Tag Archives: EU

the EU today: structural adjustment needed

July 14, 2016 By in economic problems in emerging countries, economics, emerging markets, EU financial crisis, Japanese development, Long-term themes, Uncategorized Tags: , , , , , Leave a comment

Let’s assume that my description of the EU ex the UK is correct–that beneficiaries of the traditional order (the elites) are, and will continue to be, successful at thwarting structural change that would rock tradition but produce higher economic growth.

How should an equity investor proceed?

There are two schools of thought, not necessarily mutually incompatible:

–the first is that in an area where there is little growth, companies with strong fundamentals will stand out even more from the crowd.  This lucky few will therefore gain much of the local investor interest, plus the vast majority of foreign investor attention.  If so, in places like continental Europe or Japan one should look for fast-growing mid-cap companies with global sales potential for their products and services.  These will almost certainly outperform the market.

The more important question for an equity investor is whether they will do as well as similar companies domiciled and traded elsewhere.

–my personal observation is that the general malaise that affects stock markets in low-growth areas like Japan or the EU infects the fast growers as well.  The result is that they don’t do as well as similar companies elsewhere.  I haven’t tried to quantify the difference, but it’s what I’ve observed over the years.

It may be that the local market is offended by brash upstarts.  It may be that local portfolio managers deal only in book value and dividend yield as metrics.  It may simply be the fact that local laws prevent owners from eventually selling to the highest bidder, thereby damping down the ultimate upside for the stock.  One other effect of a situation like this is, of course, that entrepreneurs leave and set their companies up elsewhere.

 

The bottom line for a growth investor like me is that these areas become markets for the occasional special situation, not places where I want to be fully invested most of the time.  Because of this, and because of Brexit, the UK assumes greater importance for me.  So, too, Hong Kong, as an avenue into mainland China.  And to the degree I want to have direct international exposure–which means I want to avoid the US for whatever reason–emerging markets also come into play.

 

A final thought:  one could argue that the lack of investment appeal I perceive in Japan and continental Europe has nothing to do with political or cultural choices.  Both areas have relatively old populations.  If it’s simply demographics, signs of similar trouble should be appearing in the US within a decade.  I don’t think this is correct, but as investors we should all be attentive to possible signs.

 

internal/external adjustment and the EU

July 13, 2016 By in Brexit, economics, Uncategorized Tags: , , , , , Leave a comment

Yesterday I wrote about the tools a country has available if it faces a combination of sluggish GDP growth, excessive borrowing/weak banks and non-competitive industry (processes are outmoded and costs are too high).  Greece is the poster child among EU countries   …but Italy is the major EU economy that this description calls to mind.  France is riding a compartment or two away.

What can an EU country whose economy is structurally out of balance do?

Well, external adjustment–meaning currency depreciation–is out, since it’s part of the euro.

That leaves internal adjustment, which can take three forms:

–tariff or other regulatory barriers.  Yes, the EU can, and does, erect barriers to protect local industries against imports.  But most EU countries trade more with each other than the outside world.  So, say, Italy can’t bar imports from super-competitive Germany or lower-cost eastern Europe.

–slowing the borrowing, which is intended to maintain the current (unsustainable) lifestyle, by raising interest rates in a way that will cause a recession.  This is the German “austerity” solution, which few, if any, other countries (nor any politicians concerned about being reelected) will willingly adopt.  The EU experience after the 2008-09 recession shows austerity doesn’t work particularly well, either.

–that leaves structural reform.

This gets me to why I started writing about this.  Paul Krugman recently reviewed a book I haven’t read, The End of Alchemy, by  the former head of the Bank of England, Mervyn King. In the review, found in the New York Review of Books, Krugman says of King:

“He argues that Europe’s imbalances in production costs and hence in trade are too large to be resolved without either abandoning the euro or moving to full political union, and that given the lack of will for the latter, the former it must eventually be.”

What grabbed me is the “imbalances in production costs” part.   In other words, despite almost two decades of having the euro, plus all the time before its debut when companies knew it was coming, inefficient EU countries have done very little to bring their production costs down.  In addition, the reason Mr. King gives for this is “the lack of will.”  In other words, the forces of the status quo, aimed at preserving local fiefdoms (both political and industrial), are so strong that no progress can–or will–be made.

Sounds a lot like Japan, with a twenty-year lag.

Tomorrow:  investment consequences, if the King/Krugman analysis is correct.

 

 

Brexit looming

June 16, 2016 By in Brexit, Uncategorized Tags: , , , , Leave a comment

Voting takes place a week from today in the UK on the question of whether the country should remain in the EU or leave.

If the vote is in favor of Brexit, the government will presumably inform Brussels of its intention to depart, which will start the clock on a two-year waiting period before Britain can officially withdraw.

Recent polls have begun to show for the first time that a majority of citizens favor severing ties with the EU.  This is the reason for recent weakness in London stocks.

My thoughts:

–polls on issues like this are notoriously unreliable.  Some are either tacitly or overtly political, with question design (on the order of “You do favor leaving the EU, don’t you?”) slanted to one side or the other.  As far as internet surveys go, it’s impossible to know whether the respondents are a representative sample of likely voters.  During in-person, and especially during phone, interviews, respondents often tend to be less than truthful, giving instead what they perceive to be expected responses

–Pro voters, who seem to think that exiting the EU will return Britain to its eighteenth-century glory, are delusional

–the two-year waiting period gives both sides time to renegotiate trade agreements (almost half of Britain’s exports are to the rest of the EU).  It’s reasonable, I think, to assume that new agreements will be less favorable than the current ones.  But it’s hard to know whether they’ll make a significant practical difference

–non-EU multinationals who have located operating divisions and general headquarters in the UK because of its being inside the EU will presumably begin to shift operations elsewhere (Ireland?)

