EYE ON THE EU: GDP DOWN, TRADE DEFICIT UP

Not all European economies are created equal…

It now appears clear to most observers that the European recovery will lag America’s as the difference in economic resilience of the various continental economies become more apparent and the cracks in the European Union become more pronounced. GDP figures released on Friday by Germany, Europe’s largest economy posted Q4 GDP at -1.65 % year-over-year, whereas Italy’s figure, was -2.61% over the same period.

Yesterday, the Eurozone reported a trade deficit of €32.1 Billion in 2008, its biggest since the Euro’s inception ten years ago. The lack of global appetite for European exports is pronounced, in particular European carmakers have been severely hit by the credit crunch. The European Automobile Manufacturers’ Association reported that European car sales plunged 27% percent in January to the lowest level in two decades. Total December Eurozone exports fell 0.9% from a month earlier.

Politically, cross EU dialogue is heating up. Today German Finance Minister Peer Steinbrueck said euro-region countries may be forced to bail out other members of the Union that face problems refinancing their debt, despite the previous understanding that no Union member is obligated to come to the rescue of insolvent members.

While Steinbrueck didn’t mention any countries that may need a bail-out, a quick look at European bond yields helps answer this question. We’ve noted the divergence between Europe’s “most stable” country, Germany, and countries such as Spain, Portugal, and Greece, which have shown widening yields over the recent weeks. Further, Eastern Europe (in particular the Baltic countries, Hungary and Romania) has posted some of the worst GDP declines in 2008 and projected forecasts for 2009/10 as they deal with currency devaluations, the repayment of IMF loans, and major contraction due to weakening European demand for goods and services.

We continue to diagnose the European patient. Respecting that some of these points are rear view, the declining GDP figures and rising deficit numbers still confirm our bearish view of the region. We do not own anything in Europe, and we do not intend on buying anything there for the foreseeable future. At this stage of the global economic meltdown, and at these prices, we prefer being long Chinese, Brazilian, and American Equities.

Most importantly, European investors need to consider that there is tail risk here. Tail risk, after all, is what no one thinks can happen. Steinbrueck’s statement further suggests the fear, however faint, of a potential unwinding of the EU in its present form. Should Europe’s economically stronger countries need to bail out the weaker ones it will only increase Europe’s recovery lag. We continue to trade around the region (on the short side) on a country-per-country basis. We covered our short position on the UK via the etf EWU yesterday in order to capitalize on market weakness.

Matthew Hedrick
Analyst

Andrew Barber
Director

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