-and-dried affair than I had imagined.  There appears to be plenty of parliamentary room for following the letter of Leave while retaining the substance of Remain.  We’ll see.

–Post-vote polling shows not only strong pro-Remain sentiment in Scotland and most urban areas in the UK, but also a very large age difference in voting patterns.  Support for Leave was strong among those over 50, with those over 65 intensely in favor of exit from the EU.  Younger citizens were equally strongly in favor of Remain.  The actual voting tally implies that the former group was out in full force on Thursday, while about half the latter neglected to cast a vote.  …a cautionary tale for the US?

the UK is leaving the EU building

June 24, 2016 By in Brexit, EU financial crisis, Uncategorized Tags: , , , , Leave a comment

The UK voted yesterday, by a 52% -48% margin, to leave the European Union.

What does this mean?

As I’m finishing this, at 9:00 am edt, sterling is down by about 6% vs the US$ and the Financial Times 100 is off by around 4%–meaning a total 10% loss for the index in US$ terms so far in today’s trading.  The euro is off by 2% against the US$; the EUROSTOXX 50, an index of the largest EU equities, is down by close to 9%.

Pre-market trading in the US suggests an opening decline of about 3% for the S&P 500, which is better than the -5% decline of around midnight, when the voting results were first announced.

My thoughts:

–my guess is that there won’t be much deep reflection behind trading in the US today. It will be more knee-jerk reaction.  So there’s a chance to upgrade a portfolio by buying economically sensitive stocks that may be being sold for no other reason than because they’re typically more responsive to the general ups and downs of the overall market.

–today’s fall in the UK index–so far, anyway–just brings it back to where it was ten days ago

–the earliest that the UK/EU relationship can change is in two years, so there’s plenty of time for new economic ties between the UK and the rest of the EU to be established.  I have no idea what those may be like, so I see no reason to base buying/selling on hunches about those possibilities

—currency is my guess for the most important factor that has changed.  Weakness in the euro and in sterling is good for multinationals in Europe that have large non-Europe customer bases.  By default, the US$ and the yen are stronger, making the road for US and Japanese multinationals a little tougher (the main reason, I suspect, that Japanese stocks fell by 7% overnight)–and therefore domestic-oriented companies a bit more attractive.

–the main concern in continental Europe is that the UK leaving may have a snowball effect, making it more likely that, say, Greece will exit

–UK polls and UK betting houses were very wrong about a last-minute pro-EU shift by the electorate.  The UK equivalent of Trump supporters–losers in globalization, anti-immigration and suspicious of career politicians–turned out in unexpectedly high numbers to vote to leave the EU.  Poll failure in highly emotionally charged circumstances is no real surprise:  people who hold what the think are socially unacceptable positions are always loathe to reveal their true thoughts to pollsters.  There will doubtless be some carryover into US politics from the Brexit vote.  Whether this is comfort to the Trump camp or increased vigilance in the Hillary corner remains to be seen.