Positions in Europe: Short France (EWQ); Long German Bonds (BUNL)
Keith added EWQ to our Real-Time Positions at $21.58 on 10/15. EWQ’s immediate term TRADE support is $20.34 and intermediate term TREND resistance is $21.84, which is currently broken to the upside.
With regard to the trade Keith said: “Re-shorting a country that has failed in their Keynesian policies to deliver the elixir of GDP growth. France has stagflation instead.”
We’ve long had a skeptical eye on Socialist President François Hollande, beginning with his very loud “tax the rich” campaign slogan and lack of focus on reducing France's fiscal fat.
Late last month Hollande delivered on much of what he promised; the 2013 budget notables included:
- €10B of spending cuts and €20B of tax increases
- Tax of 75% on incomes over 1MM EUR
- Goal to bring the deficit down to 3% of GDP next year from a projected 4.5% this year (vs Spain 4.5%; UK 6.6%; USA 6.3%)
- +0.8% GDP growth forecast for 2013
We frankly think that both its GDP and deficit reduction targets are overly optimistic. And with public debt pushing 91% (as a % of GDP), France is above the level of 90% that economists Reinhart and Rogoff have indicated as destructive to growth.
In recent weeks France's business federation has vetted its frustrations with Hollande’s polices. The group is rightly concerned about a competitiveness drag, including from Article 6 of the new tax law, which raises the top rate of capital gains tax from 34.5% to 62.2%. For reference these levels compare with 21% in Spain, 26.4% in Germany and 28% in Britain.
Given its debt drag and the square stagflationary position the economy is in (Q2 GDP Final 0.0% Q/Q and 0.3% Y/Y and CPI registered 2.2% SEPT Y/Y vs 2.4% AUG) we expect not only growth to underperform expectations, but an upward inflection in its relatively stable and low yields (see charts below) alongside a heightened risk profile with a likely downgrade of the sovereign by another main credit agencies this year. [Currently, the Standard & Poor’s has cut France to AA+, while Moody’s and Fitch remain at AAA].
The most current data also confirms a sagging economy: French PMI Manufacturing fell to 42.7 SEPT vs 46.0 AUG and Services dampened to 45.0 SEPT vs 49.2 AUG, both below the 50 line indicating contraction. Confidence figures also remain depressed: Business Confidence (down to flat since March 2012); Consumer Confidence (down since June); and Consumer Spending has been negative (year-over-year) for the last two readings.
While Spain is taking the sovereign spotlight light in the Eurozone right now – as rumors swirl today that Madrid is considering requesting a credit line, rather than a full-scale bailout from the ESM, and may qualify for the ECB's OMT – we caution on the rising risk profile of France. We expect growth and competitiveness to take large hits under Hollande’s fist and think combined with the likely downgrade of the sovereign that credit spreads should inflect off their current lows to represent France fiscal imbalances.
Matthew Hedrick
Senior Analyst
