Protectionism Is More Than a Political Statement
(Bloomberg View) -- If the only arrows in your quiver were fundamental and technical analysis, then you might look at Europe and see opportunity. Many investors apparently lack other means of investigation and have reached the conclusion that Europe is a good place to invest. They are nearsighted, failing to consider pending “events” in Europe that make it a very risky place to put money now.
The French elections begin on April 23 with 11 contenders for the presidency. However, there are really only four that matter: the independent Emmanuel Macron, center-right Republican Francois Fillon, the Communist-backed Jean-Luc Melenchon and far-right National Front candidate Marine Le Pen. The prevailing wisdom is that Le Pen will end up in the second and final round on May 7 but will be defeated by one of the centrist candidates.
I would not take this bet.
The surging candidate is presently Melenchon, who bears a great similarity to Bernie Sanders. He wishes to opt out of many European Union programs including the stability mechanism that caps a country’s borrowing capacity. He has proposed “universal disobedience” to many EU regulations.
It is not that he wants out of the EU, but he wishes to reform it, meaning that France will be far out of sync with Germany and the rest of the northern European nations. He, for example, wishes to raise the top individual tax rate to 90 percent, nationalize many of France’s corporations and immediately spend 100 billion euros ($107.6 billion) on new social programs.
The “disaster scenario” for France is that the two candidates in the May 7 runoff are Melenchon and Le Pen. Either one will stretch the EU far past what it can sustain, both politically and economically, and the result of either of these two candidates becoming the President of France will be European chaos. One way or the other way: Vive la révolution.
In Italy, the banks, according to the European Central Bank, are saddled with $385 billion of non-performing loans, which is one-third of the euro zone’s total. Three banks in Italy, including Monte dei Paschi, the world’s oldest bank, are struggling to survive, and the government is in a battle royal with the EU and the ECB concerning their restructuring.
Italy has set up several bad bank funds, but they are woefully inadequate to confront the real losses that have taken place. My view of the entire Italian banking system is that it is “bust.” The situation is a ticking time bomb and it might explode at any time given the precarious position of the outcome, for both equity and debt holders, under the EU’s rules.
The EU could bend its rules, once again, and try to stabilize the political situation in Italy, but even then the Five Star Movement, which wants to exit the EU, is likely to still be ahead in the polls. Further, it will do nothing to prevent a wholesale banking crisis that is not too far out on the time horizon.
Yet again, Greece is another crisis in progress, as the nation has a $7 billion debt payment to make in July and nowhere near the cash on hand to pay it. The official debt-to-GDP figure is 183 percent, according to EU data, but it is a nonsensical number. The ECB lends money to the Greek banks and the banks lend money to the country. This is the epicenter of the rigged scheme.
If you take the total public debt and add in the debt of Greek banks, then the total debt to GDP ratio is 302 percent, based on my calculations. One more time bomb ticking as the International Monetary Fund will not lend any new money to Greece, in my opinion, with the U.S. representatives on the IMF now reporting to the Trump administration.
It is not the size of the country that matters but the size of the debt, and a $560 billion public and bank debt load is no small figure. Since it is virtually impossible in many European countries to forgive the debt, given their political constraints, the “breakpoint” may finally be arriving. This means Greece will be leaving the EU, one way or another, and defaulting on its debts.
Now, you can hold whatever view you like on these situations. You can ascribe to the “muddle through” theory or the “kick the can” theory. But what you cannot do is pretend that there are not significant risks facing the EU. We have these three “risk situations” in progress, and then we have Brexit under way, and it is my opinion that the EU is coming apart at the seams.
Many large financial institutions are looking aghast at the U.S. Treasury market. Virtually every leading bank has been predicting a return to a 3.00 percent yield for the benchmark 10-year note, and they have all been wrong -- again. In fact, this is probably the biggest “pain trade” so far this year.
Many people blame a “short squeeze” for the recent drop in yields on Treasuries. That is only part of the reason. The other has been the flow of capital, which is headed out of Europe and into the United States. “Protectionism” is more than a political statement.
Asian money managers are exiting Europe, and the European money managers are exiting Europe, and the relative safety of the U.S. bond markets is providing a haven from European risk. This is a sound strategy, in my opinion. “Buy American, Sell American and Trade American” is where I want to be at the present time.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mark Grant is a managing director and chief strategist at Hilltop Securities.
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