–as far as portfolio investors like us are concerned, the main direct economic effect of Britain leaving the union will likely be the weakening of the currency that’s happening now.  So far there has been no counterbalancing positive movement by stocks where the costs incurred by the underlying companies are primarily in sterling but where revenues are in euros or dollars.  Such firms, however, should be star performers if the vote is for Brexit and as the currency stabilizes.

 

My conclusion:  prepare to buy multinationals traded in London on a further selloff that will likely occur if the vote next week is for Brexit.

thinking about Brexit

June 9, 2016 By in Brexit, EU financial crisis, Uncategorized Tags: , , Leave a comment

In two weeks, on the 23rd, the UK will vote on whether to remain in the EU or leave.  Polls show that the leave forces, which were once in the minority, have pulled to just about neck and neck with the remain camp.  One caveat:  I don’t know enough about the national mood in the UK to have a view about whether citizens are likely to reveal their true intentions to pollsters, which is always an issue with controversial topics.  My sense is the leave camp is populated with the same left-behind-by-globalization people as in the rest of the world, who dream that a return to a semi-mythical isolationist past will solve all their problems.

Britain has never been in favor of the ultimate “United States of Europe” destination for the EU project, which imagines an ever-closer union to mimic, and counter, the political/economic power of the US.  Because of this, some have argued (incorrectly, in my view) that a vote to leave will be a long-term political plus.

As investors, though, our task in understanding the implications of a possible Brexit is simpler:  what are the implications of Brexit for publicly traded firms doing business in the UK?

I see two, both negative:

–over the course of the past decades, many non-EU multinationals have decided to make the UK their base of EU operations.  The UK offers a large potential workforce, English as the national language and a legal system less strongly tilted to favor locals than is the case elsewhere in the union.  Also, of course, being inside the EU frontier, the UK is not subject to the tariff and red tape barriers that outsiders might face.

A “leave” vote on Brexit eliminates this last advantage.  At the very least, a period of uncertainty would follow until new trade, travel…agreements are negotiated.  These are unlikely to make the lot of the UK better–the question is how much worst things will be.  For companies without extensive manufacturing in the UK, the best solution may be not to wait but to decamp to, say, Ireland as fast as possible.

–the UK is by a mile the financial capital of the EU.  Same reasons as for multinationals in general.  In addition, the UK pursued a “regulation lite” policy to lure financial firms to its shores in the runup to the banking collapse of almost a decade ago.  (One result of that regrettable policy is that much of the highly unethical behavior of US and foreign banks that led to the financial meltdown, and which would have been against the law elsewhere, was technically ok in the UK.)  Post-Brexit, these firms would be on the outside looking in.  New EU banking policies would determine their fate.

 

My overall guess is that the UK leaving the EU would be bad economically for both sides–although the effect might well be lost in the general malaise (aging populations, generally weak government finances, hometown-favoring legal systems) that characterizes the EU today.  Subsequent action by EU policy makers to favor, or not, exports from the UK (which make up almost half of Britain’s total exports) will determine how badly UK-based multinationals will be hurt.  In the meantime, absent large falls in their stock prices (my guess is that 10% declines, a figure I plucked out of the air, will be the norm), I don’t imagine the firms in question will be drawing much favorable investor interest.

Grexit a 50/50 possibility…

March 24, 2015 By in economics, EU financial crisis, Greece Tags: , , , , , , , Leave a comment

…according to financier George Soros.

Personally, I have a hard time dealing with Mr. Soros’s Donald Trump-ish nature.  In his book The Alchemy of Finance, for example, he claims to have invented the thesis-anti-thesis-synthesis explanatory pattern that was introduced to European thought by Hegel in 1807 and developed by Marx later in that century.  Hard to believe Mr. Soros, who studied philosophy, is completely unaware of either of these seminal figures.  I’ve also thought that a significant amount of the success of his Quantum Fund was due to Soros’ less well-known partner, Jim Rogers.

If there’s one thing, George Soros knows about, however, it’s currencies and politics.  So his view that it’s a flip of a coin whether Greece stays in the EU or leaves, is well worth listening to.

The short story of Greece’s woes is that after joining the EU it racked up so much sovereign debt using the implicit repayment guarantee of being in the euro (kind of like having a credit card that can’t be maxed out) that it can’t possibly pay all of it back.  The gravity of the situation came to light several years ago when a newly installed (and now gone) government announced  the previous administration had been falsifying the country’s national economic accounts  for years.

Greece has since been negotiating for debt concessions in return for ending its spendthrift ways.  Its strategy so far has been to promise reform in return for debt relief   …but to do nothing.    This tactic seems to have recently passed its “sell by” date.  The EU and the IMF now appear to believe that the moral hazard risk of continue to accommodate Greece is worse than the potential damage to the Eurozone from expelling it.

As I see it, the ball is now clearly in Athens’ court.

For what it’s worth, I think Grexit would turn out to be a genuine tragedy for Greece, but far less damaging to the euro than is commonly believed.  Rather than giving encouragement to breakaway movements in the UK, Spain and elsewhere, I think Greece outside the EU–substantial currency depreciation, loss of access to external finance–would serve as a cautionary tale instead.    Think Argentina without the farm wealth.

My guess is that the euro would decline a bit on Grexit.  The banks might have a rocky time, too.  It’s very possible, though, that the markets would be happy just to have the situation resolved–and that any fallout would be small and short in duration.